Ashok Leyland , Good Long Term Buy

Brief Overview:

ALL is the second-largest commercial vehicle manufacturer in India. The Hinduja Group holds 51% stake in the company through a holding company Hinduja Automotive, UK. ALL has six manufacturing plants at four locations in India

• Ennore (Tamil Nadu)
• Hosur (Tamil Nadu)
• Alwar (Rajasthan)
• Bhandara (Maharashtra)

The company is focused on the Medium & Heavy Commercial Vehicle segment and has a significant presence in the bus segment.

In the Indian domestic market, the Ashok Leyland has about 37% of the bus market and 26% of the truck market. That puts it well behind frontrunner Tata Motors, which has about 65 per cent of all bus and truck sales.

Ashok Leyland is strongest in buses and in the medium-to heavy truck sector, where it faces stiff domestic competition from Tata, Mahindra and Eicher. It has International competition from European rivals Volvo, Daimler, Scania and MAN, Japan’s Hino and Russian maker Kamaz. Chinese maker Foton is also eyeing the Indian market.

Truck sales are regarded as a key indicator for the Indian economy because of the role they play in the construction and infrastructure sectors. India’s sales of commercial vehicles above 5 tonnes peaked at 352,000 units in 2007, before the global financial crisis saw a drop to 306,000 units in 2008 and 272,000 units last year. Expectations are high that full-year sales will top 315,000 in the 2010-11 financial year.

Recent Developments:

ALL has its own joint venture with Nissan, struck in 2008, to build a range of light commercial vehicles for cargo and passenger use. The first of these LCVs is due out in 2011 from its Hosur plant.

In July 2010, Ashok Leyland agreed to buy a 26 per cent stake in the UK bus manufacturer Optare for US$7.5 million, to gain access to the latest bus technology.

In February 2011, Ashok Leyland Defence Systems Ltd has entered into a tie up with Krauss-Maffei Wegmann GmbH and Co KG, Germany to cooperate in developing advanced defence systems.

Company is also planning to enter American market by launching its products in this segment this year with the help of US-based John Deere

Key Positives:

• Company is targeting total sales of 90,000-plus for FY2012.Projections of its vehicle output in the 2012-13 financial year ranged from 98,800 - 103,650 units.
• The company is hoping for big things from its U-Truck modular platform covering tippers and prime movers in the 16-tonne to 49-tonne range. Another 15 models are due to follow over the next 12 months and the U-Truck platform will completely replace existing platforms before the end of 2012.
• To fast-track the company’s global thrust through both organic and inorganic modes.
• Ashok Leyland already exports to South Asia and the Middle East, but is also keen to break into commercial vehicle markets in Latin America, Africa and other parts of Asia.
• Company sold 9,800 units in February, up 25 per cent from a year ago, as a rapidly growing economy spurred demand for its trucks and buses.
• Budget presents a slew of excise and customs duty concessions for the use of green technology, will benefit companies like Ashok Leyland alreadyinto green technology.
• Ashok Leyland's new vehicle manufacturing factory in the UAE, which was set up as a joint venture with the Ras Al Khaimah Investment Authority, was formally inaugurated on Dec, 2010.
• Exports in Q2FY11 grew by ~42% during the quarter backed by demand from Sri Lanka, Bangladesh and Saudi Arabia.

Key Negatives:

• A proposal seeking Rs 1.35 crore as damages from Ashok Leyland will come up before the BEST committee by February 15.
• Ashok Leyland Oct-Dec net drops 59 per cent. In Q3FY11, Revenue was down 18% QoQ on 25% dip in volumes ; EBITDA margin down 390bps YoY, 380bps QoQ
• Net average realisation was flat in Q2FY11 due to the increase in excise dutyand change in product mix.
• Interest cost triplingto Rs475 mn in Q3FY11 vs. Rs162 mn in Q3FY10.
• Margins during the quarter Q3FY11 were impacted due to a onetime charge of Rs26 Cr on account of bonus payments for FY10.
• Gross debt as on December 2010 stood at Rs30 bn(including cash credits), with long term loans of Rs26 bn and working capital loans of Rs4 bn. The company plans to bring down debt to Rs26 bn by March 2011

Recommendation:

Mid Term View: (4-6 Months) >> Accumulate Cmp :53 Target:65

• Truck sales is on an upturn from the lows of 2008 (306K units) and 2009 (272K units). With the Govts thrust on infrastructure sector, Ashok Leyland will be a key beneficiary going forward.
• Also the new plant coming up at Pantnagar will help the company generate better margins in FY2012.
• The stock price has corrected significantly after Q3 results to a low of Rs 45. With EPS(TTM) at Rs 4 and CMP at Rs 53, the stock is trading at an attractive valuation of P/E = 13. Maintain a hold for the medium term with target of Rs 65 (13.5X EPS year ending Q2FY12 at 4.8), upside potential of 22% from current levels.

Long Term View: (9-12 Months) >> BUY Cmp :53 Target:79

• Company has cap-ex lined up in the tune of 700 Cr for FY11 and 500 Cr for FY12. Major spend will be towards manufacturing of Neptune engines, next generation cabs, joint venture with Nissan.
• Another 800 Cr is marked as investments in Joint Ventures (Ashok Leyland Finance, LCV project with Nissan, and the John Deere project)
• With economic recovery company is steadily recovering market share especially in South Indian markets.
• John Deere JV will see product launch during Q1FY12, while Nissan JV will be operational in June 2011. The outlook seems positive from FY12 perspective.
• The company has been expensing all costs related to Pantnagar to P&L a/c from April 2010 onwards. The plant is expected to produce 15K units in FY11 and 35K units in FY12.
• With expected better volumes ( as seen in Feb 2011, 9.8K units) and price hike, ALL will yield better margins going forward.
• Company estimated to clock 10K per month sales in 4QFY11, totalling to 95K for FY11. Estimated EPS for FY11 is around 4.1. With increased sales estimation for FY12, together will better margin will yield healthy profit growth for FY12.
• With a P/E of 14 for FY12, the one year forward target price would be Rs 79, implying an upside potential of 49% from current market price.