Commercial vehicle (CV) volumes jumped 33% in FY10. This momentum is bound to continue considering the recent trends in industrial activity, rise in infrastructure focus and better finance availability. Our market share gain expectation for Ashok Leyland is based on: (i) commencement of Uttarakhand plant translating into higher share in the northern region; (ii) strong traction in the southern market; (iii) entry into newer segments; and (iv) support from Hinduja Leyland Finance for CV financing. Our assumptions factor in sales of 87,000 vehicles in FY11 and 95,000 in FY12, compared to 63,942 in FY10.
The oligopolistic nature of the domestic CV industry has allowed manufacturers including Ashok Leyland to raise product prices by 10-12% over the last 12 months. Such pricing power along with excise duty benefits from the Uttarakhand plant, gains from operating leverage and stable raw material prices, would result in resilient margin performance in the medium term. We are factoring in a 70 bps rise in margins over the next two years.
We expect Ashok Leyland to witness revenue CAGR (compound annual growth rate) of 23.6% during FY10-12E on the back of 22.2% CAGR in volumes. This, along with an expected 70 bps increase in operating margin and 200 bps lower tax rate (benefits of ramp up at Uttarakhand) would result in earnings CAGR of 36% during the same period. The stock now trades at 12.2x FY12E EPS (earnings per share) of Rs 5.9, which we feel is attractive considering the uptrend in business cycle. We re-iterate our Buy rating with a target price of Rs 83 based on 14x FY12E earnings.
We believe that the CV up-cycle is at a distance from peaking out considering historical cyclical trends. We infer this from analysing correlation of change in total CV volumes in the domestic market vs change in the index of industrial production. Over the last decade, the two parameters have seen a correlation of 65%.
Over the next couple of years, substantial investments have been planned for mining activities in the country, especially for coal and iron ore. Further, real estate investments are on a boom. Freight-generating sectors such as steel (12% YoY consumption growth), petroleum products (10% YoY higher demand), cement (strong infrastructure and realty investment to propel demand) will keep operations profitable for fleet operators.
Current market share for Ashok Leyland is lower than the peak levels achieved during the previous industry up-cycle. The company is well placed to bridge this gap based on the factors mentioned above. The company?s JV with Nissan will widen its presence in the light commercial vehicle segment, where it has a very low market share now. Further, launch of U-truck platform, designed to suit domestic and global customer requirements, will take its product profile to the next level in terms of technology.
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