In the six months up to June 2009, truck and bus maker, the Rs 5,981-crore Ashok Leyland Limited (ALL) lost market share. Although the northern and western parts of the country were bouncing back from the downturn, the Chennai-headquartered firm?s turf, the southern market, wasn?t seeing as much action. Moreover, at the time buyers seemed to be less focused on the bigger multi-axle vehicles and trailers, which are among ALL?s best-selling products. But since then, the south, ALL?s biggest market has joined the rest of the country in the industrial revival. And that has helped the firm regain most of its lost market share. ALL now has about a fourth of the Rs 30,000 crore-plus commercial vehicles (CV) market in the country. And the newly-commissioned Uttarakhand plant should help it tap markets in the eastern and northern parts of the country where it doesn?t have such a strong presence.
The Uttarakhand plant is set to roll out around 25,000 vehicles this year, putting ALL in a good position to tap increasing demand. In a move aimed at increasing sales, the auto major has set up a non-banking finance company (NBFC) Hinduja Leyland Finance?a captive financing arm. India Infoline observes that the NBFC can kick off operations across 130 centres in 16 cities and plans to expand the business to 300 centres and believes it could be a useful tool for ALL to grow market share.
The Street seems to be pricing in the good news and more. While the ALL stock had slipped to levels of Rs 46 in mid-February in line with the weak sentiment in the market, it has more than bounced back, from its early December levels of Rs 52-53 to almost Rs 57, somewhere near its 52-week high. The move is not too surprising since the stock is a play on a reviving economy. And ALL?s volumes reflect the revival in demand. In the December 2009 quarter, ALL?s revenues were up 81% year-on-year to Rs 1,820 crore on the back of a 100% growth in volumes. Operating margins, which gained from better operating leverage, moved up to 11.4%, a gain of 300 basis points year-on-year, though they were also partly driven by lower other expenditure. Of course, the strong numbers must be read in the context of the December 2008 quarter, which created huge disappointment in the wake of the global financial crisis.
But ALL?s volumes for the March 2010 quarter were up close to 140% year-on-year, despite the fact that the country?s factory output may have grown at a slightly more subdued 15.1% in February, compared with a robust 16% in January. As is well known, truck sales have a high correlation with industrial production, at 0.87, observed over the last 28 years. Some of the buying in the three months to March, industry watchers point out, could be attributed to the fact that purchases may have been advanced, given that truck prices were tipped to rise with the introduction of the new BS-III emission norms. Nevertheless, it?s been a smart bounceback. ?Yes, the recovery does seem to happening at a good clip?, agrees R Seshasayee, managing director, ALL, who confirms that freight rates, which were softening in February, are now reasonably firm, bringing good news for fleet operators.
While the economy could well grow by about 8% in 2010-11, there could be a number of bumps ahead for auto players. The rollback in excise duty cuts may not hurt demand too much, but ALL may not manage the 25% rise in volumes that it expects; analysts believe the growth in volumes could be closer to 20% with the base effect wearing off. Typically, going by the long-term average, truck sales come in at two times the industrial production. More important, automobile makers will have to negotiate higher input costs, which are already beginning to hurt. Says Seshasayee: ?With iron ore prices up sharply, clearly steel prices will be higher and prices of non-ferrous metals too are going up. That apart, with rubber prices up, we?re clearly going to be paying more for tyres too.? It?s not immediately whether truck makers will be able to pass on the higher excise duties and the higher cost of raw materials.
The excise holiday in Uttarakhand, analysts point out, could bring down costs by about Rs 50,000 per vehicle. But some of these gains, in terms of margins from the Uttarakhand plant, estimated at around 100-150 basis points, could be lost in higher costs on raw materials, if it cannot pass on the cost to customers. Of course, the top two players in the industry, Tata Motors and ALL, command 85% of the market in terms of volumes and have not found it too difficult to pass on the input cost increases. As India Infoline points out, over the past year, manufacturers have taken three price increases amounting to a total increase of 5%. With the excise duty now moving up by 2% and prices expected to go up by another 2-3% with the change in emission norms, vehicles prices would have increased by 10% in 12 months. Indeed, with the industry upgrading to better emission norms, a process that is to be completed by October, capital costs for manufacturers would certainly go up.
That is not good news for ALL?s balance sheet, which has been carrying a fair amount of debt over the past couple of years; analysts note that the company?s net debt to equity could go up to around 64% this year from about 59% last year. While that?s not too much of a concern, expenses on interest and depreciation could go up somewhat as the company will stop capitalising interest and capital expenditure once the Pantnagar factory goes on stream. Interest costs for 2010-11 are estimated at close to Rs 120 crore and may move up further in the following year. Nevertheless, with revenues for ALL estimated at close to Rs 9,200 crore, the operating profit margins for the current year (2010-11) should come in at around 10.5%. The bottom line is expected to be around
Rs 540 crore and so, the net profit margin would be just short of 6%.
The estimates could fall short of reality though, because while the environment is benign?with interest rates likely to harden, even if not at a very fast pace?fleet operators may start to feel the pinch. Already, fuel costs have risen and crude oil prices aren?t really coming off; indeed, there?s concern that crude prices may actually move up. Industry experts point out that freight rates haven?t really firmed up too much even though freight volumes picking up. That, they say, could be reflecting the overcapacity in the industry, which would need to be tracked closely since it could affect volumes for truck makers. Not surprisingly, Seshasayee is guarded in his optimism. ?Certainly some degree of tightening could happen and that could have a dampening effect on demand?, he says. ?This is an industry dependent on confidence levels and not too scientific,? he observes, adding: ?Demand can get affected if the perception changes though overall, I would say things are on track and the mood is optimistic more than gloomy,? says the managing director.
With Mahindra & Mahindra entering the truck market, the competition can only get sharper. But Seshasayee doesn?t seem to be perturbed about that. ?We?ve seen competition before. As long as we have our products in place and the distribution in shape, we should be fine,? he says.
Macquarie Securities, however, had observed in a report in February, that increasing competition could limit market share gains for the company. Of course, at the time, the southern market hadn?t fully recovered from the slowdown, but there?s little doubt that even with the economy in good shape, competition will remain keen especially since market leader Tata Motors has planned several new launches. Nevertheless, the worst is certainly over for ALL. After a couple of difficult years, its profits this year will cross the profits that it posted in 2007-08. Now, it needs to negotiate the competition.