Ashok Leyland’s (AL) Q1FY22 operating performance was below consensus estimates as EBITDA margin dropped 1,238bps to -4.7%. Drop was largely driven by negative operating leverage even as fixed costs remained elevated on lower volumes. The earnings call focused on demand outlook: a) no new greenfield capacity planned; debottlenecking to be undertaken as demand increases; b) vehicle enquiries are rising and with the GoI’s infra push, M&HCV segment is expected to witness strong improvement in demand; and c) freight rates likely to edge higher as utilisation improves. We estimate AL’s volumes to rebound to ~31% CAGR FY21-FY23E driven by strong market share gains in LCV and M&HCV revival coupled with building of an EV-ready portfolio. AL remains a good proxy play to cyclical recovery in autos. Valuations remain reasonable (FY23E: FCF yield: 5%, EV/EBITDA: 13x). Maintain BUY.

Key takeaways from the earnings call: AL expects its key exports markets (e.g. Middle East, Bangladesh, Sri Lanka and Nepal) to gradually improve as many regions were still under covid lockdowns.

In the domestic market, demand push-back from axle load norms is likely over and demand for M&HCVs is expected to pick up on GoI’s strong infra push. Profitability of the M&HCV segment is expected to improve as production volumes ramp up.

Demand for LCVs is strong in e-commerce and white goods segments. Inquiries for tippers (38% of market) and ICVs (35%) are gradually picking up.

Company took price hikes of 2% each in Mar’21 and Jul’21. RM cost inflation for Q1 was at 12-15% for steel prices. EBITDA margin witnessed 0.5% contraction due to production being higher than sales. Improved mix tilt towards non-M&HCV segment at 48% share of sales (Q4: 65-70%) led to the dip in margins.

Outlook and valuations: We believe FY23E could start a multi-year upcycle in M&HCV demand with strong export ambitions from the new Phoenix, and AVTR platforms could boost margins to 11-12% trajectory. We value the core business at 14.5x (earlier: 14x) FY23E EV/EBITDA on the improving CV cycle outlook and add Rs 6/share for investments to arrive at an SoTP-based target price of Rs 156. Maintain BUY.