Clear signs are emerging of a slowdown and industry volumes could weaken significantly if replacement demand falters
Domestic MHCV industry volumes have declined y-o-y in June 2016 which the market considers a one-off due to strong growth in April-May 2016. We believe freight demand in the economy is weak and our channel checks suggest replacement demand is also moderating. Slowdown in the below 25-ton segment is even more steep while truck freight rates are not increasing. We downgrade Ashok Leyland to sell (from add earlier). Revise target price to Rs 85 (from Rs 110).
Early signs of slowdown in MHCV industry volumes
Domestic truck industry volumes grew 26% CAGR in the FY14-16 period; sales volumes in tonnage terms grew 35% CAGR over the same period due to stronger growth in higher tonnage segments. After two years of strong growth, we believe clear signs are emerging of a slowdown and industry volumes could weaken significantly if replacement demand falters. Growth has moderated in higher tonnage segments with 18% y-o-y growth in the below 25-ton segment in Q4FY16, flat y-o-y volumes in May 2016 and possible double-digit y-o-y decline in June as compared to 40% volume CAGR in the FY14-16 period. Freight rates on the Delhi-Mumbai route declined by 1.5% in July 2016 despite 9% increase in diesel prices since May 2016. Core IIP data is growing in low-single digits while rail freight growth has been negative in the past few months clearly indicating weak freight growth in the economy. Domestic steel prices have gone up by 10-15% q-o-q. Truck OEMs will need to increase prices by 1.5-2% to protect their margins but only Tata Motors increased prices by 1% at the end of June while Ashok Leyland has not done so yet.
We cut our earnings estimates by 11-12% over FY17-18E
We have cut our truck volume estimates by 6% over FY17-18 as we now expect the domestic truck industry to grow at 12% y-o-y in FY17 and 8% y-o-y in FY18 (versus 20%/12% y-o-y earlier). The cut in our volume estimates have led to a 70 bps cut in our Ebitda margin estimates and 11-12% cut in our EPS estimates. We have thus dropped our target price to Rs 85 (from Rs 110). We have cut our target multiple to 8.5X EV/Ebitda on FY18 estimates (versus 10X earlier).