Ashok Leyland Rating – Buy: Volumes up, but margins disappointed

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November 22, 2021 2:30 AM

Truck upcycle is a positive, mkt share loss a concern; TP up to Rs 175; FY22e EPS cut by 6%; ‘Buy’ maintained

We expect further improvement as operating leverage comes back and commodity cost pressures peak out. We expect margins to recover to 10.0/10.8/11.1% in H2FY22/FY23/FY24.We expect further improvement as operating leverage comes back and commodity cost pressures peak out. We expect margins to recover to 10.0/10.8/11.1% in H2FY22/FY23/FY24.

AL’s Q2 EBITDA grew 67% y-o-y but was 26% below JEFe on lower-than-expected margin. Truck demand is recovering fast, and we expect a big upturn ahead. AL’s truck market share has dropped 10ppt since FY18 though, raising concerns on the franchise. Rationale for sale of e-mobility service business to promoter entity is also unclear. Valuations have limited headroom with stock at 5.6x FY23e PB vs last cycle peak of 5.8x. We retain Buy, but prefer TTMT (Buy) over AL.

Margin miss in Q2: AL’s Q2 volumes rose 42% y-o-y; Ebitda grew 67% y-o-y but was 26% below JEFe due to lower-than-expected margins. Q2 ASP was flattish q-o-q but gross margins fell 260bp q-o-q on higher input costs. Ebitda margin still expanded 780bp q-o-q to 3.0% on operating leverage benefit from higher volumes; Ebitda/vehicle was up 18% y-o-y. AL reported net loss of Rs 0.8 bn. Net debt fell 25% q-o-q in Q2 but was still 19% from Q4FY21.

Trucks rising: Trucks entered a downturn in Nov-2018 and wholesales fell 56% over FY19-21. Indian economy is recovering well and Jul-Oct e-way bills, measure of road freight movement, were 23-39% above 2019. Truck retails in Sep-Oct were also 1-5% higher than 2019. We expect a big demand rebound ahead with volumes rising 40%/35%/15% y-o-y in FY22/ FY23/FY24; our FY24 volume is still 5% below FY19 peak.

Big drop in truck market share: AL gained 10ppt share in trucks from 23% in FY14 to 34% in FY18; however, its share has slipped back to 24% in H1FY22. In heavy trucks (16-ton+), AL has lost 9ppt share over FY18 to H1FY22, while in medium duty trucks, its share is down 11ppt. AL attributed these losses to (i) adverse regional mix in demand trends, and (ii) industry shifting towards CNG vehicles where it will launch new products from Q4. While the latter could drive some improvement, we are skeptical of market share recovering to past highs.

Margin improvement ahead: AL’s Ebitda margins fell from an average 11% in FY16-19 to 3.5% in FY21 and -4.7% in Q1FY22, but have started to recover now (Q2: 3%). We expect further improvement as operating leverage comes back and commodity cost pressures peak out. We expect margins to recover to 10.0/10.8/11.1% in H2FY22/FY23/FY24.

Retain Buy but prefer TTMT over AL: AL outperformed Nifty by 140% over Apr-2020 to Feb-2021, but has lagged by 7% since. We see potential for stock to go up given trucks are in an early up-cycle, but returns are likely to be moderate as the big valuation expansion has already happened. Stock is already at 5.6x FY23e PB vs last cycle peak of 5.8x, while AL market share is slipping. We cut FY22 EPS by 6%, but maintain FY23 EPS. We retain Buy with a revised target price of Rs 175 (6.0x Sep-23E PB).

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