Stock Update

Ashok Leyland
Tough times ahead; downgrade to Reduce

Sector: Auto After five consecutive years of strong growth, MHCV sales of Ashok
Leyland Ltd (ALL) contracted sharply by 13% in Q1FY2020. Lower freight
Company Update demand due to a slowdown in manufacturing, consumption and lower
agricultural output impacted demand. We expect demand weakness to
Change deepen further. Moreover, a higher carrying capacity owing to changed
axle load norms and a steep rise in ownership costs due to BS-VI norms
would drag down sales over the next two years. An 8% drop in sales and
á
Reco: Reduce
a steep slide in margins due to operating deleverage, higher discounts
CMP: Rs. 85 and expiry of fiscal incentives would lead to a sharp 26% drop in earnings
á in the next two years. Hence, we downgrade the stock to “Reduce” from
Price Target: Rs. 76 “Hold”. Our PT stands at Rs. 76.
á Upgrade
á MHCV demand weakness to deepen: For ALL, MHCV demand has been
á á

No change Downgrade
under pressure, with sales volumes declining by 13% in Q1FY2020. A
slowdown in the manufacturing and consumption sectors affected freight
Company details demand. Lower agricultural output has also reduced freight. Moreover,
the CV industry is also facing a capacity increase due to revised axle
Market cap: Rs. 24,996 cr
load norms that have increased truck carrying limits. The advent of BS-
VI emission norms from the FY2021 would drive up ownership cost by
52-week high/low: Rs. 137 / 78
10%, which would further dampen the demand. We expect the demand
NSE volume: (No of
weakness to deepen further and volumes to drop by 8% CAGR during
shares)
2.26 cr FY2019-2021 period, as against a 9% growth in FY2019.
Margins to shrink severely: The company’s margins are expected to fall
BSE code: 500477 sharply by 280 bps y-o-y in the the next two years. Operating deleverage
due to a decline in volumes would impact margins. Moreover, the industry
NSE code: ASHOKLEY is likely to see a rise in discounts as demand declines and players try to
protect their market shares. Moreover, expiry of fiscal incentives for the
Sharekhan code: ASHOKLEY Pantnagar plant is likely to weigh on margins.
Free float: (No of Our Call
143.5 cr
shares)
Valuation: Earnings to shrink 26% in two years; downgrade to Reduce:
Domestic MHCV demand has dropped sharply by 13% in Q1FY2020 and
Shareholding (%) is unlikely to recover owing to weak freight demand. Weak demand and
higher capacity due to axle load norms would continue to drag volumes.
Promoters 51.1 Steep cost increases post BS-VI emission norms are likely to aggravate
Institutions 10.0 demand woes. Margins are expected to drop due to operating deleverage,
higher discounts and expiry of Pantnagar plant incentives. We have
Corporate Bodies 3.8
reduced our FY2020 and FY2021 earnings estimates by 16% and 36%
Foreign 20.9 respectively. We downgrade ALL to “Reduce” from “Hold”. Our PT stands
Public and Others 14.2
at Rs 76.
Key Risks
Price chart Announcement of scrappage policy for trucks can stimulate demand;
140
volume recovery would boost margins and profitability and is a key risk
130
to our call.
120

110

100

90 Valuation Rs cr
80 Particulars FY17 FY18 FY19 FY20E FY21E
70
Net sales 20,140.1 26,356.4 29,055.0 27,675.9 27,395.5
Jul-18

Nov-18

Jul-19
Mar-19

Growth (%) 6.4% 30.9% 10.2% -4.7% -1.0%

EBIDTA 2,202.6 2,963.5 3,135.8 2,616.3 2,193.7
OPM (%) 10.9% 11.2% 10.8% 9.5% 8.0%
Price performance
PAT 1,558.6 1,746.2 2,040.7 1,399.5 1,077.1
(%) 1m 3m 6m 12m Growth (%) 30.8% 12.0% 16.9% -31.4% -23.0%
FD EPS (Rs) 5.3 6.0 7.0 4.8 3.7
Absolute -6.5 -7.4 -10.7 -36.7 P/E (x) 15.9 14.2 12.2 17.7 23.1
P/BV (x) 4.1 3.5 2.9 2.6 2.4
Relative to EV/EBITDA (x) 11.5 8.2 7.9 8.9 10.6
-3.8 -7.7 -16.9 -41.2
Sensex RoCE (%) 21.6 28.0 25.7 18.2 12.9
RoE (%) 25.4 24.4 23.9 14.8 10.6
Sharekhan Research, Bloomberg
Source: Company; Sharekhan estimates

July 11, 2019 2

 Stock Update
MHCV sales slide in Q1FY2020; demand to weaken further: Ashok Leyland (ALL) MHCV volumes dropped
sharply 13% in Q1FY2019. A slowdown in GDP and IIP growth led to a fall in freight availability, thereby
affecting demand for new trucks. Weakening manufacturing output and consumption is affecting freight
generation. Moreover, freight availability from the agricultural sector has declined. Besides a slowdown,
the truck industry has witnessed a rise in capacity owing to the revised axle-load norms that took effect
from September 2018. These norms have increased carrying capacity by 15-20%. A demand slowdown and
increased capacity has put pressure on freight rates thereby dampening demand for new trucks. We expect
demand to weaken further. Moreover, ALL currently has inventory of about seven weeks (against norm of 2-3
weeks), which points to weak sales in the near term.

IIP, GDP growth slowdown MHCV volumes expected to be severley impacted

10 7 140,000 25

9 6 120,000 20
5 15
8 100,000
4 10
7 80,000
3 5
6 60,000
2 0
5 1 40,000
-5
4 0 20,000 -10
Q1 FY18

Q2 FY18

Q3 FY18

Q4 FY18

Q1 FY19

Q2 FY19

Q3 FY19

Q4 FY19

0 -15
FY17 FY18 FY19 FY20E FY21E

GDP Grth % LHS IIP Grth (%) RHS MHCV Volumes (nos - LHS) Growth (% - RHS)

Source: MOSPI Source: Company, Sharekhan estimates

BS-VI pre-buying unlikely; absence of scrappage policy disappointing; demand woes to aggravate in
FY2021: Commercial vehicles would move from BS-IV emission norms to BS-VI emission norms from April
01, 2020 and are likely to witness a cost increase of about 10%. The industry is hopeful of pre-buying of
BS4 trucks in Q4FY2020 (ahead of the switchover to BS-6 norms). But given the weak freight demand and
capacity increase due to axle-load norms, truck utilisation rates have fallen and fleet owners are postponing
purchases. Therefore, we do not expect any pre-buying activity and expect sales to remain under pressure.
Further, the MHCV industry was expecting announcement of scrappage policy (incentives on new trucks for
fleet owners if they scrap old trucks ) in the Union Budget, which did not happen and thus sentiments are
expected to remain weak. With steep cost increases post introduction of the BS-VI norms, demand is likely to
worsen further. Overall, we expect MHCV demand for ALL to fall at an 8% CAGR during FY2019-2021.
OPM to plunge due to operating deleverage, increased discounts & expiry of incentives: Sales volumes
are likely to decline in the next two fiscals leading to operating deleverage which is likely to drag down
operating margins. The impact of operating deleverage is more pronounced on companies like ALL which
are pure-play MHCV manufacturers, deriving about 75% of revenue from the segment. Further, we expect
discounts to increase as demand weakens and players resort to protecting market shares. Moreover, expiry
of fiscal incentives in the Pantnagar plant from April 1, 2020 would further drag down margins of ALL. We have
factored a 280 bps y-o-y margin drop for ALL in the next two years.

Margins expected to fall steeply Sharp deterioration likely in return ratios

3,500 12 30
3,000
11 25
2,500

2,000 10 20

1,500 9 15
1,000
8 10
500

0 7 5
FY17 FY18 FY19 FY20E FY21E FY17 FY18 FY19 FY20E FY21E
EBITDA (Rs Cr - LHS) OPM (%-RHS) ROE (%) ROCE (%)
Source: Company, Sharekhan estimates Source: Company, Sharekhan estimates

July 11, 2019 3

 Stock Update
Outlook
Earnings to slump 26% in two years; downgrade to Reduce: ALL’s earnings are expected to drop sharply by 26%
y-o-y over the next two years. Weakening freight demand, due to a slowdown in manufacturing and consumption
and fall in agricultural output coupled with capacity increases due to axle-load norms would continue to dampen
demand for new trucks. Further, steep cost increases post the introduction of BS-VI norms would worsen woes
in FY2021. A steep fall in margins on account of operating deleverage, higher discounts and expiry of fiscal
incentives would affect earnings. Given the steep earnings fall, we downgrade our recommendation to “Reduce”
from “Hold” earlier.
Valuation
Cut estimates to factor volume concerns; Downgrade to reduce with PT of Rs 76: Domestic MHCV demand has
plunged 13% in Q1FY2020 and is unlikely to recover given weak freight demand. Moreover, higher inventories
and advent of BS6 norms would further dampen demand. A fall in volumes and expiry of incentives at the
Pantnagar plant would impact margins. We have reduced our FY2020 and FY2021 earnings estimates by 16%
and 36% respectively. We downgrade our recommendation on ALL to Reduce with PT of Rs 76.

One year forward EV/EBIDTA (x) band

Source: Sharekhan Research

July 11, 2019 4

 Stock Update
About company
Ashok Leyland (ALL) is the flagship company of the Hinduja Group and is the second-largest domestic
manufacturer of medium and heavy commercial vehicles (MHCVs). ALL derives 70% of volumes from MHCV
segment, while light commercial vehicles (LCVs) form the balance 30%. ALL is the market leader for MHCV
buses with a market share of 41%, while it is the second-largest player in MHCV trucks having a market share
of 33%. Domestic revenue contributes 87% of the revenues while exports contribute the balance 13%.

Investment theme
Ashok Leyland’s fortunes are linked to that of the MHCV industry. The effect of revised axle load norms,
weakening demand and absence of any announcement on the scrappage scheme for CV industry in FY2019-
20 budget is likely to weigh hard on demand for trucks. Slow economic growth, elevated channel stocks
would reduce the probability of a likely revival in demand due to pre-buying ahead of the introduction of
BS-VI norms. Given weak demand, we expect ALL’s earnings to be under stress with a strong probability of
further downgrades.

Key Risks

ŠŠ ALL is a pure CV play, with MHCVs constituting ~75% of revenues. The MHCV industry is cyclical and exposes
ALL to the volatility of the industry cycles.
ŠŠ Trend of persistent higher discounts in the MHCV segment to defend market share would affect industry
margins.
ŠŠ Adverse regulations such as axle-load norms to impact truck demand

Additional Data
Key management personnel
Mr Dhiraj Hinduja Chairman
Gopal Mahadevan Chief Financial Officer
Nitin Seth Chief Operating Officer
N Ramanathan Company Secretary
Source: Company Annual Report

Top 10 shareholders
Sr. No. Holder Name Holding (%)
1 Hinduja Automotive Ltd 34.73
2 Hinduja Bank Switzerland 4.94
3 JP Morgan Chase & Co 4.4
4 Kuwait Investment Authority 1.72
5 Government Pension Fund Global 1.63
6 Norges Bank 1.63
7 ICICI Prudential Life Insurance Company 1.5
8 Vangaurd Group Inc 1.49
9 Blackrock Inc 1.43
10 Life Insurance Corp of India 1.36
Source: Bloomberg

Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

July 11, 2019 5

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