Ashok Leyland - "Margins disappoint, cut target, maintain BUY" - LKP Research

Q3 profitability subdued as operational costs go up

Ashok Leyland (ALL)'s Q3 FY12 reported net sales of Rs28.8 bn, a growth of 29% yoy and a fall of 7% qoq. Volumes for the quarter were at 23,215 units, which was 2.5% down qoq due to sharp fall of the company's business in the South Indian markets due to policy uncertainties over there. The company lost market share in the tractor trailer side in the northern region, while the company grew by 30% in the tipper segment. At the EBITDA levels, margins came in at 7.3% due to sharp rise in employee costs and other expenses. Employee costs (9.5% of net sales) included a one-time expense of Rs160mn on account of short provisioning of bonus payment done in the earlier quarter and Rs40 mn hit taken for increase in the headcount cost at the rapidly expanding Pantnagar plant. Other expenses (9.3% of net sales) were also significantly up due to a one time Annual Maintenance Charge of Rs200mn, exchange loss of Rs150mn and the Dost launch expense of Rs70mn. Adjusting for the one-time expenses, EBITDA margins were at 8.6% for the quarter. Interest expenses came in at Rs550 mn, while tax rate was at 7% due to MAT credit and provisioning of tax done in the previous quarter.

Volumes to be close to 1 lakh units, 4-6% growth to be observed in FY 13E

With improvement in the South Indian markets seen in January, increasing demand for tippers strengthening presence in non south markets may see ALL regaining lost market share. The company expects to touch 25% market share by the end of March from current level of 21%. We believe a 23-24% market share is quite achievable viewing a gradual improvement in south Indian markets. We are expecting the company to close this year with volumes of 98,960 units and next year to post a 6% growth in line with management's expectations of 4-6%. Over and above this, accounting of sales of LCV Dost outside Tamil Nadu (currently ~70%) will provide the additional trigger to volume growth as Dost has got an encouraging response. Bus segment is a laggard and hence we expect -1% growth this year. Any contract wins on the bus side from the STUs, or revision in the JNNURM contracts may act as an upside trigger for our estimates.

Q3 margin performance pulls down yearly estimate, to improve going forward

Cost pressures on the employee costs and other expenses pulled down the adjusted EBITDA margins to 8.6%. Going forward, we believe this concern to get negated, as Dost launch expenses will get reduced and appreciation of Rupee against dollar will mitigate the currency loss incurred in Q3. Increased production from the Pantnagar facility to a targeted 4000 p.m. from March from current levels of ~2,600 p.m. will provide additional savings. Reduction in inventory levels from 9500 at the end of December to 9,000 by January end is expected to reduce further as demand improves for ALL, mainly in South India. The company had also taken a price hike of 1.2% in January which got more than offset by the higher discount of 1-2% taken in December.

However, reduction of discounts will help margins to improve going forward. In spite of these positive triggers we are reducing EBITDA margins for ALL from 10.7%/11.2% to 10.1%/10.5% for FY12E/13E on the back of weak Q3 margins and higher U truck sales which still has under recoveries associated with it.

PAT to be boosted on reduced tax rate

Reduction in interest rate with repayment of debt in line with management's expectations despite increased working capital expenses and lower tax rate helped Q3 Adj.PAT to move up to Rs1.03 mn. Tax rate in the quarter was at 7% due to MAT credit benefit taken in the quarter, however this will move slightly upwards in Q4. Nevertheless, the tax rate for the year is slated to move down close to 15% considering lower tax rate for Q3. In FY13E, we expect tax rate getting normalized at 18% after the one off aberration observed in FY 12. However, with increased production from Pantnagar facility, we still expect tax rate for FY 13E to be lesser than FY 11 level of 21%.

Outlook and valuation

In view of weak Q3 margin performance, we have reduced our margin expectations for FY 12E and FY 13E, while maintaining volume estimates. However, with improving business prospects, we are still positive on the stock, though we have pruned down our target price from Rs 33 to Rs 30(@11 times FY 13E earnings of Rs 2.75), which gives an upside of 11% from current levels.

Source : Equity Bulls

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