Ashok Leyland - Shifting gears...finally! - Ambit

Ashok Leyland's (AL) aggressive capex and investments in FY08-13 coupled with the industry slowdown since FY13 have led to higher debt:equity (to 1.9x as at end-September 2013) and bottom-line losses. However, with a strong cash-generating franchise, aggressive capex/investment phase behind us, and a credible management starting to deliver on its targets, AL has much better prospects going forward. We revise our TP to Rs21/share and retain our BUY stance.

Competitive position: MODERATE Changes to this position: STABLE

Aggressive capital allocation gone awry

AL's capex and investments during FY08-13 (Rs56bn) was nearly 4x the FY02-07 levels driven by: (a) rising management confidence (helped by strong demand growth in FY03-07); (b) increasing competition in CV space; (c) LCV boom; and (d) desire to shed the conservative tag. However, some investments (Hinduja Foundries, Hinduja Energy) remain questionable. The aggressive capex/investment (particularly with industry demand slowdown) has resulted in the net debt level increasing from 0.03x in FY08 to 1.9x in 1HFY14.

The course correction

AL's management has set a near-term strategy to bring about balance sheet improvement and help increase the profitability of the business. These involve (a) augmenting cash of Rs7.5bn-10bn which will be utilised to reduce debt; (b) breakeven reduction by 20-30% to 50-55k units; (c) improve shareholders' perception through a change in the investment holding structure subject to approval) and (d) expand the business (through new launches, step up in marketing efforts and growing exports/aftersales services).

Can AL stage a turnaround?

The double whammy of debt burden and an economic downturn has left the company's financials in poor shape. However, on the positive side, we like AL's cash-generating franchise. Whilst aggressive capex has hurt the company, we believe capex would moderate going forward. Even as our primary data sources speak positively about the new management, our take on the management is positive. We have also seen initial signs of the management delivering on their targets. We believe AL can have much better prospects from FY15 onwards.

Valuation and recommendation

Our DCF model values the core standalone CV business at Rs16/share, implying 8.0x one-year forward EBITDA, in line with its five-year average (vs last published valuation of Rs13/share). Of the total investments in various entities made by AL, we assign values to its stake in Nissan John Deere JVs and IndusInd Bank to arrive at a SOTP-based TP of Rs21/share, a 20% upside from current levels and 18% higher than our previous target price.

Source : Equity Bulls

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