Accumulate Ashok Leyland - Way2Wealth

Ashok Leyland (ALL) Q1FY11 results have been below our expectations mainly on account of cost pressures on the raw material and employee cost front. But looking into 9MFY11, we take comfort from the fact that the expansion in volumes remains unchanged with ~35% YoY growth expected at 86k units in FY11. During the quarter, ALL has seen an improvement in market share in the Southern region at ~46% after the fall it witnessed last year. The northern and western markets have also showed no signs of slowdown with the company's market share maintained at 26% and 18% respectively. The Eastern market is relatively weaker for ALL (10%) than Tata Motors as this region prefers semi forwards where ALL is not present. The company intends to maintain its market share at 27%-28% in FY11. We expect its domestic volumes to go up by 22% YoY and export volumes by 34% YoY, taking the total to 86k for FY11. However our volume estimates has an upside risk looking into the M&HCV cycle and the managements revised guidance of 89k units.

Cost pressures would continue to be overbearing with interest and depreciation on the upward trend with the commencement of its Pantnagar operations. Please note that cost increase specific to the quarter has been reasoned below. Q1FY11 has also seen the impact of high Raw Material costs with a Rs5-6/tonne increase in steel. But going forward this is expected to soften, providing a relief to the margins. In any case, ALL had undertaken a price action of 1.5% in April, which got actualized in Q1FY11, mitigating the downside in margins. Futheron it took a price action of 2.5% at the end of June 2010, which would be actualized in Q2FY11.

As the upgradation in emission norms would be implemented from October 2010, we have estimated Q2FY11E volumes higher at 30k units. This leaves us with a volume estimate of 34598 units for H2FY11, which according to us is reasonable. Changes in emission norms are expected to increase the vehicle cost by Rs40k/unit. But as the company is ramping up its production from Pantnagar, which allows a tax benefit of Rs35k/vehicle, the impact would be partially offset. It produced 800units at Pantnagar, which is expected to be ramped upto 3000 units by Q3FY11. At the same time, with a presence in the northern market, the company would have a cost saving of Rs5k-7k per vehicle with higher produce from Pantnagar to its northern counterparts. In a nutshell, the Pantnagar facility would help improve realizations as and when the production levels are ramped up.

One major risk to our volume estimates would be the capacity constraints ALL faces from its vendors in respect of fuel injection pumps and tyres. ALL would require 20k-30k tyres in order to achieve the 35% growth in volumes. As it has received an import license, it intends to import the same from China with partial demand met by domestic suppliers. On a positive side, the company has indicated that this issue should be resolved by August.

Our Q2FY11 estimates (given below) factors in a better quarter on the back of a higher volume expansion and easing cost pressures. The company's JV's with John Deere and Nissan are on track to commence operations from H2FY11. New launches are planned on the U-truck platform alongwith Neptune engines and next generation cab facilities, which entails a capex plan of Rs1200cr over 2 years from FY11. As the company has a cash surplus of Rs 500 cr with a net debt position of Rs2300cr, we are of the view that the company may raise equity to retire the debt which is due for repayment in FY13-FY15. At the CMP of Rs 72.3, the stock quotes at a P/E of 15.6x, its FY11E earnings of Rs 4.6. Investors may ACCUMULATE.

Source : Equity Bulls

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