Ashok Leyland: Buy

An expected revival in commercial vehicle (CV) sales, diversification into the less cyclical light commercial vehicle (LCV) segment, and promising prospects for higher tonnage vehicles make a good case for investment in the Ashok Leyland (ALL) stock. At the current market price of Rs 22, it trades at a PE of about 8.4 times its estimated earnings for FY13. Investors with a perspective of one-year and more can buy the stock.

Volumes to revive

After clocking healthy volumes in 2010-11, the CV industry has been confronted by a moderation in economic activity along with high inflation, fuel prices and interest rates in 2011-12.

For April-November 2011, CV industry volumes have grown year-on-year by about 20 per cent, compared to the 35 per cent in the previous year. However, ALL has performed worse than the industry, showing about 2 per cent shrinkage in volumes. This has been due to three reasons. One, lower demand for trucks in the southern markets, its stronghold. Demand here has been affected by elections in Tamil Nadu, the Telengana trouble and the ban on mining in Karnataka. Two, the company's absence in the LCV segment, which has boosted volume growth for the industry in this period. Three, the lull in orders for buses from the state transport undertakings (STUs), where the company has a 40 per cent market share.

Going forward, the company is poised to witness better times. Compared to the first half of the year (April- September 2011) in which ALL saw a year-on-year shrinkage in volumes almost every month, the company's volumes have picked up in October and November. Already, strong agricultural growth and stable freight rates indicate good cargo availability for trucks.

With the RBI pausing rate hikes in the recent review to revive economic growth, a pick-up in industrial activity will additionally keep volumes ticking. Besides, to diversify from its focus on the South, ALL is improving its penetration in the northern and eastern markets by setting up more dealerships and services stations. To cash-in on the increasing demand for fully-built tippers , the company is ramping up its bodybuilding capability too. .

Boost from DOST and U-Truck

Another boost to volumes is also expected from the company's entry into the LCV (goods) segment with the launch of the 1.25 tonne DOST. These LCVs, being predominantly used for last mile connectivity, are not subject to the cyclicality of the MHCVs. For example, a break-up of the 20 per cent growth achieved by the CV industry in April-November 2011 will show that volumes in the MHCV segment grew only by 9.4 per cent, while LCVs grew by a much higher 29 per cent. This implies that LCVs can act as a shield in times of a slowdown.

On the other hand, what would help improve its margins and realisations is the launch of its new U-truck platform . Currently used in the tractor-trailers and tipper vehicles, the company will benefit from the shifting demand in these segments to higher power to weight and higher tonnage vehicles

Orders for buses

Orders for buses (JNNURM scheme) has taken a beating this year, but ALL is supplying about 700 semi-low floor, fully built CNG buses to the Delhi government. While it has already won an order in September 2010 from Tamil Nadu for the supply of 2850 buses, more may be on the cards after the recent restructuring of fares in the state. in The company has also won export orders for buses from Bangladesh and Tanzania.

It hopes to become a prominent player in the international bus market too. Towards this end, it has increased its stake in the UK-based Optare, which has one of the best design and technologies for low-floor and electric buses to 75 per cent recently, from 26 per cent last year.

Financials

For the quarter ended September 2011, net sales grew by 14 per cent to Rs 3,095 crore, while net profits dropped by about 8 per cent to Rs 154 crore, mainly due to higher interest ( on working capital) and depreciation costs .

The company plans to prune working capital by about Rs 400-450 crore by reducing production inventory, cutting down on loans and advances and realising the dues from STUs.

Operating margins came in at about 10.7 per cent. With material costs cooling off and price increases effected in November, the company expects to maintain margins in the second half year.

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