Shifting gears

STOCKS/ ASHOK LEYLAND

It looks like a good quarter ahead for CV manufacturers. With the new Euro 111 norms coming into effect earlier than expected in April 2005, truck manufacturers may see the bulk of the demand coming in the March quarter.

Apart from numero uno Tata Motors (TM), the benefits are also expected to flow to Ashok Leyland (AL) which is the second-largest manufacturer of medium and heavy commercial vehicles (M&HCV) in India.

AL has a market-share of around 28 per cent in the domestic CV segment and a marginal presence of 1 per cent in LCVs (light commercial vehicles).

It is also a key player in the passenger bus segment with a market-share of around 50-55 per cent. CVs and passenger vehicles contributed to around 90 per cent of the company's revenues in FY04 while engines, CKD (completely knocked down) units, castings and spare parts contributed to the rest.

The company's performance has been on a mend and analysts say the ensuing pick-up in truck demand would serve as a kicker for better times ahead.

Pressure points
Rising raw material prices have been a sore point for CV manufacturers for some time now. For proof, check out the December-quarter results across the sector.

TM and AL have seen raw material costs rise 648 basis points and 252 basis points respectively as a percentage of sales, depressing operating margins.

For AL, the 50-basis-point increase in operating margins came as a relief after a 450-basis-point fall in the September quarter.

This was because the company was hit by the double whammy of rising input prices and a strike that crippled production at its Hosur plant towards the end of August.

As a result, while the topline grew at a steady rate of 11 per cent y-o-y in the September quarter, the bottomline witnessed a fall of 20 per cent.

These developments seemed to have affected the performance of the stock. The scrip slipped from the above-Rs 25 levels that it traded at before the strike and was stuck around Rs 18 for over two months from September 7, 2004 to November 17, 2004.

Counter strike
The strike had an impact on the company's September and October sales, especially since engines for its trucks and buses were manufactured at the Hosur plant.

The strike had been resolved a couple of months later as the management agreed to raise workers' wages by around Rs 3,500 per month. In return unions agreed to raise production from 154 engines a day to 240.

A section of analysts feels that the 6 per cent increase in the wage bill due to the settlement is expected to squeeze margins.

Others, however, feel that the rise in wage cost would be more than compensated by an almost 50 per cent increase in productivity in the long term.

However, in the short term, the company may feel the pinch from increasing input costs along with the cost of extra wages. A more worrying twist is that the strike had helped TM garner additional volumes in the CV segment.

Not that TM needed any encouragement in this regard. It is the undisputed leader in the CV segment with a market-share of 66.6 per cent in the M&HCV segment and its market-share has been rock steady over the years.

On the other hand AL has its stronghold in the south.

Pleasant surprise
Analysts see AL's December-quarter results, especially its efforts to expand margins, as very positive. The company's margins rose 50 basis points - thanks to cost reduction measures and a price hike in November - compared to a 111-basis-point fall in TM's operating margin.

"The growth momentum for AL looks good for the next three quarters," says S Ramnath, auto analyst at SSKI Securities.

He says analysts were unnecessarily sceptical about the growth in CV demand even in the beginning of last year and points out that if the buoyancy in the economy continues, the company will continue to reap benefits.

"Production constraints have cleared for the company. This, combined with the positive run in demand, indicates very strong sales numbers for AL," says an analyst.

Analysts expect the company to sell about 16,500 to 17,000 trucks in the next quarter, which translates into a volume growth of around 14 per cent.

The company expects a y-o-y volume growth of about 15 per cent for FY05, mainly driven by production which is expected to cross 55,000 units for the full year.

Analysts are also upbeat on the company's passenger vehicle segment which has been its forté. AL earned the tag of being a regional player as it sells more vehicles in the south.

However, this is set to change, claims the company. "AL has succeeded in increasing its marketshare in the north-east," says R Seshasayee, managing director, AL.

"We would be consolidating this position through an appropriate marketing strategy," he adds.

AL is also looking at exports and defence orders to ramp up growth. "Our marketing network in African and Middle East countries is getting revamped," says Seshasayee.

"We are increasing our presence in the defence sector by offering various application-oriented vehicles like light recovery vehicles and fire crash tenders. Together with improved product offerings in the higher end of M&HCV segment, we hope to increase our revenues by 20 per cent next year," he adds.

Besides, the company is looking at components supply to OEMs (original equipment manufacturers) across the globe to aid growth.

At Rs 23.7, the stock is trading at a P/E of around 10.8 times FY06 estimates.

"The downside from the current levels is limited, but the company's efforts at regaining lost marketshare and consistent performance in the operating margins will be the key to better valuations," says Kalpesh Parekh of ASK Raymond James Securities.