Ashok Leyland: Gains led by commercial vehicles

Volume growth to improve operating leverage, margins set to improve, believe analysts

After declining for consecutive years, medium and heavy commercial vehicle (MHCV) sales have started growing, though those of light commercial vehicles (LCVs) continue to decline. Ashok Leyland, the country's second largest CV maker, has reported overall volume growth of 16.7 per cent year-on-year (y-o-y) and a 6.2 per cent month-on-month growth (8,331 units). It reported 18 per cent growth in MHCVs and 14 per cent in LCVs (Dost and Stile).

The stock has moved up 140 per cent over six months and 21 per cent over the past month, on hopes of a cyclical revival in CV sales. This market is in the early stages of a revival and Leyland is in a position to benefit but analysts are concerned about the run-up in the stock and the current valuation. It is trading at 12 times its EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation, and amortisation) on March 2016 estimates, says Kotak Institutional Equities, a 33 per cent premium to historical averages and considered to be expensive. The valuations don't include the value of subsidiaries, as these are not profitable.

  The positive sentiment is driven by higher freight rates, up three to four per cent over April to August, suggesting an improvement in utilisation. Leyland has improved its market share by 440 basis points (bps) this financial year, thanks to a recovery in South India. Analysts are not sure if this can sustain. Kotak expects the company’s market share to take a hit of 200 bps over FY15-17, as competition remains strong in the segment. The industry has strong players like Bharat Benz and Eicher Volvo, which might impact its market share. Analysts expect the company's share to touch 26 per cent by FY16-17, the peak.

There is a contrarian view as well. While Kotak expects the company to be impacted by the competition, Ambit Capital expects new entrants to have a minimal impact. The brokerage claims setting up distribution for new players isn't easy and Leyland will benefit from expanding its footprint in northern and eastern India. The HCV segment is dominated by Tata Motors and Leyland, with a combined market share of 90 per cent.

Also, with volumes reviving, operating leverage would improve and boost margins. Ambit expects the company to report a rise in operating margin from 1.7 per cent in FY14 to 7.1 per cent in FY15 and 9.8 per cent in FY16. Also, sale of non-core assets and funds raised from the recent qualified institutional placement of Rs 667 crore will help reduce debt.