Ashok Leyland: Sudden deceleration

Ashok Leyland has lowered guidance for the year

Less than two weeks ago, Ashok Leyland had maintained its guidance for FY05, indicating a volume growth in the region of 15-20 per cent. It now expects sales growth to be lower at 10-15 per cent. So what has changed in the past couple of weeks?

For one, domestic sales declined in July. But the downward revision has more to do with the sluggish trend continuing this month. The company has said that with the peaking of oil prices and with the confusion surrounding interest rates, sentiment has been hit.

This should be true for competitor Tata Motors as well. But Tata Motors grew sales by 16 per cent in July, albeit at a lower rate compared to the June quarter.

Ashok Leyland's performance in the first four months of this fiscal reiterates the fact that it lags behind Tata Motors in terms of capitalising on an upward trend in the CV sector. Its domestic sales grew 17 per cent in the April-July period, compared to a 40 per cent growth for Tata Motors.

Ashok Leyland has been making up through higher exports, which grew three times year-on-year. Exports accounted for 13.6 per cent of volumes in the April-July period. This was mainly due to exports to Iraq, which had commenced earlier this year. A high proportion of exports will surely help when the domestic cycle turns against CV makers.

While Tata's proportion of exports in CV sales is much lower, it is diversified thanks to its presence in the passenger vehicles segment. As a result, Tata Motors continues to be a preferred play on the CV sector, despite its higher valuation.

Bond market

The bond market has seen several strong signals recently""inflation at 7.51 per cent and the rate hike of 25 basis points by the US Federal Reserve on the one hand, and the government's decision to slash the employee provident fund ( EPF) rate to 8.5 per cent on the other.

The EPF rate cut was a lifeline thrown to the market, but, as the subsequent trading has showed, it wasn't enough.

The results of the auction for the Rs 8000 crore government borrowing on August 9 was interesting, translating all these signals into market cues. The market was quite enthusiastic towards the floating rate paper 2015 although there was also Rs 2000 crore worth of 30 year government stock for sale.

The floating rate paper was auctioned at a spread of 50 basis point to the 364 day treasury bill rate. This effectively means that one year paper is available at 5.12 per cent as against 4.62 per cent last week.

The market accordingly repriced the entire yield curve ( i.e. the yield of government papers across maturities) in line with increased cut off. Consequently, the ten year benchmark paper 7.37 per cent 2014 closed on Monday at 6.50 per cent after reaching an intra day high of 6.55 per cent as against a 6.40 per cent last week.

Moreover the market is hopeful of the fact that with the increase in cut off yield translating into higher yield for the one year segment has opened up scope for hike in the short term yields. In short, the pricing of the floater has led the market to believe that a possible hike in the 7- day repo rate is round the corner.

Stocks or bonds?

Will bonds or stocks be a better investment in the next decade? Alan Jacobs, Senior Economist and Strategist at AMP Capital ($A 66 billion under management), and Investment advisor to AMP Sanmar Life Insurance Co Ltd, points out that between 1995 and 2002 the Indian market was very peculiar, because gilts offered a higher return for less risk.

With interest rates high, the total return from bonds was higher than the return from stocks. Obviously, there was little incentive to include stocks in a portfolio.

Since then, inflation has fallen and interest rates have come down, making stocks attractive. With valuations remaining the same, Jacobs forecasts the total return on Indian stocks at around 12.7 per cent for the next decade.

Real growth is assumed at 6.5 per cent, inflation at 4.5 per cent, and dividend yield at 1.7 per cent, adding up to 12.7 per cent. The return from bonds is forecast to be around the current yield on ten-year government paper. Stocks now pay for their higher risk.

Jacobs says that the dramatic change in the outlook for Indian stocks vis-a-vis bonds is similar to the UK experience.

Over the period 1970 to 1982, the total return from UK stocks and bonds was about the same""because inflation was high, interest rates high, and growth tepid. In that environment, bonds gave a high return, while returns from stocks reflected the low growth.

With structural change and deregulation, however, inflation fell, growth rates rose, and stocks rallied and bond yields fell, and the return from stocks has been much higher than the return from bonds in the UK since 1982. Something similar has happened in India, improving the medium-term outlook for Indian equities.

With contributions from Mobis Philipose and Anindita Dey