Analyst Corner: Downgrade Ashok Leyland to ‘hold’ with TP of Rs 132

Ashok Leyland’s (AL) operating performance in Q3FY21 was below consensus estimates as EBITDA margin came in at 5.3%. Gross margins eroded ~321bps QoQ to 25.6% due to high input cost pressures. Key medium-term industry monitorables economic activity and growth trends in infrastructure-led demand; used vehicle demand/pricing trends; and c) contours of scrappage policy. We estimate volume rebound at ~35% CAGR FY21E-FY23E, which we reckon will raise asset efficiencies, margins for AL leading to healthy FCF generation (~Rs 30bn cumulative FCF in FY22E 23E) assuming subdued capex intensity. Stock is up ~75% since Q2 earnings, valuations at ~15x EV EBITDA FY23E leave limited room for disappointment. Key upside risk lies in the possibility of a well-incentivised scrappage policy. Downgrade to HOLD.

Key highlights of the quarter: Topline grew 20% YoY to ~Rs48bn as volumes rose 7% YoY at 33.4k units. ASP improved ~12% YoY driven by BS-VI introduction effect. EBITDA margin contracted slightly by 33bps to 5.3% as gross margin declined 88bps YoY to 25.6% due to steep commodity price inflation. Employee expenses edged higher (by 265bps) to Rs 4.5bn as production ramped up. AL reported PAT loss of Rs 193m as AL took an exceptional charge of Rs 460m.

AL positioned to benefit from CV cycle revival. The CV segment has been in a downcycle since FY18 and, with ~70% revenue contribution from M&HCVs, AL is witnessing the start of the next upcycle with good traction in ICVs and tippers; Budget-driven infrastructure push is also expected to drive HCV demand (~35-40% CAGR FY21E-FY23E). AL, as a key player in the segment, has taken the downcycle as an opportunity to remodel its portfolio with the launch of a unique AVTR platform for trucks and bring in new LCVs (e.g. Bada Dost). The LCV launches would help AL bridge the existing product gaps (3-3.5T), increase its addressable market to ~65%. The AVTR platform would bring a superior cost structure with enhanced customer flexibility. Export push towards under-penetrated African and ASEAN markets is likely to further boost margins. Key to note Tata Motors has started to outperform AL on CV margins in the recent quarters.