With growth in its key segments (multi-axle vehicles and trailers) and geographies (south) picking up, Ashok Leyland Ltd has regained most of its lost market share. Additionally, the Uttarakhand plant has been commissioned in March and with expected production of 20,000 vehicles in FY11, it is likely to provide a margin benefit of 100 basis points (bps) in FY11.
The commissioning of the Uttarakhand plant and the starting of its captive financing arm should help the company gain market share in the northern and eastern markets. Ashok Leyland’s market share in the first half declined on account of slower recovery in its key geographical market (southern India) and a slower recovery in higher tonnage vehicles (trailers and multi-axle vehicles). With both these factors starting to reverse, Ashok Leyland’s market share has gone back to the previous levels of approximately 25%.
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The Uttarakhand plant, we believe, will improve the company’s ability to serve the northern and eastern markets, where its market share is relatively low. The company plans to supplement this through its non-banking finance company, Hinduja Leyland Finance Ltd, for which it has recently received approval from the Reserve Bank of India (RBI). Thanks to tax incentives at this plant, earnings before interest, tax, depreciation and amortization (Ebitda) margins on vehicles produced here will be about 500 bps higher than those produced at its other plants. This, we reckon, provides the company a margin cushion of 100 bps and 175 bps for FY11 and FY12, respectively.
In spite of the sharp increase in commodity prices, commercial vehicle (CV) manufacturers have been able to maintain their Ebitda margins at 11%-plus levels in the last two quarters. With the top two manufacturers commanding over 85% market share by volume, they have not found it difficult to pass on input cost increases. In fact, manufacturers have already taken three price increases in the last 12 months, amounting to a total 5% increase in prices. With the 2% increase in excise duty and the anticipated 2-3% increase on account of change in emission norms, vehicle prices would have increased by over 10% in 12 months.
With freight rates remaining soft in the last three months, this could be an area of concern for freight operators and could hamper CV demand.
The company aims to produce 30,000 and 50,000 units at its Uttarakhand plant in FY11 and FY12, respectively.
Ashok Leyland’s captive financing arm, Hinduja Leyland Finance, has received approvals from the RBI to commence operations covering financing of commercial vehicles and allied vehicle financing. This company is already ready to start operations in 130 centres covering 16 states, and aims to increase this to 300 centres in the next three years. The initial capital of Rs100 crore will be contributed by Ashok Leyland, Ashley Holdings Ltd and Ashley Investments Ltd. The company plans to disburse Rs850 crore in the first year of operations. We believe this could be a useful tool for Ashok Leyland to increase its market share in the domestic market.
With the weighted-average deduction on research and development going up to 200% and the income-tax benefit at the Uttarakhand plant, Ashok Leyland will be a minimum alternative tax paying company for the next two-three years. The upward revision in volume and margin estimates and the lowering of the tax rate results in a approximately 15% upgrade to our earning estimates. The stock is still trading at a reasonable price-earnings (P-E) multiple of 11.5 of its FY12 estimates, which is in line with its average P-E in the last five years. We don’t expect a material re-rating from hereon, but with a 33% earnings per share compounded annual growth rate over FY10-12, earnings growth should drive stock performance. We upgrade the stock to buy.
Graphic by Yogesh Kumar/Mint