High costs stymie Leyland’s profit growth despite better realizations

High costs stymie Leyland’s profit growth despite better realizations

A disappointing December quarter for truck and bus maker Ashok Leyland Ltd raises several questions. Will it meet fiscal 2011 estimates for sales volumes and earnings? Do the results signal growth constraints for the sector?

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Market expectations were already tempered as Ashok Leyland’s sales volumes had fallen month-on-month in October and November. But, with a price hike in October, revenue grew to Rs2,227.2 crore, 22.7% higher on a year-on-year (y-o-y) basis.

Interestingly, realizations per vehicle grew on a q-o-q (quarter-on-quarter) basis by about 9.5%. But the key question is whether volumes will pick up in the last quarter.

While the management has maintained sales guidance of 95,000 vehicles for fiscal 2011, this requires sales of another 30,000 units, which seems tough given its run rate of around 7,200-7,500 units a month. The company hopes to ease supply constraints arising on account of changed emission norms. The silver lining during this quarter was the 147% jump in exports to 3,513 units. Yet, the biggest negative for the quarter was the 390 basis points (bps) y-o-y and 370 bps q-o-q drop in operating profit margin to 7.5% due to high costs. Raw material costs, although flattish on a q-o-q basis jumped 180 bps y-o-y to 73.2% of sales. One basis point is one-hundredth of a percentage point.

Employee costs also rose. Analysts say that higher sales of low-margin buses to state undertakings was another reason for poor margins.

What’s more, interest costs at 2.1% of sales, rose by three times over a year ago. “A new loan of Rs360 crore availed for capex along with greater working capital burden due to higher vehicle inventory (at 9,500 vehicles) were the main reasons," said K. Sridharan, director, finance, Ashok Leyland. As a result, net profit plunged 59% y-o-y and 74% q-o-q to Rs43.4 crore, about half of analysts’ expectation. The scrip at Rs60 apiece trade at 15 times estimated fiscal 2011 and 11 times fiscal 2012, which prices in future earnings growth.

Meanwhile, the market is cautious on the commercial vehicle sector. Freight rates have been flattish in the last four weeks while the index of industrial production data shows a steady monthly decline in commercial vehicle sales from 47% in June to 19% in November. Interest rate rises could add to the negative sentiment.

Graphic by Yogesh Kumar/Mint