The Street seems to be betting that the government may announce incentives for scrapping old trucks. Among the biggest beneficiaries would be Ashok Leyland Ltd, as this step will translate into demand for new trucks to replace the old ones. Will this trigger a rally in the stock?
The going has been good for Leyland, the country’s second largest truck maker, in the last several months. Robust truck and bus sales and steady rise in profitability led to a 25% jump in the stock price since last July. It trades at 10.5 times the estimated earnings for fiscal year 2017, a fair price given that the positives are factored into this valuation.
In the near term, budget-related indirect sops for the auto sector may trigger a euphoric rally. But a sustained upmove for the stock will come from rising sales and market share. Ashok Leyland’s share in trucks has inched up steadily from 20% to 24% in the last couple of years, although Tata Motors Ltd remains the undisputed No. 1, with nearly twice Leyland’s share. Note that higher market share in future would be a bigger struggle, given that there are new entrants like Volvo, Bharat Benz, etc. in the fray.
The big bet for the near term is the scrapping of old trucks. Yes, this will force transporters to buy new ones. But the impact for truck makers depends on the age and type of trucks included and the nature and quantum of incentive announced, if at all.
The Street is also hopeful that any infrastructure boost by the government will, in the long run, lift demand for tippers, even as general economic recovery raises demand for commercial vehicles. If this happens, Ashok Leyland’s growth rate could continue to outpace that of the industry on account of its niche product portfolio that caters to segments across infrastructure. For the December quarter, it posted a 38% volume growth as opposed to an industry growth of about 22%.
According to Emkay Global Financial Services Ltd, unless government spending and the manufacturing sector improve significantly, fiscal year 2017 could be a pretty lacklustre year.
Sustained sales growth is important to improve profitability as only with higher production will economies of scale kick in. December quarter operating margin no doubt was 343 basis points (bps) higher at 10%. But, this came on the back of a huge fall in raw material costs too. A basis point is one hundredth of a percentage point.
From these levels, higher profitability can come mainly from higher sales. Both these factors are important for expansion in price-to-earnings multiple.
The writer does not own shares in the above-mentioned companies.