Ashok Leyland Ltd’s shares have risen by around 13% so far this month, thanks primarily to a 25% year-on-year (y-o-y) jump in its volumes in February. Coming on the back of a 2% drop in sales in January and dismal results in the December quarter, the higher sales growth in February provided welcome relief to investors. Until end-February, the company’s shares had declined by as much as 42% from its high in November, even while the broader markets had fallen only by 15.5%.

Sales rose by 27% last month compared with the January numbers. What’s more, Ashok Leyland is confident of selling 12,000 vehicles in March. According to the management, volumes were affected between October and December due to logistics issues and component shortages, and things have turned around.

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During fiscal 2012, the company expects to clock volumes of 110,000-120,000 units. This represents a 17-28% y-o-y growth compared with this year’s estimated sales.

The higher end of the target certainly looks ambitious. Higher interest rates will drive up the costs of truck operators, which in turn will slow demand. Besides, freight rates have been flat in the past three months, which again has raised concerns about the growth in demand for commercial vehicles. Further, higher commodity costs could keep margins under pressure.

In the immediate term, margins should rise compared with the low base in the December quarter. One reason is better operating leverage due to higher volumes and a 2% price hike the company took effective January.

Ashok Leyland is also confident of reducing the inventory pile-up of the third quarter, which will also lower working capital needs and interest costs.

In the next year, margins would be aided by a rise in production at the company’s Uttarakhand plant. Ashok Leyland aims to treble production at this plant, since it enjoys excise and tax exemptions.

“A trigger for margin expansion in the longer term is the rising contribution from the tax haven Pantnagar plant (from 10% currently to around 30% by FY12e)," Antique Stock Broking Ltd said in a report.

At the current market price of Rs52, Ashok Leyland’s shares trade at about eight times estimated fiscal 2012 earnings. While this appears cheap, a further rise in valuations will depend on the consistency in the volume growth as well as the outlook on macro trends, which drive demand for commercial vehicles.

Graphic by Sandeep Bhatnagar/Mint

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