As Ashok Leyland earns profits mainly from trucks, the positive impact of replacement demand will be significant
Given Leyland’s revenue and profits accrue mainly from trucks, the positive impact of replacement demand would be significant
Even after some profit booking on Wednesday, Ashok Leyland Ltd’s shares were up 20% in a week, beating the Nifty Auto and Nifty 100 indices, which rose by 8% and 7%, respectively.
While the cut in corporate tax rate, which is expected to boost Leyland’s earnings in FY20, drove the stock price, investors are now focusing on the government’s proposed vehicle scrappage policy. Here’s why Leyland could be the biggest beneficiary.
As per the draft policy, re-registration fees for cars, two-wheelers and commercial vehicles (CVs), which are more than 15 years old, will be raised substantially. For medium and heavy CVs (trucks), where about 40% are 10-20 years old, the scrappage policy is likely to trigger replacement demand. This should help reverse the current cyclical downturn.
A Kotak Institutional Equities Research report said: “Conservatively, if we assume 20% of the population of trucks (aged 15-25 years) is scrapped, new truck demand (based on compliance of the truck operators) can increase by up to 200,000 units, which is 50% of the annual truck sales based on FY19 domestic sales volume. This could result in steep demand uptick for trucks over the next few years."
Given Leyland’s revenue and profits accrue mainly from trucks, the positive impact of replacement demand would be significant. Indeed, Tata Motors Ltd is the largest manufacturer of trucks in India. But, its revenue and profits are tied to the fortunes of its Jaguar Land Rover unit that makes luxury cars.
Be that as it may, there is lack of clarity in some key areas. For instance, after scrappage of old vehicles, how will a truck owner be incentivised to buy a new one? In developed countries, the government incentivises purchase of new trucks through tax and depreciation benefits.
The auto sector needs scrappage yards for old vehicles. Until these issues are addressed, truck sales are likely to trend lower. August sales of Leyland halved from the year-ago period. Production cuts announced in September do not offer muchhope for improvement. A report by Sharekhan Ltd forecasts Leyland’s FY20 sales volumes will drop 16% from FY19 when it grew 9%.