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Free cash flows imperative for investor comfort
Ashok Leyland’s (AL) operating performance in Q2FY20 was below consensus expectations, mainly due to significant negative operating leverage and increase in competitive intensity. We remain cautious on AL due to a) rising competitive intensity (discounts rise to ~Rs 500k/vehicle), b) cyclical volume slowdown in M&HCVs owing to factors ranging from reduced economic activity to increase in system capacity due to axle load norms, c) high capex intensity as AL undertakes new projects to be future-ready amidst d) weaker outlook for profitability and free cash flows. These challenges show up in our modest earnings estimates (~-3% CAGR between FY18-FY22E). Maintain HOLD with a revised target price of Rs77 (earlier: Rs66).
* Key highlights of the quarter: Topline declined 48% YoY to Rs39.3bn with fall in volume growth of 46% YoY due to 59% decline in M&HCV volumes and ASP decline of 4.2% YoY (due to weaker product mix). EBITDA declined 72% YoY to ~Rs2.3bn with EBITDA margin at 5.8%. Gross margin improved 362bps YoY and 86bps QoQ to 31%, primarily due to lower volumes and favourable commodity prices.
* Key takeaways from concall:
a) Average discounts for Q2FY20 were ~Rs525k as against Rs425k last year,
b) company maintained its market share at 32.6% YoY as decline in M&HCV volumes were compensated by demand in LCV segment (driven by ecommerce players) and buses,
c) inventory rationalisation undertaken from 27.5k to 13.2k units in Q2FY20,
d) FY20 capex is expected to be Rs10bn-15bn (FY20 investments in subsidiaries are likely to be trimmed from Rs2.3bn to Rs1.8bn),
e) exports remained subdued due to slowdown in key markets of the Middle East region, Bangladesh, Sri Lanka and Nepal,
f) by FY21, AL plans to launch LCV Project Phoenix in 3.5-5.0MT segment and new modular platform for each segment giving customers greater flexibility in customisation of products and
g) M&HCV range certified by ARAI for BS-VI compliance.
* Near-term demand and BS-VI transition are the big twin challenges: We believe decline in volume growth in FY20 will be in double digit possibly arrested by pre-buy before BS-VI emission norms take effect from FY21 (shift to BS-VI could lead to 10- 15% prices increases). However, despite the expected volume growth, we believe discounting will be high in H2FY20 due to strong competitive pressures. We expect a volume decline of ~5% YoY in FY21E (unless a strong scrappage policy was to be implemented by the government).
* Maintain HOLD: We cut our FY20/FY21 estimates by 35%/34.6% respectively. We increase our target valuation multiple slightly for core business at 16x (earlier:15x) Sep’21E EPS and add Rs8/share for investment in HLFL to arrive at a SoTP-based target price of Rs77 (earlier: Rs66). We maintain our HOLD rating on the stock.
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