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Tighter cost control aids margin

Ashok Leyland’s (AL) Q4FY21 operating performance beat consensus estimates as EBITDA margin came in at 7.6%. This was driven by driven tighter control on fixed costs, strong operating leverage even as gross margins shrunk (~248bps QoQ to 23.1%) due to high input cost pressures. Key industry monitorables: a) pace of recovery of economic activity and capex trends in key segments (e.g. infrastructure); b) used vehicle demand/pricing trends; and c) trends in freight rates. We estimate AL’s volumes to rebound at ~29% CAGR FY21-FY23E driven by M&HCV revival coupled with market share gains in LCV segments. Improved asset utilisation and rising margins is likely to aid healthy FCF generation (~Rs22bn cumulative FCF in FY22E/23E). AL remains a good proxy play to a cyclical recovery in autos. Valuations have turned reasonable (FY23: FCF yield: 6%/ EV/EBITDA: 12x). Upgrade to BUY from Hold.

Key highlights of the quarter:

Topline grew 82% YoY to ~Rs70bn as volumes rose 67% YoY at 44k units. ASP improved 9.4% YoY driven by commodity led price hikes. EBITDA margin expanded 286bps to 7.6% even as gross margin declined 581bps YoY to 23.1% due to steep commodity price inflation. Employee expenses declined (by 494bps) to Rs4bn potentially due to lower bonus provisions. AL reported PAT of Rs2.1bn.

AL well positioned to benefit from CV cycle revival:

CV segment has been in a downcycle since FY18 and AL, with ~60-70% revenue contribution from M&HCVs, is likely to benefit from the upcoming demand upcycle. GOI’s infrastructure push along with strong demand from mining sector is expected to drive HCV demand (~35-40% CAGR FY21-FY23E). AL has used the downcycle as an opportunity to remodel its portfolio towards next-gen platforms with the launch of a unique AVTR platform for trucks and bring in new LCVs (e.g. Bada Dost). The new LCV range would help AL bridge the existing product gaps (3-3.5T) and increase its addressable market to ~65-70%. The AVTR platform would bring a superior cost structure with enhanced customer flexibility. Export push towards under-penetrated African and ASEAN markets is likely to further boost growth and margins

Upgrade to BUY:

We believe H2FY22E could mark the start of a multi-year upcycle in M&HCV demand. However, we upgrade our FY22E/FY23E estimates by ~11%/14% as the CV OEM’s margins positively surprises despite cost headwinds. We value the core business at 14x (unchanged) FY23E EV/EBITDA on the improving CV cycle outlook and add Rs6/share (earlier: Rs7/share) for investments to arrive at an SoTP-based target price of Rs143 (earlier: Rs132). We upgrade the stock to BUY from Hold.

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