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Ashok Leyland Ltd. (ALL) reported 36.5% YoY decline in net sales in Q2 FY20 to INR 40.2 bn. M&HCV/LCV/Total Volumes registered degrowth of 39.2%/13.9%/31.2%. Realizations declined 11% due to higher contribution of LCV segment and higher discounts. EBITDAM declined to 5.6% (down ~465 bps YoY and 21 bps QoQ) due to negative operating leverage and higher discounts, despite major cost cutting initiative that saved other expenses during the quarter. EBITDA and PAT stood at INR 2.25 bn and INR 278 mn respectively, representing de-growth of 65.3% and 92.7% respectively. We expect M&HCV segment volume to remain subdued in next couple of quarters and see a gradual recovery in 2H FY21 post implementation of BS6.
EBITDAM declined 465 bps, negative operating leverage and higher discounts outweigh lower employee expenses.
Gross margin declined 342 bps YoY. Mainly on the back of inventory clean-up resulting in higher overheads. Weaker product mix (higher share of buses sold to state transport undertakings with lower margins and lower mix of high margin higher tonnage trucks) and higher discount levels (5.25 lac/vehicle) also played spoilsport.
EBITDAM stood at 5.6% which was in line with our expectation due to surprisingly low employee cost (down 45.4% YoY and 36.9% QoQ) on the back of reversal of bonus provisioning done during previous quarters due to weak performance and reduction in employee headcount due to VRS scheme. In the near term, margin pressure is expected to persist given the weak demand environment and BSVI transition costs. Management's cost focus and benign commodity costs would alleviate the impact.
* Inventory levels (dealer + plant level) for ALL stands at around 6,500 units currently (Rs 3.1k at dealer level and remaining at plant level) as compared to 27.5k units as of June end and 18k units as of September end. Inventory levels will further come down in next 2 months due to transition to BS6 norms. The company indicated that production of fully built BS4 vehicles will continue till almost end-March. The company has started trial production of BS6 vehicles, but dispatches will primarily start from late March.
* Net debt declined to ~ INR 19 bn in the quarter (~INR 27 bn QoQ) led by improvement in WC cycle due to reduction in inventory levels.
* The company has cut capex guidance to ~INR 12-13 bn in FY20 from ~INR 18-20 bn earlier. Investments in subsidiaries will also be limited to only INR 0.8-1 bn in FY20. Maintenance Capex is expected to remain in a range of INR 4-5 bn.
* Launch of Phoenix range of LCVs have been delayed to April-May from March earlier.
* Q3 revenue mix: Domestic trucks 41%, buses 20%, exports 9%, LCVs 14%, and spares, defense and others 16%. Spares revenue has grown at 10% YoY in 9MFY20
* Export remained subdued over the past year and a half due to weak demand in ALL's traditional markets of UAE, Bangladesh, Nepal and the Middle East. The company is targeting 20% growth in export volumes in FY21 led by pick-up in markets such as Africa, Bangladesh and Sri Lanka..
Valuation & Outlook We expect CV demand to remain under pressure in Q4 FY20. However, on a high base of FY19, we expect domestic M&HCV volume to pick in H2FY21. FY22 is expected to witness further improvement in volumes as mandatory scrapping of trucks is likely to benefit CV demand. Over the long term, ALL's focus on expanding and creating new profit/revenue pools is likely to derisk the business, with the share of domestic trucks in revenue likely to shrink. Considering bottoming out in the domestic M&HCV sales volume, we value ASHLEY's standalone business at 11x FY21 EV/EBITDA and assign INR 6/sh for HLFL stake and recommend HOLD on the stock with a target of INR 83.
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