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Elevated scale drives profitability; cash outflow for Switch as expected

Ashok Leyland’s (AL) Q4FY23 EBITDA margin at 11% (up 214bps QoQ) was 70bps ahead of consensus estimate on strong benefit of operating leverage along with 70bps improvement in gross margin QoQ. We believe strong pricing discipline and benefits of its modular platform AVTR other than favourable commodity price movements have helped GM recover partly. Capex in FY24 would be ~Rs6-7.5bn, dedicated towards product development, capacity augmentation and debottlenecking of supply chain with limited need for capacity addition across segments. AL plans to invest Rs12bn in Switch Mobility (EV arm) from its internal accruals in FY24 to fund the capital requirements of Switch, as there has been no stake sale till now at a desirable valuation in order to help AL raise funds externally for Switch. We estimate AL’s M&HCV volume CAGR at ~6% for FY23- FY25E, with market share holding at ~32%. We cut our EBITDA estimate for FY24E/FY25E by 4%/10%, respectively, as we believe there is limited scope for EBITDAM to sustain at ~11% across FY24-25E. We downgrade AL to ADD from Buy with a revised DCF-based TP of Rs165 (earlier: Rs183), implying 12x FY25E earnings. Majority of the cut in valuation is due to an increase in cash outflow on account of investment in Switch, with limited visibility of EBITDA generation from it in the near term.

Q4FY23 result conference call takeaways and our views

* Post ~45% growth in industry level TIV, AL expects it to normalise down to ~8-12% in FY24, with Q1FY24 being soft on account of pre-buying in Q4FY23. With market share in excess of ~32% in goods M&HCV space, AL is confident of retaining it, with ever improving service network compared to market leader and customers benefitting from its AVTR platform modular trucks. With majority of trucks being bought by bulk carriers (we believe ~75-80%) as against it being equally shared with fringe truckers till FY20, AL believes, industry has leeway to see growth for a couple of years more. Market grew in excess of 45% despite elevated interest rates, rising cost of tyres and trucks and much lower discounting in FY24, signifying the underlying demand strength. We are factoring in 8% industry TIV growth in FY24E and a flat FY25E.

* Aided by strong operating leverage, AL reported ~11% EBITDAM, the highest quarterly EBITDAM in the current CV upcycle. Falling raw material prices, strong pricing discipline (~80% price hike retention), benefits of AVTR modular platform together have been helping AL improve profitability along with rising scale. We believe with steady raw material prices, continued operating leverage benefit, strong pricing discipline (~2% price hike from April in addition to BS-6 led hikes), AL would be able to deliver ~10% EBITDAM in FY24E.

* Driven by the need of funding for Switch Mobility and lack of any stake sell in it to raise funds for expansion, AL invested Rs2bn in Switch in Q4FY23 through ICD and would invest further Rs12bn in it across FY24, in order to meet the funding needs for Switch expansion and product development. Thus, over and above Rs7bn capex need for AL in FY24, it would be putting Rs12-15bn in overall investments across FY24. Though the cash outflow in FY24 would look elevated, any stake sale in Switch would help AL get back the amount invested in it other than helping AL do value unlocking, we believe. Multiple LCV launches, 9mt and 12mt buses both for domestic and export markets are planned under Switch in the quarters to come.

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