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Below our estimate; better mix dilutes adverse operating leverage

Demand recovery and ramp-up in LCVs and exports to drive a sharp recovery

* AL’s 1QFY22 performance was impacted by an adverse operating leverage. Its performance continues to remain weaker than peers, but it is too early to assess due to discontinuities in the market. AL remains a pure play on a CV cycle recovery, with a focus on expansion of revenue pools.

* We have downgraded our FY22E/FY23E EPS estimate by 54%/5% due to COVID-related volume cuts and RM cost inflation. We maintain our Buy rating with a TP of INR155/share (12x Mar’23E EV/EBITDA + INR11/share for NBFCs).

Favorable product mix and price hike boost gross margin

* Revenue declined by ~58% QoQ to INR29.5b in 1QFY22 (est. INR27b). It reported an operating/adjusted loss of INR1.4b/INR2.8b (est. a loss of INR0.3b/INR2.1b).

* Net realization improved by 3% QoQ (-4% YoY) to INR1.64m (est. INR1.51m), led by higher contribution from non-Vehicle sales (+10pp QoQ). Volumes declined by 59% QoQ.

* Gross margin expanded by 280bp QoQ to 25.9% (est. 25%) on the back of better mix (non-Trucks is 47% of revenue v/s 34% in 4QFY21) and higher production than sales (30-50bp benefit).

* However, higher staff costs (+5% QoQ), one-off expenses of ~INR0.4b, and operating deleverage, resulted in an operating loss of INR1.4b (est. loss of INR269m v/s profit of INR5.3b in 4QFY21).

* Net debt increased to INR41.7b (v/s INR26.1b in Mar’21) due to higher working capital. There were no ICDs outstanding as of Jun’21.

Highlights from the management commentary

* Demand outlook: While there are headwinds from higher diesel prices and supply-chain issues, CV volumes should bounce back, driven by Infra and an economic recovery. LCVs have seen a strong demand recovery on the back of e-commerce and FMCG activity. The intensity of the third COVID wave is an unknown, but higher diesel prices and financing issues will get addressed through a demand recovery.

* AL’s market share stood at 27% in 1QFY22. This is not a true reflection as it is the outcome of the mix (product and market) in markets with several discontinuities. AL’s area of strength (southern market and Buses) was the most impacted due to the lockdowns.

* Commodity cost inflation: Steel prices increased by 12-13% in 1Q, but is expected to soften in 2HFY22. It hiked prices by 2.5%/2% in 1QFY22/Jul’21 to offset the commodity cost inflation.

* The ground situation remains positive, with traction in inquiries during the last four months, especially in Aug’21.

* Warranty costs have decreased significantly in FY22 YTD, a reflection of the superior quality of vehicles.

* Capex for FY22 would be under INR7.5b, largely for maintenance and debottlenecking capacities. It might also invest in HLFL (less than INR2b).

Valuation and view

* Valuations at 24.3x/10.9x FY22E/FY23E EV/EBITDA are at an early recovery cycle. This does not fully reflect AL’s focus on adding new revenue streams and profit pools. We maintain our Buy rating with a TP of INR155/share (12x FY23E EV/EBITDA).

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