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Beats estimate; drivers in place

Ashok Leyland (AL) reported an 18% EBITDA (INR1.3bn) beat driven by better-than-expected revenue, even as gross margin remained under pressure. As part of bringing focus to its EV strategy, AL transferred its EV assets to Switch Mobility for INR2.4bn. It also transferred its Mobility-as-a-Service business to promoters for INR650mn.

We remain bullish on M&HCV demand. However, the delay in recovery impels us to cut FY22E EBITDA by 26%, while we retain the FY23 estimate. Maintain ‘BUY’ with an unchanged TP of INR178 as we roll over the valuation to Mar-23E. Our key concern for AL is loss of market share. We shall keenly watch out for improvement with demand shifting to M&HCVs, and AL’s foray in CNG.

Q2FY22: Product mix drives the show

Revenue at INR44bn (up 57% YoY, 52% QoQ) came in 8% higher than our estimate. This was driven by a favourable mix and price hikes. However, gross margin declined 260bps QoQ to 23.3% (similar to Q1) as the mix started to normalise QoQ with higher share of M&HCVs QoQ. Also commodity cost under-recovery impacted gross margins. The company has been taking price hikes for the last three quarters. Despite that, a much stronger rise in steel price restricts the ability – industry-wide – to fully pass on the cost pressure. Control over staff cost and other expenses led to an EBITDA beat of 18% versus expectation at INR1.3bn

Outlook improving; margin levers exist

Encouraging economic indicators, supportive government policies, low inventory (down almost 50% QoQ to 2200 units), diversifying product portfolio, strong export focus and well-managed debt and liquidity positions imply AL is poised to capitalise on the potential uptick in demand. Besides, unrelenting focus on efficient operations to lower breakeven should support margins, in our view. Execution of the exports strategy has been disappointing in the past. Should AL get the execution right, it will be an additional lever. Similarly, defence revenue can also be a lever in FY23.

Outlook and valuation: Play on potential upcycle; retain ‘BUY’

We like AL’s efficient manufacturing and sound balance sheet (ex-vehicle financing business). Maintain ‘BUY/SO’ with a TP of INR178 (17.5x Mar-23E EV/EBITDA and INR10/share for financing business). The stock is trading at FY23E PE of 22x.

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