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Entering a period of better profitability

We recently interacted with Ashok Leyland (AL) management in order to understand the company’s growth and profitability outlook. Following are the key takeaways: a) industry demand continues to be robust led by growth in inter alia infrastructure, mining and e-commerce segments; b) need for new trucks is being driven by replacement demand, ageing of fleet population and better productivity of new multi-axled trucks; c) small truckers are yet to push new truck demand with goods M&HCV market already moving closer to FY19 levels, implying that the present CV upcycle is still far from peaking out; d) with production scale of ~9k-10k M&HCVs a month, AL is currently operating at ~6% EBITDAM vs ~10% in FY17, at a comparable scale. With the lag effect of falling steel prices, gradual price hikes and improving mix, AL is looking forward to move up to >10% EBITDAM in the coming quarters; e) targeted capex is expected to be sub-Rs7bn in FY23 given that there is no need for capacity addition. Company expects to close Switch Mobility funding needs in FY23 itself. We maintain BUY on AL with a DCF-based target price of Rs180, implying 12x FY24E EV/EBITDA, keeping our estimates unchanged.

Key takeaways from our interaction with management:

* Retail demand for goods trucks is being strongly aided by infrastructure push, private capex cycle picking up, metals / mining / cement production remaining robust, and sizeable replacement demand. With FY23 goods M&HCV market volumes yet to match FY19 levels (present retail run-rate is similar to FY12 levels), the rising demand for road freight is being catered to by the ageing fleet with fleet population remaining largely static. Thus, with minimal dependence on fringe truckers and need for replacing old fleet with more efficient new trucks, AL is confident about the CV upcycle lasting till FY25. Company has recovered its goods M&HCV market share from sub-25% a year back to ~32% currently and is confident of retaining it. We are building-in goods M&HCV industry volumes of 0.36mn units for FY25E vs the earlier peak of 0.35mn units in FY19, with AL’s market share at ~31% through FY23EFY25E. Passenger bus demand staged brisk recovery in H1FY23 with equal market shares for AL, TTMT and VECV.

* At AL’s present production scale of ~9k-10k M&HCV units a month, the company is operating at ~6% EBITDAM vs ~10% levels in FY17 with comparable scale. The margin deficit is due to: 1) steep metal inflation in H1CY22, and 2) expiry of tax incentives for Uttarakhand facility (impact of Rs3.6bn p.a., ~80bps on present revenues). Pricing discipline is much better now than in the previous upcycle as it is relatively easier to retain price hikes. However, the quantum of metal inflation being much higher this time, price hikes have been effected in smaller tranches, leading to larger under-recoveries. AL has taken ~1.5% price hike in Nov’22 (~80% retention ratio) and, together with benefit of ~6-7% cut in steel price contracts w.e.f. Q3FY22, EBITDAM is expected to rise towards 10%, amidst robust production of ~10k M&HCV units a month.

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