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Demand recovery critical, coupled with ramp-up in LCVs and exports

Ashok Leyland (AL) is the 2nd largest manufacturer of CVs in India and 3 rd/ 10th largest manufacturer of buses/trucks in the world, respectively.

Expect good recovery from lows of FY21:

AL faced challenges related to weak demand in 1QFY22. This time around, rural demand is low, but the management expects a rebound on the back of strong farm fundamentals. We expect demand recovery in CVs to sustain and gain momentum in FY22E. With recovery expected in FY22E/FY23E, on a low base of FY21, we estimate domestic M&HCV volumes to recover to FY20 levels in FY22E and exceed the peak volumes of FY19 in FY24E. LCV demand is likely to be aided by the e-commerce channel. It expects construction and infra spends by the government to drive demand for M&HCVs. The voluntary scrapping of trucks would boost CV demand, although not substantially.

Focus on creating and expanding profit/revenue pool:

AL is focused on expanding and creating new revenue and profit pools. The de-risking of the M&HCV business and expansion of nascent businesses – such as Spares (9% of FY20 sales), Exports (9%), LCVs (12%), and Defense (1%) – are key focus areas. The share of domestic trucks in revenue is, thus, likely to contract to ~55% by FY23E (v/s 68% in FY19). AL has also set up a new business vertical – Customer Solutions – targeting a higher share of the customer wallet across the product lifecycle in areas such as Finance, Spares, and Fuel.

New platforms – AVTR for M&HCV and Phoenix for LCV – to drive market share:

Unlike PVs, modular strategy is uncommon in M&HCVs globally due to the higher number of SKUs as well as deeper changes required in the normal way of doing business. This could be an important driver of market share gains for AL as it would improve the response time and is a better application fit for the customer. This, coupled with upcoming LCV launches, would expand AL’s addressable market in India (in LCV by 2x) and globally (by offering a wide range of products, from LCVs to M&HCVs).

Strategies in place to venture into EVs and expand exports:

Switch Mobility UK would be the EV division for AL. It is closely working with its British counterparts on the development of EVs. It expects EVs to be more of an urban phenomenon (buses/LCVs). Going forward, it expects bi-fuel and hydrogen cell technology to power its M&HCVs. In the case of exports, markets are yet to fully open up. It has a clear strategy to gain entry into new export markets. It would first introduce LCVs, followed by ICVs and then M&HCVs. It has partnered with big conglomerates in these markets for its dealer expansion initiatives.

Price hike to offset commodity cost inflation:

Commodity cost inflation has continued to hurt the company’s gross margin. However, it raised the prices of M&HCVs (by 2%/2%/2.5% in Oct’20/Jan’21/Apr’21) and LCVs (1.5%/1.5%/ 2%) in 2HFY21. It took a 1.5–2% price hike in 3Q and 4Q each of FY21 and a 1.5–2.5% hike in 1QFY22. While this would help reduce the loss in the gross margin, discounts remain quite high.

Valuation and view:

AL remains a pure-play on the CV cycle recovery. Unlike the previous cycles, it is on a strong footing (lean cost structure and reasonable debt) and is focused on adding new revenue/profit pools. AL’s revenue/EBITDA/PAT is estimated to post a 23%/44%/78% CAGR over FY20–23E on a low base of FY20. Valuations of 19.5x/10.4x FY22E/FY23E EV/EBITDA are at an early recovery cycle. We maintain Buy, with TP of INR156/share (12.8x FY23E EV/EBITDA).

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