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Speed bump ahead
Ashok Leyland’s turnaround was historic. But now, with macro headwind, policy changes and a drop in market share, can it sustain its run?

Prathamesh Mulye

Frontline: A commercial vehicle being assembled at Ashok Leyland’s Ennore plant

Since 2014, Ashok Leyland has scripted one of the best turnaround stories in the history of India Inc. A couple of years before that, it was caught in quick sand. There was a slowdown in the mining industry, which led to a fall in demand for heavy vehicles such as trucks, which in turn led to unsold stock and investor panic. The management took hard decisions — including downsizing and moving out of its non-core businesses — and, buffeted by recovery in infrastructure and agriculture, Leyland saw remarkable improvement over the next three years.

Its market share had risen to 34% in FY18 from 27% in FY15. Ebitda margin rose to 10.4%, from 3.51% in FY15, led by sales growth of 23.61% annually during the period. (see: Top speed). As the transformation continued, investors turned bullish on the stock, which continued to rally. On May 8, the shares of Ashok Leyland were at its record high of 167 with the company commanding a market cap of 485 billion. 

The company’s first quarter results of FY19 were also heartening. Revenue was up 47% (YoY) to 62.5 billion driven by a hike in sales volumes of medium and heavy commercial vehicles (M&HCV) of 10 to above 16 tonne gross vehicle weight (GVW) and light commercial vehicle (LCV) of eight to 10 tonne GVW. The former grew by 54% to 30,647 and the latter, 33% to 11,481. Raw material costs had shot up — by 68% to 47.53 billion — but Ebitda had doubled from 3.03 billion in June 2017 to 6.41 billion in June 2018. 

Then again, Leyland’s performance continued to look good in the September quarter, having delivered a 24.58% (YoY) growth in net sales and 37% rise in PAT, but failed to match investor expectations. 

Analysts were expecting the margins to be above 11%, but competitive pressure and discounting impacted the EBITDA margins which expanded only marginally. Going ahead too, analysts believe that margins will at best remain flat due to rising cost and competitive intensity.  Additionally, the worry is also that its robust sales growth, which stood at 32%, significantly higher than the industry average of 26% in the September quarter, will taper off  in the short term due to hike in fuel prices. 

Despite correcting, the brent crude price is still at $67 as of November 19. And diesel prices have increased 25% compared with a year-ago. Historical trend suggests that diesel price hike and sales have a strong inverse relation, which means demand may be impacted if the situation does not reverse soon enough.  

Adding to near-term uncertainty, Vinod Dasari, chief executive and managing director, who is the mastermind behind turning around the company, will relinquish his post in March 2019. 

Notwithstanding its stellar performance so far, Leyland’s woes are one too many, and the stock has been reflecting this changed sentiment since its record high in May. In seven months from May 8 to November, the stock has dived 35 per cent, with 171.14 billion in market cap going up in the smoke. 

Heavy sinker

On July 16, came the first big blow for the stock, when the Ministry of Road Transport & Highways increased the rated load-carrying capacity of M&HCVs — vehicles above 16 tonnes — by 14-17%, bringing it in line with global norms. According to a Motilal Oswal Securities report of July, overloading is rampant on inter-state highways — as high as 50-60%. This move partially formalises the rampant overloading practice in certain states. 

For Ashok Leyland, which holds a market share of 30% in the segment, CVs contribute 66% to its sales, this norm was seen as a potential threat to earnings. Unlike its rivals Tata Motors and Eicher Motors, the company derives its profit chiefly from M&HCVs. 

While the new axle norms are expected to have minimum impact on Ashok Leyland’s sales, analysts believe the new policy could lead to higher production cost. “The increase in payload will lead to redefining of the axle. It can affect other components as well. The impact will be large and there will be an increase in manufacturing cost,” says Chandel. 

Ashok Leyland’s management, however, remains unfazed. “Around 60-65% of our vehicles won’t be impacted since they are volumetric — oil tankers, haulage, scooter or car carriers and white goods. These are used for transporting volume load and not a dense load,” says Anuj Kathuria, president, global trucks, Ashok Leyland. The weight of the consignment or any increase in it, therefore, has little play on their fortune, he claims.

At least, the numbers favour Ashok Leyland in the near term. Sales have grown at 20-30% each month between May and October, and the management attributes it to pick up in economic growth. “For the past six months, infrastructure has been a major growth driver. There is improved demand for road-construction projects. With this, the movement of cement increases and this raises demand for multi-axle vehicles,” says Kathuria. Overall, though, the big picture hardly looks pretty. 

Headwind

Ritika Mankar Mukherjee Director, Ambit CapitalThe macro fundamentals of the economy have been erratic this fiscal after growing at a moderate pace over the past five years. Growth in industrial production slipped to 4.5% in September, from 7% in June. Over the next two years, the Indian economy is set for a roller-coaster ride, believes Ritika Mankar Mukherjee, director and senior economist, Ambit Capital. While she expects GDP growth to accelerate in the current fiscal, in FY20 she expects the trend to reverse. That’s because the new government will invariably cut back on revenue expenditure, after the pump priming ahead of general elections. Growth this fiscal will be driven mainly by higher consumption growth and higher government support. “Investment growth rates are likely to remain mediocre as capacity utilisation numbers are yet to rise meaningfully in a range of sectors. Plus, rising cost of capital due to the tight liquidity conditions will also be a dampener,” says Mukherjee.

CV industry volumes are highly correlated with industrial activity, agriculture GDP and investment cycle. All three do not look too good in the coming quarters. Along with the macro headwinds, Indian Railway’s dedicated freight corridor is also likely to be commissioned in parts over the next couple of years, which would impact demand for trucks.

Thus, in July, CLSA had downgraded Ashok Leyland to ‘sell’ with a view that the sector’s demand outlook is clouded, given the industry is in the fifth year of up-cycle. “We cut FY19-20 earnings per share (EPS) by 8-11% despite factoring in pre-buying in FY20 now,” says the report which. Most of the truck upcycles (see: Turn of cycle) historically tending to last for four or five years. With CV sales having clocked 13%  growth between FY15 and FY18, a down cycle could be arriving soon. 

Additionally, Leyland is also facing the heat from rivals. Its market share has started to slip with rising competitive pressures from Tata. 

In M&HCV trucks segment, its share dropped from 34% in FY18 to 29% in Q1FY19 with Tata Motors gaining in the higher-tonnage segment (see: Changing track). Market experts say that Tata Motorsfaced problems from dealers in FY18. But the company has now adopted a three-pronged strategy to regain lost ground. “They are marketing aggressively and have created a sales portal to address issues dealers face. They have introduced a new portfolio and are offering discounts,” says Chandel. Tata Motors expects to clock 20% growth in its CV segment in FY19. The company is focusing on “fully-built” vehicles (including load bodies or the compartment where the load is stacked) in line with global practices. At present, it sells tipper trucks with load bodies. 

Close advantage

The only glimmer of hope seems to be the Supreme Court’s decision of enforcing Bharat Stage VI norms from April 1, 2020. The Bharat Stage Emission Standards (BSES) are to cut down on air pollutants emanating from vehicles. 

The previous model, BS-IV vehicles, cannot be sold after this deadline. But one can drive them. Therefore, sellers will be giving discounts and customers will line up for pre-buying. Market experts believe that majority of sales growth in this and the next financial year will come from this pre-buying spree. “Before this kind of a major regulatory change, there is a lot of pre-buying because the vehicles are at a lower price. So a lot pre-buying will happen in the last six months of FY20,” says a fund manager who holds a stake in Ashok Leyland since 2012. 

Atul Chandel###CEO, Autobei Consulting Group

Manufacturers are already selling CVs at discount, ahead of implementation of BS-VI norms, says Atul Chandel, CEO of Autobei Consulting Group. “Hence, heavy-duty trucks sector has reported better growth than the other segments,” adds Chandel. While margins might be slightly impacted due to discounts, the pre-buying will spur demand for trucks. “It’s a usual practice to offer discounts and margins might be impacted. But the CV manufacturers cover it up through maintenance costs,” says Chandel. 

It’s not just the BS-VI norms, but the company is also banking on a new warehousing model that sprung up after the Good and Services Tax (GST) implementation. Since July last year, FMCG and retail firms have started relying on the hub-and-spoke model of warehousing. That is, one central warehouse with smaller warehouses around it. Warehousing consolidation due to the removal of tax arbitrage at state-level is leading to long-distance trips for road transportation companies, and in turn spurring up demand for higher tonnage vehicles. In FY18, the company’s overall sales recorded a volume growth of 20.5% at 175,000. 

Along with bigger vehicles, companies also need smaller trucks for last mile connectivity. In FY18, Ashok Leyland’s LCVs saw a record sale of 43,441 vehicles, a 37% growth over the previous year. Demand for intermediate commercial vehicles (ICVs) also went up 80%. “In fact, the demand for vehicles of 16 tonnes is not much,” says Kathuria. Over the same period, M&HCV vehicles sales increased by 15.8% to 131,432 units. 

The company has a product mix partial to heavy vehicles, and has only a marginal presence in the smaller vehicle segment. Its market share in ICV is around 20% and in LCV is 8%. Currently, domestic LCVs account for 7% of the revenue, while trucks — the major revenue generator — contribute 66%. Buses make up 5% of the revenue.  

Jinesh Gandhi Senior VP, equity research, Motilal Oswal

That’s something the management wants to change. It is stepping up its presence in relatively weak segments such as LCVs, and school buses and expects the LCV volume to increase from nearly 32,000 vehicles to 100,000 vehicles by 2020. But whether the nascent businesses grow, remain to be seen. Chandel is not impressed, saying tongue-in-cheek, “They have been trying to diversify for 20 years.”

Besides, Leyland has been working on creating new revenue streams, de-risking its dependence on the M&HCV business. “Ashok Leyland has set up a new business vertical — customer solution — to target a higher share of the customer wallet across lifecycle in areas such as finance, spares and fuel,” says Jinesh Gandhi, senior vice president, equity research, Motilal Oswal Securities. He adds that a person who buys a truck for 2 million would also be spending 35 million over a 10-year period in operating and maintaining the truck. The company’s key focus areas now are spares (5% of sales), exports (9% of sales) and defence (3% of sales). 

Ashok Leyland claims its spare parts business grew 39% last year, the highest in its history. “We have worked with suppliers to rationalise costs and reduce variants of parts which helps in offering better value to customers. We have started selling product categories which were so far catered to by tier two or generic brands,” says Sanjeev Kumar, vice president – parts. The company is also looking at overseas market to expand its footprints. “Our focus on exports has increased. We are now exporting to more countries than before, including LHD (Left-hand drive) markets. We intend to sell one vehicle abroad for every two vehicles sold in India,” adds Gopal Mahadevan, president, finance & chief financial officer, Ashok Leyland. But then, can these really make-up for a changing macro climate?

Good times 

Ashok Leyland’s turnaround over the past three years came on the back of the recovery in infra and agricultural activity, and the strict implementation of the overload ban in a few states since November 2016. Seizing the opportunity, Ashok Leyland embarked on a transformation and profitably gained market share to 34.2% in FY18, from 27% in FY15. It increased the distribution network, met customers’ demands by introducing new trucks, buses and innovative digital solutions, and was able to absorb the fixed cost and maintain a higher base of volumes. That led to a remarkable turnaround from a loss of 2.13 billion in FY14, to a profit after tax (PAT) of 18.19 billion in FY18. From being a South India focused company, it today has a presence in the western and northern parts of India such as Uttar Pradesh, Madhya Pradesh and Haryana. Its dealership in M&HCV segment has grown 4x from 780 to 2,894 in these three years. Clearly, the company is much stronger on all counts. 

But with uncertainty over economic growth and policy changes looming large, its ability to sustain its growth trajectory is in serious question. And so is its valuation.Despite the steep fall in its price, the stock still trades at 16.75x on a one-year forward basis. It means the stock has already factored in the gains coming out of the near-term tailwinds such as the government intensifying investment ahead of elections and pre-buying due to BS-VI norms. While Ashok Leyland traded at an average 12x P/E between 2006 and 2013, its P/E multiple had improved to an average 19x in the last three years. CLSA believes the multiples will contract again given demand and market-share concerns.Even CIMB Securities believes that the company’s strong short-term demand momentum is well captured in its current rich valuation, but that risks to truck demand from rising fuel prices and political risks from the upcoming elections have not been factored in. With policy changes, economic uncertainty and a drop in market share expected to weigh on earnings, Ashok Leyland is in for a bumpy ride.

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