Ashok Leyland may cool off after rising 111%

Though CV cycle is set to turn & volume growth is expected to pick up in FY15, current valuations look stretched

The country’s second-largest commercial vehicle major has been faced with multiple challenges over the past two years. While the economic slowdown impacted sales of commercial vehicles, the company’s capital expenditure of Rs 6,000 crore over FY08-13 added to its debt burden. The company’s under-utilised capacities have hurt operating leverage and tilt towards light commercial vehicles (CVs) hurt volumes. The CV maker’s profitability took a huge hit both counts. With the mining industry in distress and industrial output collapsing, the outlook remained weak for the CV industry. But with the new government taking charge, the outlook for Ashok Leyland has dramatically changed. The stock has risen 53 per cent in the past month and 111 per cent over three months, in anticipation of the cycle turning.

Ashok Leyland is known to generate the superior returns when the stock is bought during a cyclical downturn. The  run-up in the stock price over the last three months makes it relatively unattractive, even though it is a top pick for most leading brokerages. ICICI Securities says while it ascribes to the view that Ashok Leyland’s performance is likely to improve on a low base, valuation multiples have run much ahead of fundamentals and are likely to cool off.  After this run-up, investors would need to be patient before the stock moves higher. CLSA expects the stock to deliver strong absolute returns as the cycle turns, although patience is needed till that happens.

Despite the stock’s up-move, some fundamental factors continue to show promise. For starters, the company is done with capital expenditure and has no further capex line up for FY15 and FY16. The company’s financial performance has also shown signs of a turnaround during the March quarter. Even as Ashok Leyland’s revenues during the March quarter fell 18 per cent year-on-year, they rose 58 per cent sequentially to Rs 3,076 crore. The company's net profit also surprised positively due to higher operating margins. During the quarter, Ashok Leyland reported operating margins of six per cent against the estimated 2.2 per cent and its operating profit. Despite rising competition in the CV space, the company has maintained its market share at 25 per cent levels in past five years.

Analysts are factoring in 15-20 per cent idle capacity among fleet operators and as a result are factoring in volume growth in tandem with GDP this fiscal. Nomura, however, is a lot more optimistic, and has raised medium/heavy commercial vehicle industry's volume growth estimates to 15 per cent in FY15 and 30 per cent for FY16. Given the low base of the past couple of years, this is not an aggressive estimate the brokerage argues.