Recovery hopes drive gains for pure-play CV maker Ashok Leyland

Street expects trend to continue with valuations supporting upmove

Ashok Leyland was the biggest gainer among auto stocks on Friday rising 4 per cent stretching its returns to over 15 per cent over the past month. The stock has outperformed its peers on the back of expectations that it will be a key beneficiary of the recovery in the economy.

An analyst at a foreign brokerage says that cyclicals tend to gain the most as the economy recovers, with Ashok Leyland being ahead of the pack as it is the only pure play commercial vehicle (CV) maker. Government spending on infrastructure and fiscal expansion policy should boost demand initially in the replacement segment and later from new truck additions as recovery takes hold.

In addition to this, Mitul Shah, head of research at Reliance Securities points out that positive commentary from the managements of Bharat Forge and Tata Motors post March quarter results coupled with healthy margin performance by both companies have increased investor confidence in the CV industry. He expects Ashok Leyland to outperform going ahead with strong volumes in the medium and heavy commercial vehicles (M&HCV) and light commercial vehicles (LCV) in the second half of FY22 with improving margins.  

While a potential third wave is a key risk, the street is betting that increased vaccination and pent up demand will drive volumes as was the case last year. Though the demand was subdued earlier due to axle load norms and BSVI related rise in prices, volumes were gradually picking up led by higher freight rates and capacity utilisation.

Emkay Research’s Raghunandhan NL says that Ashok Leyland offers the best play on the commercial vehicle recovery and estimates its volumes and revenues to grow in the 42-48 per cent range in the FY21-23 period. He expects margins to expand to over 10 per cent in the next two years from under 4 per cent in FY21. The company could end FY21 with a loss of over Rs 200 crore before posting a volume-led recovery.  

While commodity costs have been weighing on margins, analysts believe that prices should cool off given the high inventory levels and sharp rise in raw material to sales ratios for manufacturing companies. Analysts at JM Financial highlight that their underweight theme on metals has counterbalanced overweight plays in sectors such as autos with their preferred picks being Maruti Suzuki, TVS and Ashok Leyland.

In the M&HCV goods segment, analysts expect the company's share to recover to over 30 per cent. Its share had slipped to 28 per cent last year due to the downturn, with the recovery bringing its portfolio skew towards heavy trucks into play.

The other trigger for the company, according to Anish Rankawat of Centrum Broking has been the strengthening of the light commercial vehicle portfolio especially the 3 tonne segment. The company launched the Bada Dost in September last year helping it to improve its market share in the LCV goods segment by 200 basis points y-o-y to 11.7 per cent last year. With the company expanding its portfolio, Rankawat expects share gains in this segment to continue while adding that LCVs bring stability during M&HCV downcycles. Driven by the ecommerce segment, the LCV segment did better than heavier trucks over the last year.

What has been supporting the stock is that valuations are at attractive levels and trading at a discount to long-term averages. The stock is trading at 11 times its FY23 enterprise value to operating profit as compared to its historical average of 16 times. Investors should await signs of volume gains and management commentary post Q4 results later this month before considering the stock.