Ashok Leyland gaining ground but volume uptick vital

While demand remains subdued, ongoing deleveraging measures coupled with operational gains are positives

 

The Ashok Leyland stock has gained 21 per cent through the last 10 days due to an improvement in truck rentals through the last three months, a fall in discounts in the sector and an expected recovery in demand for commercial vehicles (CVs). The company, a pure-play CV maker, unlike its other listed peers, Eicher Motor and Tata Motors, will benefit if there is a rise in demand.

Analysts such as Bhaumik Bhatia of IDBI Capital say given recent freight rental data and freight movement, especially from agriculture-related segments and the consumption space, are encouraging. As far as the CV cycle is concerned, it could be close to the bottom. Freight rentals have, on an average, risen six-eight per cent in January and an additional three-four per cent in February, across routes. Another area likely to help CV makers is the reduction in discounts, helped in part by the fall in excise duty (12 per cent to eight per cent) and the fact that these companies haven’t fully passed on the benefit. While CV volumes continue to languish, analysts believe there could be a recovery in the second half of FY15.

Ashok Leyland has sold a few non-core assets to deleverage and improve cash flows. In an April 3 report, Ashvin Shetty and Ritu Modi of Ambit Capital said, “The company has strong business prospects in the coming years, based on expectations of a cyclical recovery from the second half of FY15, the minimal impact of rising competition (new entrants), and balance-sheet deleveraging.” While things could improve for the Chennai-based CV maker, given there are no major triggers, especially on the demand front, most analysts continue to be bearish on the sector, as well as on Ashok Leyland. This is because other than the strong agri-related pick-up, there hasn’t been any major infrastructure or demand boost. For March 2014, Ashok Leyland reported a 20 per cent fall in CV sales compared to March 2013. According to Bloomberg, of the 50 analysts tracking the stock, 24 have a ‘sell’ rating, 17 have ‘hold’ and nine have a ‘buy’ rating. The consensus target price is Rs 17.23, compared with the current price of Rs 23.15.

Encouraging signs but no recovery yet
One of the indicators of demand growth is truck rentals. This barometer has been on the rise for the last three months. While some of the reasons for the rise in rentals were higher diesel prices and moderation in supply of new capacity, a rise in rural consumption and increased movement of goods, especially through the last two months, has played a key role. Most analysts believe the fall in demand is bottoming out. After interactions with financiers, fleet operators and dealers, Motilal Oswal analysts say the worst seems to be over in the sector, with the March quarter witnessing the sharpest rise in freight rate in two years. However, the extent of the CV recovery will depend on the pace of recovery in economic activity, they add. A positive aspect is after peaking in the December quarter, discount levels (on new CVs) have started to moderate and are expected to fall further. This should provide a cushion to margins for CV makers, including for Ashok Leyland.

Deleveraging gains
The company’s net debt had crossed Rs 6,000 crore in August 2013, against Rs 4,000 crore in FY13. The company plans to reduce this to Rs 5,000 crore, with a combination of non-core asset sales and reduction of working capital. Ambit Capital estimates this number is likely to fall to less than the management target (to Rs 4,830 crore), given the recent sale of IndusInd Bank shares, which fetched it Rs 240 crore. It estimates the company’s net debt to fall to Rs 4,160 crore on better cash flow, sales of non-core assets and balance IndusInd Bank shares. It also expects the earnings before interest, tax, depreciation and amortisation margin to improve from 0.7 per cent in FY14 to about 6.5 per cent in FY15, owing to higher volumes (leverage) and lower discounts.