Ashok Leyland: A heavy load

Rising raw material costs have dented the company’s operating margins.

The revised outlook on Ashok Leyland Ltd’s issuer rating, to negative from stable, by Fitch appears to have been prompted by the higher levels of borrowings made by the Chennai-headquartered firm. Fitch has, of course, maintained the rating at AA. An external commercial borrowing of $200 million has pushed up ALL’s total debt/operating profit ratio to 1.1 in FY08.

The truck and bus maker has fairly big plans to increase manufacturing capacity from 84,000 vehicles to 1,84,000 vehicles per annum and proposes to spend around Rs 3,700 crore between now and FY11. ALL’s results for the June 2008 quarter reflect the difficult conditions in the commercial vehicles sector.

The numbers were disappointing with escalating raw material costs denting operating margins by 150 basis points y-o-y to 8 per cent. If the top line grew at 16 per cent, to Rs 1,884 crore, it was driven more by the non-automobile businesses such as engines, spares and defence supplies.

Thus, adjusting for extraordinary items, the profit before tax was flat at Rs 108 crore. Given the challenging environment, however, the company has done fairly well to sell nearly 16,500 medium and heavy commercial vehicles (M&HCVs) between April-July 2008, an increase of 4 per cent over the previous year. There’s little doubt that sales of M&HCVs in the domestic market continue to remain sluggish; according to SIAM they were up just 5.5 per cent in April-July this year compared with the same period in 2007; in FY08, sales had dropped by about a per cent compared with the previous year. ALL, with a market share of 27.8 per cent, remains the number two player in the industry though analysts have pencilled in very modest truck volumes over the next couple of years.

While ALL may not be able to do brisk business in trucks, sales of buses may continue to do well, say industry watchers. ALL is expected to close FY09 with revenues of around Rs 8,400 crore and a net profit of close to Rs 400 crore.

At the current price of Rs 32, the stock, trades at around 10.5 times estimated FY09 earnings.