>ASHOK LEYLAND: Commercial vehicle demand has been surprisingly resilient this year

Volume revival in a steady market: Commercial vehicle demand has been surprisingly resilient this year despite a considerable slowdown in the economy. Underlying indicators, mainly related to the health of financiers’ CV loans, operator profitability and freight rates, continue to be healthy. Therefore, we view this as a mid-cycle slowdown rather than the beginning of a new down-cycle, and expect the industry to grow at high single-digit/low double-digit rates in the medium term. Amid the general strength in the market, though,
Ashok Leyland's (AL) volumes have suffered largely on the back of weak demand in the southern region and production issues at its Uttaranchal plant. We see a reversal in both of these factors - demand in south seems to be bottoming out, while production rampup at Uttaranchal should accelerate in the coming months. We expect AL’s MHCV volumes to grow at 10% p.a. in FY12E-14E. Aided by mix improvement/pricing and growth in nonvehicle businesses, we forecast revenue growth of 15% p.a. over FY12E-14E.


Profitability and cash flow to improve: Weak volumes and high commodity cost pressures have impacted AL’s margins in FY12E (-c150bps YoY). Going forward, we expect operating leverage as well as benefits from its tax-exempt plant to boost margins (c160bps expansion over FY12E-14E). Balance sheet health, on the other hand, is also set to improve as the company passes the peak in capex spends/JV investments. Lastly, we also forecast an improvement in its working capital cycle, which in the past few quarters has deteriorated on account of production mismatches and weak volumes.


Valuation/Risks
Our PT of Rs37 is based on an EV of 7.5x FY13E EBITDA (typical mid-cycle multiple). AL currently trades at an EV of 6x FY13E EBITDA, below its historical average. With revenue growth of 15% p.a. and EBITDA growth of 24% p.a. over FY12E-14E, we see significant potential upside to current valuations. Moreover, we observe a strong correlation between AL’s P/B multiples and return trends. Given our expectation of improving returns (25% in FY14E vs 17% in FY12E), we expect the stock to re-rate going forward. Risks a) a sharp decline in the CV industry and b) intense competition from new players


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