Ashok Leyland - Avendus Report

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India Equity Research  Automobiles  February 23, 2012   Ashok Leyland  BUY  Target Price (INR)  41  A play on revival of MHCV growth  INITIATING COVERAGE    Last Price (INR)                   28 AL IN Bloomberg  code ASOK.BO Reuters code Avg. Vol. (3m)(mn) 6.60 Avg. Val.(3m)(INRmn) 171 30.6 / 20.0 52‐wk H/L (INR)                         18,145 Sensex MCAP (INRbn/USDbn) 74.77 / 1.52 Shareholding (%) 9/11 12/11 Promoters 38.6 38.6 MFs, FIs, Banks 15.4 15.8 FIIs 16.2 1
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  Please   refer   to   the   disclaimer   towards   the   end   of    the   document.   India   Equity   Research   Automobiles   February   23,   2012 BUY   Ashok   Leyland   Target   Price   (INR)   41   A   play   on   revival   of    MHCV   growth   INITIATING   COVERAGE   AL   is   likely   to   be   the   biggest   beneficiary   of    any   positive   development   in   domestic   MHCVs   as   it   derives   a   large   portion   of    its   total   income   from   this   segment.   FY12f    may   end   with   an   estimated   3%   fall   in   sales   volumes   of    domestic   MHCVs   for   AL.   FY13f    is   likely   to   enjoy   a   recovery   with   double ‐ digit   growth   driven   by   the   fall   in   interest   rates   and   revival   in   investment   activity   leading   to   rise   in   freight   volumes.   The   company’s   focus   on   increasing   touch   points   and   loan   disbursements   are   also   likely   to   aid   sales   volume   growth.   AL   is   also   increasing   its   exposure   to   LCVs   and   other   businesses   to   de ‐ risk   itself    from   the   cyclicality   of    domestic   MHCVs.   We   arrive   at   a   Mar13   target   price   of    INR41,   by   applying   the   mean   EV/EBITDA   multiple   of    the   previous   CV   cycle.   The   potential   upside   stands   at   46%,   assuming   valuations   revert   to   the   mean.   Initiate   with   Buy.   Risk   factors   are   the   high   exposure   to   MHCVs   and   higher   commodity   and   fuel   prices.   Domestic   MHCV   demand   likely   to   revive   by   FY13f    AL   is   a   play   on   the   domestic   MHCV   segment,   as   this   segment   is   likely   to   contribute   over   75%   of    total   income   for   the   company   over   FY12f  ‐ FY14f.   Domestic   MHCV   sales   volume   growth   is   likely   to   recover   to   10%   by   FY13f    after   an   estimated   fall   of    3%   in   FY12f,   on   account   of    a   pick   up   in   investment   activity   and   freight   availability   due   to   the   likely   reversal   in   the   interest   rate   cycle.   In   addition,   higher   loan   disbursements   and   touch   points   are   also   likely   to   aid   sales   volume   growth.   Strengthening   existing   operations   and   entering   new   businesses   To   strengthen   its   technological   capabilities,   AL   has   invested   in   companies   that   manufacture   and   supply   Euro ‐ V   emission   compliant   vehicles   to   developed   countries.   To   penetrate   the   high ‐ growing   LCV   segment,   the   company   has   launched   a   cargo   LCV   in   JV   with   Nissan   Motor   Co   (7201   JP;   NR)   in   Sep11.   We   estimate   this   JV   to   break ‐ even   by   FY14f.   To   continue   the   diversification,   AL   has   also   invested   in   new   businesses;   most   of    these   businesses   reported   losses   in   FY11.   The   company’s   share   of    earnings   from   these   businesses   is   likely   to   break ‐ even   in   FY14f.   Total   income   growth   to   settle   at   a   CAGR   of    13%   over   FY12f  ‐ FY14f    We   estimate   a   CAGR   of    13%   in   total   income   over   FY12f  ‐ FY14f    due   to   a   revival   in   domestic   MHCV   sales   volumes,   increasing   contribution   of    the   ‘Dost’   LCV   and   robust   exports.   Export   volume   growth   is   likely   to   be   strong,   at   a   CAGR   of    19%   over   FY12f  ‐ FY14f,   due   to   the   growing   acceptance   of    Indian   CVs   in   developing   countries.   Rising   sales   promotion   costs,   and   the   increasing   contribution   of    low ‐ margin   LCVs   in   the   overall   product   mix,   is   likely   to   reduce   EBITDA   margins   from   11.0%   in   FY11   to   9.8%   in   FY14f.   We   estimate   EBITDA   and   PAT   to   grow   at   a   CAGR   of    9%   over   FY12f  ‐ FY14f.   Initiate   with   a   Buy   rating   and   a   Mar13   TP   of    INR41;   upside   of    46%   We   apply   an   EV/EBITDA   multiple   of    8.6x   to   AL’s   core   business   to   arrive   at   a   fair   value   of    INR39/share.   This   multiple   is   based   on   the   mean   valuations   of    the   previous   CV   cycle.   The   likely   earnings   rebound   in   AL   over   FY13f  ‐ FY14f    on   account   of    the   recovery   in   domestic   MHCV   sales   volume   growth   provides   a   buying   opportunity.   We   have   valued   AL’s   investment   in   IndusInd   Bank   (IIB   IN,   Buy)   at   INR2/share.   Our   SOTP ‐ based   Mar13   TP   for   AL   stands   at   INR41,   which   provides   a   46%   upside.   Initiate   with   Buy.   Risk   factors   are   the   high   exposure   to   MHCVs.   Last   Price   (INR) Bloomberg   codeReuters   codeAvg.   Vol.   (3m)(mn)Avg.   Val.(3m)(INRmn)52 ‐ wk   H/L   (INR)SensexMCAP   (INRbn/USDbn) Shareholding   (%) 9/11 12/11 PromotersMFs,   FIs,   BanksFIIsPublicOthers Stock   Chart   (Relative   to   Sensex)Stock   Perfm.   (%) 1m   3m   1yr   AbsoluteRel.   to   Sensex Financials   (INRmn) 03/11 03/12f 03/13f  SalesYoY   (%)EBITDA   (%)A.PATSh   o/s   (diluted)A.EPS   (INR)YoY   (%)D/E   (x)P/E   (x)EV/E   (x)RoCE   (%)RoE   (%) Quarterly   Trends   03/11 06/11 09/11 12/11 Sales   (INRmn)PAT   (INRmn) 28   111,17715.413.916.210.519.3146,064125,99515.838.6 38.618,145   74.77   /   1.5215.610.619.42.61910.714.7 669   2,6612.2 1,541   28,798   2,6615.4 ‐ 3.013.10.116 30,946   7.88.910140.8 ‐ 70.91112.81610.05,840139.96,9665311.06,3130.72,6612.448AL   INASOK.BO6.6030.6   /   20.0171 2,982   38,285   11.88.51117 863   24,955   20242832 Feb11 Jun11 Oct11 Feb12 Ashok Leyland Sensex Rebased   Sri   Raghunandhan   N   L ,   +91   022   6684   2863   raghunandhan.nl@avendus.com     India Equity Research Ashok   Leyland   Automobiles   2   Table   of    Contents   Investment   Summary ........................................................................................................................ 3   Domestic   MHCV   demand   likely   to   recover   to   10%   by   FY13f.................................................................3   Strengthening   existing   operations   and   entering   new   businesses.........................................................3   Total   income   growth   to   settle   at   a   CAGR   of    13%   over   FY12f  ‐ FY14f......................................................3   Initiate   with   a   Buy   rating   and   a   Mar13   TP   of    INR41..............................................................................3   Domestic   MHCV   demand   likely   to   recover   to   10%   by   FY13f.............................................................5   Domestic   MHCV   sales   volumes   to   witness   a   fall   of    3%   in   FY12f............................................................5   Demand   to   revive   on   pick   up   in   investment   activity.............................................................................5   Strengthening   existing   operations   and   entering   new   businesses.....................................................7   Strengthening   financing   and   technological   capabilities........................................................................7   Partnering   Nissan   to   enter   the   high ‐ growth   cargo   LCV   segment..........................................................7   Diversifying   into   new   businesses...........................................................................................................8   Total   income   growth   to   settle   at   a   CAGR   of    13%   over   FY12f  ‐ FY14f..................................................9   Exports   to   outpace   domestic   sales   volume   growth   over   FY12f  ‐ FY14f ..................................................9   EBITDA   growth   likely   to   lag   total   income   growth..................................................................................9   Free   cash   flow   likely   to   turn   positive   by   FY13f....................................................................................10   Initiate   with   a   Buy   rating   and   a   Mar13   TP   of    INR41 ........................................................................11   Valuing   core   business   at   8.6x   EV/EBITDA............................................................................................11   SOTP   target   of    INR41;   initiate   coverage   with   a   Buy   rating..................................................................11   Risk   factors..........................................................................................................................................12   Financials   and   valuations.................................................................................................................13     India Equity Research Ashok   Leyland   Automobiles   3   Investment   Summary   AL   is   a   play   on   domestic   MHCVs   as   it   derives   a   significant   portion   of    its   revenues   from   this   segment.   We   estimate   domestic   MHCV   sales   volumes   to   fall   by   3%   in   FY12f    due   to   postponing   of    purchases   by   freight   operators—on   account   of    lower   freight   availability.   However,   domestic   MHCV   sales   volume   growth   is   likely   to   recover   to   10%   in   FY13f    on   account   of    a   pick   up   in   investment   activity   and   freight   availability—due   to   the   likely   reversal   in   the   interest   rate   cycle.   There   has   also   been   a   revival   in   LCV   sales   volume   growth   (TTM);   this   is   usually   a   lead   indicator   for   a   revival   in   MHCV   sales   volume   growth.   AL’s   focus   on   increasing   touch   points   and   loan   disbursements   are   also   likely   to   aid   sales   volume   growth.   The   company   is   also   focusing   on   strengthening   its   existing   operations   and   increasing   its   penetration   in   the   high ‐ growing   LCV   segment.   EBITDA   margins   are   likely   to   decline   from   11.0%   in   FY11   to   9.8%   by   FY14f    due   to   rising   sales   promotion   costs   and   the   increasing   share   of    the   low ‐ margin   ‘Dost’   LCV   in   the   overall   product   mix.   We   value   AL’s   core   business   at   an   EV/EBITDA   of    8.6x,   which   is   based   on   mean   valuations   of    the   previous   CV   cycle.   After   including   the   value   of    AL’s   investment   in   IndusInd   Bank,   our   SOTP ‐ based   Mar13   target   stands   at   INR41,   which   provides   a   46%   upside.   Initiate   with   Buy.   Risk   factors   are   the   high   exposure   to   MHCVs   and   higher   commodity   prices   and   fuel   prices.   Domestic   MHCV   demand   likely   to   recover   to   10%   by   FY13f    We   estimate   a   fall   of    3%   in   domestic   medium   and   heavy   commercial   vehicle   (MHCV)   sales   volumes   in   FY12f    due   to   postponing   of    purchases   by   freight   operators   on   account   of    lower   road   freight   availability.   In   addition,   expiry   of    the   Jawaharlal   Nehru   National   Urban   Renewal   Mission   (JNNURM)   scheme   is   also   likely   to   impact   sales   volumes.   We   estimate   domestic   MHCV   sales   volume   growth   to   recover   to   10%   by   FY13f,   on   account   of    a   pick   up   in   investment   activity   and   freight   availability   due   to   the   likely   reversal   in   the   interest   rate   cycle.   There   has   also   been   a   revival   in   sales   volume   growth   (TTM)   for   light   commercial   vehicles   (LCVs);   this   is   usually   a   lead   indicator   of    a   revival   in   MHCV   sales   volume   growth.   Ashok   Leyland   (AL)   is   also   increasing   its   touch   points   and   ramping   up   disbursements   from   its   captive   finance   division   to   aid   growth.   Strengthening   existing   operations   and   entering   new   businesses   AL   has   been   investing   with   three   main   objectives:   1)   to   strengthen   financing   and   technological   capabilities   in   commercial   vehicles   (CVs);   2)   to   increase   the   penetration   in   LCVs;   and   3)   to   diversify   into   other   businesses.   To   access   technology,   AL   has   increased   its   stake   to   75.1%   in   Optare   (OPE   LN;   NR),   a   European   CV   manufacturer   in   Dec11.   This   was   AL’s   second   investment   to   access   technology,   post   acquisition   of    Avia   Ashok   Leyland   Motors   (Avia)   in   Oct06.   To   increase   its   presence   in   the   LCV   segment,   the   company   launched   a   cargo   LCV ‐ ‘Dost’ ‐ in   JV   with   Nissan   Motor   Co   (7201   JP;   NR)   in   Sep11.   We   estimate   this   JV   to   break ‐ even   by   FY14f.   Finally,   to   de ‐ risk   itself    from   the   cyclicality   of    the   domestic   CV   business,   the   company   has   ventured   into   businesses   such   as   manufacturing   of    construction   equipment   and   automotive   infotronics;   most   of    these   businesses   reported   losses   in   FY11.   AL’s   share   of    earnings   from   these   businesses   is   likely   to   break ‐ even   in   FY14f.   Total   income   growth   to   settle   at   a   CAGR   of    13%   over   FY12f  ‐ FY14f    The   recovery   in   domestic   MHCV   sales   volumes   and   robust   export   growth   are   likely   to   result   in   a   CAGR   of    13%   in   total   income   over   FY12f  ‐ FY14f.   Export   volumes   are   likely   to   be   strong,   at   a   CAGR   of    19%   over   FY12f  ‐ FY14f,   due   to   the   growing   acceptance   of    Indian   CVs   in   developing   countries.   We   estimate   the   contribution   of    exports   to   overall   sales   volumes   to   increase   from   11%   in   FY11   to   12%   in   FY14f.   Rising   sales   promotion   costs   and   the   increasing   contribution   of    the   low ‐ margin   ‘Dost’   LCV   to   overall   sales   volumes   are   likely   to   reduce   EBITDA   margins   from   11.0%   in   FY11   to   9.8%   in   FY14f.   EBITDA   and   PAT   are   likely   to   grow   at   a   CAGR   of    9%   over   FY12f  ‐ FY14f.   Initiate   with   a   Buy   rating   and   a   Mar13   TP   of    INR41   We   arrive   at   Mar13   SOTP ‐ based   target   price   of    INR41,   which   provides   an   upside   of    46%.   We   apply   an   EV/EBITDA   multiple   of    8.6x   to   AL’s   core   business   to   arrive   at   a   fair   value   of    INR39/share.   This   multiple   is   based   on   the   mean   valuations   of    the   previous   CV   cycle.   The   likely   earnings   rebound   in   AL   over   FY13f  ‐ We   estimate   domestic   MHCV   sales   volume   growth   to   recover   to   10%   by   FY13f.   To   increase   its   presence   in   the   LCV   segment,   the   company   launched   a   cargo   LCV   in   JV   with   Nissan.   Export   volumes   are   likely   to   be   strong,   at   a   CAGR   of    19%   over   FY12f  ‐ FY14f,   due   to   the   growing   acceptance   of    Indian   CVs   in   developing   countries.   Initiate   coverage   with   a   Buy   rating   and   a   Mar13   TP   of    INR41.     India Equity Research Ashok   Leyland   Automobiles   4   FY14f    on   account   of    the   recovery   in   domestic   MHCV   sales   volume   growth   provides   a   buying   opportunity.   We   also   value   AL’s   investment   in   IndusInd   Bank   (IIB   IN,   Buy)   at   INR2/share.   Initiate   coverage   with   a   Buy   rating.   Risk   factors   are   the   high   exposure   to   MHCVs   and   higher   commodity   prices   and   fuel   prices.   Exhibit   1:   One ‐ year   forward   rolling   EV/EBITDA   and   EV/EBITDA   at   target   price   5101520Apr07 Feb08 Dec08 Oct09 Sep10 Jul11 May12 Mar131 ‐ yr   Fwd   EV/EBITDA Target   EV/EBITDA Average   EV/EBITDA   Source:   Bloomberg,   Avendus   Research   Exhibit   2:   Valuation   summary   (INRmn)   Total   income   EBITDA   Net   Profit EPS   (INR) P/E   (x) EV/EBITDA   (x)   EV/Sales   (x) P/B   (x) Mar10   72,447   7,628   4,269   1.6   17.5   12.6   1.3   2.0   Mar11   111,177   12,176   6,313   2.4   11.8   8.5   0.9   1.9   Mar12f    125,995   12,653   5,840   2.2   12.8   8.9   0.9   1.8   Mar13f    146,064   14,405   6,966   2.6   10.7   7.8   0.8   1.6   Mar14f    161,394   15,864   8,160   3.1   9.2   6.8   0.7   1.5   Source:   Company,   Avendus   Research  
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