Analyst Corner: ‘Buy’ on Ashok Leyland with price target of Rs 75

Ashok reported on EBITDA loss of Rs 3.3bn in 1Q as Covid related lockdown impacted operations in an already weak cycle. Trucks continue to be in a severe downturn and have not seen any meaningful pick-up yet, but we expect a rebound in FY22-23 on an exceptionally low base. Its 2.4x FY22E PB is in line with long-term average and attractive in context of an impending up-cycle. Reiterate ‘buy’.

ASPs rose 13% QoQ led by the cost push for BS6 emission norms along with higher share of spare parts and other non-vehicle revenues. The latter also drove a sharp expansion in gross margin; EBITDA margin was still at -51% due to the adverse operating leverage impact of low volumes. Ashok said in the call that the moratorium level for Hinduja Leyland Finance has eased from 75% in April to 40% now.

The Indian truck industry has been in a deep downturn since Nov-2018 with volumes falling 47% YoY in FY20 and a further 93% YoY in 1QFY21. While near-term demand visibility is weak, we believe the pendulum has swung too far and the deep cyclical nature of the industry will play out overthe next 1-2 years. We expect a strong rebound in FY22-23 on an exceptionally low base. We factor in truck industry volumes declining by 30% YoY in FY21 but growing 80%/25% YoY in FY22-23; our FY23 volumes are still 17% below FY19 peak.

Competition is unlikely to worsen given Tata is facing severe pressures at JLR too. Ashok’s balance sheet has worsened, turning from net cash of Rs 7.4bn at end-FY19 to net debt of ~Rs 42bn in Jun-2020 amid production shutdown and working capital pressures. We expect free cash flow to remain negative in FY21 but subsequently improve in FY22-23 as cycle recovers.

We revise FY21 estimates factoring in a higher loss than earlier, but largely maintain our FY22-23 EPS. Stock is trading at 2.4x FY22E PB, which is in-line with long-term average and attractive in context of an impending up-cycle; past peaks were 5.7x/2.7x/3.7x in 2018/2010/2006. The 5x+ PB of the last up-cycle is unlikely though given increased related-party concerns. Any significant capital need for the financing business is also a risk. Reiterate ‘buy’ with Rs 75 PT(3.0x FY22E PB).