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Ashok Leyland's Q2FY18 results (Outperformer) - Muted quarter, positive outlook

2QFY18 result highlights

• Adj PAT below estimates: Ashok Leyland’s reported PAT of Rs3.6bn(+24%yoy) was below estimate of Rs4.2bn. This was mainly on account of weaker than expected operating performance as EBITDA missed estimates.
• Revenues in-line; Margins disappoint: Revenues at Rs 60bn (+31% yoy) were in-line with estimates (Rs 62.8 bn). The growth in revenues were driven by 23% volume growth while realization supported with a 7% yoy growth.(-1% decline sequentially). Reported EBITDA margins at 10.1% declined 150 bps yoy (+290 bps qoq) as RM costs increased by 340 bps  yoy as commodity costs hardened, while other expenses declined by 190 bps on operating leverage benefits. EBITDA margins adjusted for Pantnagar benefit on GST of Rs300mn would have been higher by 50bps at 10.6%. Decline in EBITDA margins yoy was also on account of a)one time export order received in 2QFY17. b) Increased exports to Sri Lanka and Bangladesh which are less profitable b)Price escalation of Rs 500 mn on defense order in 2QFY17.
• Concall highlights: (a) The management expects domestic CV recovery to continue in 3QFY18, while 4QFY18 could see slowdown on account of higher base on pre buying due to shift to BS IV vehicles. (b) It has guided for industry growth rate of 5-10% for FY18. (c) Discounting is high in the market with average discount levels of Rs 350k for AL and ~Rs450k for the market.(d) Hinduja Foundries reported EBITDA margins of 8.5% in 2QFY18. (e) It has sold 75-80% of BS 3 vehicles lying in stock. (f) It plans to launch 6-7 products in LCVs over the next 1 year. (g)AL has taken a marginal price hike of 1% in 3QFY18 on some of its models.

Key positives: Higher other income and lower other expenses

Key negatives: Weaker operating performance

Changes in estimates: No meaningful change to our estimates

Valuations & view

With the CV cycle unlikely to have peaked, we believe that volume growth should recover in H2FY18E. AL’s improved competitiveness and medium-term plans to de-risk its business support our thesis. We maintain our Outperformer rating on the stock with a target price of Rs134 (based on an 11x Sep19E EV/EBITDA with Rs8 as the value of subsidiaries)