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Ashok Leyland's Q2FY20 results (Neutral) - Weak trends persist

2QFY20 result highlights

• Weak operating results: Ashok Leyland’s operating profit at Rs2.3bn (down 72% yoy) fell short of our and consensus estimates. However, Ashok Leyland Q2FY20 adjusted PAT at Rs1 bn (-78% yoy) was ahead of expectations due to a tax credit and higher other income. 
• Adverse Operating leverage drag margins: Revenues at 39.3bn (down 48% yoy) was little ahead of estimates. Realisations declined 2% qoq (est: 5% decline) on account of a weaker product mix (share of M&HCVs in the mix decreased from 67% to 58% sequentially). EBITDA margins at 5.8% (down 363bps qoq, down 480bps yoy) were marginally below our expectations (est 6.0%). While gross margins (up 86 bps qoq) surprised positively (lower commodity costs seem to have negated higher discounts), the operating deleverage – staff costs/other expenses rose 220bp/230bps qoq was stringer than expected. On the whole, EBITDA at Rs2.3bn (down 72% yoy) lower than street expectations. PAT benefitted from a tax credit and higher other income.

Takeaways from the conference call: (a)The management is hopeful that the worst is over and that there should be a gradual improvement in demand. (b) The discounting levels remain high with competitive pressures. (c) The current inventory has reduced to a comfortable position of 3500 units (~3-4 weeks) by October end from 8500 units in June’19 (d) The company has reduced capital expenditure target from Rs 23bn to 18 bn for FY20. (e) The management is yet to decide whether to go with existing tax rate as it has lot of MAT credit claim. (d) The company is full prepared for BSVI – managing inventory though would be a key challenge. 

Key positives: Lower tax rate, Higher than expected realization

Key negatives: Adverse operating leverage

Changes in estimates: We cut our earnings estimate for FY20/21 by 26%/4% largely to account for the weakness in volumes.

Valuations & view

We believe that over-capacity in the freight market coupled with a tightening in lending norms is likely to lead to a continued weakening in the CV demand. It seems increasingly likely that the expected pre-buying before BSVI will be highly muted. Post BSVI, there is likely to be a further weakening in demand. In view of the rising risks, we maintain a Neutral stand on AL with a target price of Rs 73 (8x FY21 EV/EBITDA and Rs 4 for HLF)