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Ashok Leyland's Q1FY20 results (Neutral) - Steady quarter; outlook further weakens

1QFY20 result highlights

• PAT ahead of expectations: Ashok Leyland Q1FY20 adjusted PAT at Rs2.5bn (-36% yoy) was ~12% ahead of our expectations but broadly inline with consensus estimates (Bloomberg). The variance with our estimates was on account of higher than estimated gross margins. 
• Gross margins surprise: Revenues at 57bn (-9% yoy) on a volume decline of 8% with a sequential realisations drop of 2% qoq. The realisation decline reflects a low value product mix (share of M&HCVs in the mix decreased from 74% to 67% sequentially). EBITDA margins at 9.4% (down 169bps qoq, down 91bps yoy) were ahead of our expectations (est 8.0%). The positive surprise was on account of a sharp improvement in gross margins (up 277 bps qoq) – the management attributed the improvement to benign commodity prices, a favourable product mix and cost cutting measures. This was partially offset negative operating leverage – staff costs/other expenses rose ~230/220bps qoq. On the whole, EBITDA came in at Rs5.4bn (down 17% yoy) with a PAT of Rs2.5bn (down 36% yoy).

Takeaways from the conference call: (a) The management indicated that the demand environment remains challenging. While demand for ICVs is steady, the tipper and tractor trailers remain particularly weak. (b) The discounting levels remain high with competitive pressures persisting – the average discounts in the quarter c. Rs400,000. (c) The company indicated that it is aggressively looking to reduce costs – it has a target to reduce costs by Rs5bn. It will also look to reduce the capital expenditure. (d) In the current format, the scrappage policy is unlikely to aid new truck demand. (e) The dealer inventory is between 30-45 days depending on the dealer. (f) The company does not expect the dedicated freight corridor impact as the corridor as it could compliment rather than compete with road transportation. (g) The company is full prepared for BSVI – managing inventory though would be a key challenge. 

Key positives: Sharp sequential decrease in raw material costs

Key negatives: Adverse operating leverage

Changes in estimates: We cut our earnings estimate for FY20/21 by 14%/13% 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.  In view of the rising risks, we maintain a Neutral stand on AL with a target price of Rs 76 (7x FY21 EV/EBITDA and Rs 4 for HLF)