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Ashok Leyland's Q2FY19 results (Neutral) - A tad disappointing; Risks building up

2QFY19 result highlights

Adj PAT below estimates: Ashok Leyland Q2FY19 Adj PAT at Rs4.7bn (+41% yoy) was ~6% below our expectations. The variance was on account of lower than expected realisations, higher raw material costs that was partially offset by operating leverage benefits. 

Realizations decline; EBITDA margins steady: Revenues at Rs 76b (~4% below expectations) grew by 26% yoy on strong volume growth. However, realizations declined by 4% qoq due to higher discounting and an adverse product mix. EBITDA margins at 10.6% (inline) increased by 20bps sequentially; while RM costs increased 310 bps qoq; (+150 bps yoy) it was offset by lower other expenses (-220 bps qoq;-70 bps yoy) on account of lower warranty expenses and lower staff expenses (-110 bps qoq;-120 bps yoy). The lower gross margins reflect (a) higher commodity costs (b) increased discounting and (c) a lower share of defence sales during the quarter.

CEO resigns; Dheeraj Hinduja to be executive chairman: Mr. Vinod Dasari, who had been instrumental in AL’s turnaround, has resigned (2 years before his term was to end) to pursue other interests.  Mr. Hinduja will be the exec. chairman in the transitioning phase (March 31^st 2019).

Takeaways from the conference call: (a) The management indicated it has witnessed marginal slowdown in demand in the past few weeks due to the NBFC liquidity crunch. However, it expects the impact to be limited to the short term. (b)It has taken price hikes in 2QFY19 along with a 2% increase in November to counter increase in commodity costs.(c) Discounting continues to be high in the industry with average discounts increased to Rs 0.4 mn in 2QFY19 from Rs 0.37 in 1QFY19.(d) It has guided for industry growth of 15-20% in FY19 with strong demand expected in FY20 on account of pre buying (preponement of 30% of demand)

Key positives: Sharp increase in raw material costs

Key negatives: Better operating leverage benefits

Changes in estimates: We increase our FY19/20 estimates by ~7%/4% as the impact of the new axle load norms maybe lower than anticipated

Valuations & view

We believe that tightening NBFC lending norms, higher diesel prices and the lagged impact of new axle norms could adversely impact CV volume growth in the coming quarters. In view of the rising risks, we maintain a Neutral stand on AL with a target price of Rs 120 (8xFY20E EV/EBITDA)