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Ashok Leyland's Q3FY19 results (Neutral) - Steady quarter; outlook weakens

3QFY19 result highlights

• PAT above estimates: Ashok Leyland Q3FY19 PAT at Rs3.8bn (-21% yoy) was ~20% above street expectations. The variance was on account of (a) lower than estimated raw material costs (b) amalgamation of LCV subsidiaries and (c) a tax credit of Rs840mn.  
• Gross margins surprise: On a like to like basis (including the revenues from amalgamation), revenues came in at Rs 63.2b down 12% yoy on a ~7% decline in volumes. Realizations declining by 6% yoy on a weaker product mix. EBITDA margins at 10.3% (down 60bps qoq, 140bps yoy) were well above estimates (est: 9.1%). While 30-60 of the beat can be attributed to the amalgamation; the surprise was a sharp sequential decline in the RM costs (down 200 bps sequentially). The management indicated that the RM cost decline was a consequence of an improved product mix, higher share of spares and better profitability in the bus segment. Excluding the impact of the amalgamation, we estimate EBITDA would have beaten consensus by ~8%.  The PBT declined 30% yoy, however PAT was supported by a lower tax rate (20% versus estimates of 30%) on the back of a tax writeback of Rs840mn in Q3 (full impact to be Rs2.5bn)

Takeaways from the conference call: (a) The management stated that January volumes had shown an improvement over December. The next 2 quarters might  be weak but thereon it expects volumes to improve on the back of pre-buying in Q2 and Q3. FY21 might be a flat if the scrappage plan does not come through. (b)Discounts have increased in Q3 to Rs4,25000 to Rs4,50,000 per vehicle (from Rs400,000 in Q2). However the management has taken a price hike of ~2% in January. (c) The company net debt is ~Rs13bn (up sharply from a net cash of Rs7bn in Q2 due to higher working capital requirements on increased inventory (d) The company will complete its range of LCVs by launching new products in the coming quarters. It intends to invest Rs10bn over the next few years in the LCV business.

Key positives: Sharp increase in raw material costs

Key negatives: Better operating leverage benefits

Changes in estimates: We broadly maintain our earnings for FY19/20. FY21 EPS is expected to decline over FY20 post the BSVI related pre-buy.

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.  In view of the rising risks, we maintain a Neutral stand on AL with a target price of Rs 83 (7x Sept2020E EV/EBITDA)