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Ashok Leyland's Q4FY19 results (Neutral) - Weak quarter; outlook remains clouded

4QFY19 result highlights

• PAT above estimates: Ashok Leyland Q4FY19 PAT at Rs6.6bn (-11% yoy) was broadly inline with estimates. While revenues were ahead of expectations, however a sharp drop in EBITDA margins led to operating profits being ~6% below estimates. This was offset by a tax writeback on account of the amalgamation of the LCV subsidiaries.  
• Gross margins disappoint: Revenues at 87.8bn (+1% yoy) was 3% ahead of estimates as realisations rose 4% qoq on account of a better product mix (share of M&HCVs in the mix increased from 68% to 74%). EBITDA margins at 11.1% (up 80bps qoq, down 170bps yoy) fell short of expectations (est 12.3%). The negative surprise was on account of a sharp decline in gross margins (down 150bps yoy, 170 bps qoq) on account of higher competitive pressures and commodity inflation. The increase in raw material costs offset cost control measures (other expenses declined 9% yoy) and sequential operating leverage benefits. On the whole, EBITDA at Rs9.8bn (down 12% yoy) was 6% below estimates. A lower tax rate on account of the amalgamation of LCVs masked the weak operating profitability. Consequently, PAT met estimates.

Takeaways from the conference call: (a) The management guided for a volume growth of 10-12% for the industry in FY20. This includes the benefit from pre-buying ahead of emission norms in Q2 and Q3. (b)The company hopes to maintain double digit EBITDA margins in FY20. (c) Discounts have Q4 were in the Rs4,25000 to Rs4,50,000 per vehicle (broadly inline with the Q3 estimates). (c) The company had a net cash of Rs7bn at the year end. During the year, working capital requirements increased as debtor days (up nearly 3x) and inventory (+52% yoy) rose sharply (d) The company will plans a capital expenditure of Rs15bn in FY20 (FY19: Rs9bn) to fund new products in LCVs, BSVI transition and its modular business program. (e)While the current year has been poor for the defence and export businesses, the management expects an improvement in improvement going forward with the new government in place (+ve for defence orders) along with its thrust in Africa.

Key positives: Sharp increase in raw material costs

Key negatives: Stronger than expected realisations

Changes in estimates: We raise our earning for FY20/21 by 5%/2% as we incorporate the complete impact of the LCV amalgamation.

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. While volumes could show an improvement in Q2/Q3 FY20 on account of pre-buying, we believe that the underlying weakness could persist in FY21. Implementation of scrappage thoug could be a positive upside risk to our cautious stance. Maintain a Neutral stand on AL with a target price of Rs 85 (7x FY21E EV/EBITDA).