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Ashok Leyland's Q3FY18 results (Outperformer) - Strong quarter, positive outlook

3QFY18 result highlights

PAT above est; Strong operational performance: Ashok Leyland’s Q3FY18 PAT at Rs4.5bn (+178% yoy) was ~14% above our estimates. The variance was on account of stronger than expected operating performance driven by operating leverage benefits. This was inspite of lower than expected other incomes (-32% qoq) and higher tax rate.

Revenues in-line; Margins disappoint: Revenues at Rs 71.1b (in-line) grew by 57% yoy with a 42% yoy jump in volumes. Notably, realizations showed a strong growth of 3% qoq (despite higher discounts) due to better product mix led by increase in higher tonnage trucks. EBITDA margins at 11.1% were above estimates (est of 9.8%) EBITDA margins expanded by 100bp sequentially on lower staff costs (operating leverage benefits). Price hikes offset discounting/commodity cost pressures.

Concall highlights: (a) The management indicated strong demand led by convergence of multiple factors such as (1)Stringent regulations on overloading in UP and Rajasthan (2)Infrastructure push in UP leading to demand for higher tonnage vehicles. (3)Revival in mining activities in East. (b) It expects robust demand over the next 2 years led by infrastructure push and pre buying in FY20 ahead of BS VI norms. (c) Discounting continues to remain at elevated levels. ALL has raised prices in Nov-17 and in Jan-18 to offset increase in commodity costs.(e) It has 21 defense tenders in pipeline worth revenues of Rs 7.5-10bn which will executed over 2 years. (f)It has guided for a capex of Rs6.5 bn which includes investments in subsidiaries Optare and HFL. (g) Aftermarket sales are performing well with a 20% penetration in M&HCVs. The company plans to increase the share to 40%.(h) Total debt was -5.4bn due to customer advances, while working capital was 6-8 days.

Key positives: Strong realization growth, higher than expected margins

Key negatives: Lower other income and higher taxes

Changes in estimates: No meaningful change to our estimates

Valuations & view

With the CV cycle unlikely to have peaked, we believe that volume growth should recover in H2FY18E. AL’s improved competitiveness and medium-term plans to de-risk its business support our thesis. We maintain our Outperformer rating on the stock with a target price of Rs138 (based on an 11x FY20 EV/EBITDA with Rs8 as the value of subsidiaries).