August 27, 2007

Ashok Leyland

About
Ashok leyland is a 7500 Cr company in the automobile industry. It is the no.2 manufacturer of commercial vehicles in india. It has a 28% market share in commerical vehicle and is no.1 in the bus segment. It has a current capacity of around 80000 vehicles which would be expanded to 100000 vehicles in the next 1-2 years. The company has 6 plants at Ennore, hosur, Alwar and Bhandar and is putting a new plant in Uttaranchal.
The company has the following product segment – Buses, trucks, defence, spares, services and now the company is entering into design and other OEM services.

Financials
The company has doing well inline with the commerical vehicle industry. The turnaround in the sector performance has happened from 2002 and the industry has seen good growth since then. ALL (ashok leyland Ltd) has seen its revenue increase by 23% per annum since then and profits increase by 25%+. The company has become more efficient as its return on capital has increased from 15% to 25%+. The net margins have gone up from 3.8% to 5.2% during this period. The increase in ROC has come from better utilization of assets which have increased from 1.9 turns to 3.6 turns.
The company has used the free cash flows to reduce debt from a ratio of 0.75 in 2003 to 0.36 currently. Net of cash and cash equivalents the company is a zero debt company.

Positives
The financials of the company has improved a lot during the last 5 years. The company has used the upcycle to improve the balance sheet and make a few strategic acquisitions.

The company has acquired the truck Business of Avia in Europe and would be selling around 1000 trucks per annum (not sure of the exact number). In addition the company has agreed to purchase DTE in the US which provides testing services to OE manufacturers in the US. The company also has a JV with in UAE to build bus bodies in the UAE. The above acquisitions and other service initiatives should add value to the company and reduce the cyclical nature of the business.

In addition the company has been a good allocator of capital in the last 5 years and has a resonable dividend payout of almost 50%.The current management team seems to be more aggressive and focussed on doing well. The company has managed to increase its market share in the last 2-3 years too.

Risks
The business is cylical and during the down cycle there is considerable margin pressure. In addition the company has turnaround its performance during the last 5 years of boyant demand. However it still remains to be seen how the company will do during the down cycle.
Competition in the Commercial vehicle segment is now increasing due to the entry of foreign players and this could increase the pressure on the margins, especially during a down cycle.
The management is currently expanding capacity. However a drop in overall demand could depress profits in the short to medium term due to this excess capacity. However this risk is on the lower side and could be mitigated by increasing exports.

Valuation
The company sells at a PE of 12. The current EPS is around 3.3 per share. The company can be expected to grow at 10-12% over the next few years. In addition the company has some competitive advantage such as a known brand name (especially in the south), long operating history and experience in the market, rational management and a decent distrubution/ service network.
The company can be valued at around 16-18 times PE and given an intrinsic value of around 60 Rs/ share.

Conclusion
The company seems to be undervalued, but it is still not a screaming buy. A 10% drop in stock price could make it a good buy. In addition the company is selling close to its 52 week lows due to the slowdown in the CV sector. A further drop in the share price could present an attractive opportunity.

4 comments:

Anonymous said...

It does look undervalued.
however when you compare it with Tata Motors(big correction in one year), does this not appear a better value.

P/E is not much different and it is in both CV and passenger segment with high growth potential as well.

With entry of foreign players, Ashok Leyland might find the going difficult unless they upgrade technology or have a foreign technical collaboration.
Let me have your views

Alok

Rohit Chauhan said...

Hi alok
i agree tata motors is also priced attractively. i am not confident if it is undervalued by a big margin. also tata motors is now a commerical vehicles and a passeneger vehicle company. on the parameter of passenger vehicle, i find maruti more attractive.
Ashok leyland at the current price is not a slam dunk ..it is attractive but not by a big margin. it seems to be turning around but both tata motors and ALL face risk from competition
i would agree that both tata motors and ALL could good buys, but i still not very comfortable at the current price

RaviAranke said...

Alok,

I expect Tata Motors price to be driven by a lot of hype (positive or negative) about the 1 Lakh rupee car that is expected to roll out early 2008.

If things go well (or rumored to go well) for 1 lakh rupee car, the price could shoot upside. If there are some hiccups (or rumors of hiccups), that would be time to buy Tata Motors at really attractive price.

At this point, from short term perspective, TATA motors is a bet on execution of 1 lakh rupee car.

Rohit Chauhan said...

Hi ravi
i am not sure if the 1 lakh car has been priced either on the upside or the downside.
i would assume the downside to the sunk cost of the project. the upside seems much higher as this could be a huge opportunity and a disruptive innovation if tata motors get it right.
also if they encounter some early hiccups (as expected), then the market could over-react and that could be a good opportunity

regards
rohit