Buy Ashok Leyland - Compelling Growth ahead

Ashok Leyland Limited (ALL) is the Second largest commercial vehicle manufacturer in India, Mainly operating in Medium to Heavy Commercial Vehicle (CV) and Bus Segments. ALL currently exports to over 30 countries in Asia, Middle East and Africa.

Sector Outlook

At the beginning of the 11th planing commission period India has registered a GDP growth of close to 9%. The manufacturing sector has been a significant contributor to this growth. The government initiative of developing road infrastructure on par with developed economies translates into significant growth in Commercial Vehicle (CV) space.

The growth going forward in the CV space will also be attributed to exports of CV and the changing domestic dynamics. The domestic bus segment is seeing a change in product modernity. The city buses with low entry height, stepless entry, air suspension and pneumatic doors emphasized safety, comfort and a faster turnaround time is gaining demand. Ashok Leyland strong presence makes it a first few entrant in this modern buses arena.

Overloading restrictions imposed by most of the state governments on heavy vehicles is also expected to spur demand in CV procurement.

Ashok Leyland Outlook

FY08 did not start of in a good note for ALL. The company registered a 7% negative growth in the first 9 months of this fiscal. We expect the CV market to stabilize in the coming year. The upcoming capacity enhancement during the course of next 2 years and the increase in market share of higher margin business (Defence, Engines and Parts) is excepted to be the key driver for ALL. Currently Defence, Exports, Engines and Spare Parts contributes around 18% of revenue.

Capacity Enhancements

1) ALL is enhancing it's vehicle capacity production from the current 84,000 vehicles to 100,000 vehicles by the current financial year.
2) The capacity of Ennore facility is expected to be increased by 50,000 Vehicles by June' 08.
3) The Company has entered into a joint venture with Ras Al Khaimah Investment Authority (RAKIA) in the U.A.E. to put up a plant for building bus bodies in the U.A.E. This is expected to go on stream by March' 2008.
4) ALL Investment in Uttarakhand is expected to be EPS assertive in 2010. The company is setting up a plant to manufacture 70,000 vehicles.
5) The company JV with Nissan to manufacture and sell LCV range of vehicles is expected to be commenced in 2010.
6) ALL Engine volumes is expected to double in 2 yrs. The company has tied up with Chinese sources for procurement of 25 hp to 75 hp engines.

Acquisitions Progress

The acquisition of AVIA truck unit a czech company is expected to provide the Company with an entry into the East European and Mediterranean markets and will also offer benefit of synergy with the Company’s product development efforts, especially in respect of a modern cabin for the medium vehicles. The acquisition is already EPS assertive.

The Company has signed a Share Purchase Agreement to acquire the entire equity capital of Defiance Testing and Engineering Services, Inc, Michigan, USA. This Company is engaged in the business of providing testing services to automobile OE manufacturers in northern USA. This acquisition is expected to provide significant synergy to the existing business activities of Ashley Design and Engineering Services Division of Ashok Leyland. It will also help ADES to provide greater value-added services to various customers in the USA.

Valuation

At the current market price of Rs. 34/- the stock trades at around 11 times it FY08E EPS of 3.10. Investor with low to medium risk profile can consider investment into this stock with a horizon of 18 to 24 months. The company investment phase is in the verge of partial completion and the investment hereon is expected to get translated in revenues. We recommend a buy rating in this stock with a target of Rs. 68/- based on our FY10E EPS of 4.25.

Risks

1) Slow down in market demand.
2) Continuing increase in input costs.
3) High domestic Interest rates.
4) Margins under squeeze. The Company is pursuing plans to increase the market share of high margin business like exports, non-auto engines and sale to Defence sector to mitigate the impact of margin pressure.