Target price for Ashok Leyland revised to Rs 134

As a stronger MHCV recovery looks likely Ashok Leyland may benefit more due to its higher share in higher tonnage trucks and the new LCV range offer an added upside. Signs of a stronger pick-up: MHCV cycle to hit its FY19 peak by FY24F. Medium & heavy commercial vehicle (MHCV) tonnage capacity in India has registered 6-10% CAGR over FY10-20 on a rolling 5-year basis. With a stronger economic recovery, we now build in ~6.5% CAGR in the industry’s tonnage capacity including DFC (vs 5.5% earlier) over FY20-25F. We expect MHCV tonnage capacity CAGR to be ~3.3% (vs 2.5% earlier), taking into account ~35k trucks per year demand lost to DFC. Thus, industry volumes would reach their FY19 peak levels by FY24F.

Demand trends are improving as reflected in the higher truck activity levels & fleet operators’ profitability. FY21 is likely to see a decline in fleet capacity for the first time at least in past 15 years, which in our view is not sustainable as capacity volumes are growing across most segments. We maintain our view that higher truck prices due to commodity costs are likely to get passed on in freight rates if there is requirement for trucks. We now factor in -33% / +85%/ +26% / +14% growth in MHCVs over FY21-24F (vs -33% /+50% / +40% / +15% earlier). AL is best-positioned to benefit from upcycle.

The company is also likely to benefit from its higher share in the >16T segment, as usually the mix shifts upward during upcycles. Its new LCV platform ‘Bada Dost’ has received strong response with LCV volumes up ~30% y-o-y in 3QFY21. This should be an added upside in this upcycle. For AL in MHCV, over FY21-23F we now factor in -37% / +95% / +30% growth (vs -33% / +47%/+38%). We also raise our LCV estimates by 16% over FY21-23F. With this, AL’s utilization should ramp up to 95% by FY24F. We raise our Ebitda margin estimates to 3.7% / 7.5% / 9.8% (vs 2.9% /5.7% /8.7%, leading to 35%/ 61% / 30% Ebitda upgrade over FY21-23F.

Valuation: TP raised to Rs 134, based on 10x FY24F EV/Ebitda. We maintain our valuation based on an unchanged 10x FY24F Ebitda (which we believe fully captures a likely recovery), discounted back to FY23F and add `9.2 for investments.

Note that AL’s R&D capitalization is significantly lower than peers. AL trades at ~9.6x FY23F EV/Ebitda, (adjusted for subs), which we believe is attractive based on our ~50% Ebitda CAGR over FY22-24F.