Ashok Leyland margin a show stopper in Q3

For perspective, in the December quarter (Q3FY24), Ashok Leyland’s Ebitda margin, a key measure of profitability, improved to 12%, up from 11.2% in Q2, and 10% in Q1. With this, the company is poised to clock the guided double-digit margin for the full year. This also suggests it is moving in line with its medium-term target of reaching mid-teen margin.

The upshot is that year-on-year Q3 Ebitda growth came in at almost 40% to ₹1,114 crore with margin expanding by 320 basis points (bps). One basis point is one-hundredth of a percentage point.

This is at a time when revenue growth stood at a mere 2.7% — a function of lower volumes to a good extent. In its Q3 earnings conference call, the management said that the domestic medium & heavy commercial vehicle (MHCV) industry in the first three quarters of FY24 has grown by 9% versus the same period last year. However, growth in H1FY24 stood at 10%, and slowed down to 7% in Q3 mainly affected by elections in several large states in the country.

What led to better Ebitda performance then? The answer is simple. The company saw a significant year-on-year jump of 400 bps in gross margin aided by higher cost savings amid softening commodity costs, leading to a 2.7% drop in raw material costs. Also, realizations improved.

So far, so good. If the company is able to improve margins further in Q4, then that may prompt analysts to upgrade earnings estimates for the immediate future. The management said that it is following a strict pricing discipline and market share gains would not come at the cost of margins. Ashok Leyland’s market share in the MCHV segment has improved to 25-30% and the management aims to reach 35% in future.

But investors should note that both Tata Motors Ltd and Ashok Leyland are anticipating some demand slowdown in the next two quarters. This, in turn, may adversely impact pricing discipline in the sector, which could have a bearing on the margin and thereby earnings estimates.

Having said that, Ashok Leyland’s management maintains that overall, the industry is still short of its peak seen in FY18-19, thereby signalling further room for growth. Moreover, industry factors for medium-to-long term growth seem favourable backed by strong macro-eco environment, healthy replacement demand, good traction on infra projects and improving freight demand. But some are skeptical.

“We believe MHCV industry has peaked in FY24E with muted future outlook (trucking system capacity up about 40-50% over FY19-24E, like increases seen in past two upcycles) as bulk of replacement-led upturn seems behind us," note analysts from Emkay Global Financial Services.

Amid strengthening prospects of electric LCVs and electric buses, Ashok Leyland has invested ₹662 crore during Q3 into subsidiary Optare Plc/Switch. In the recently held Bharat Mobility Global Expo at New Delhi, the company commenced delivery of its first Electric 55T Tractor - Trailer, and its first 14T Boss Electric Truck. The management expects Switch Mobility India to become cash neutral by the end of next fiscal year. However, analysts caution that despite Ashok Leyland’s balance sheet strength, funding/capital expenditure trajectory needs to be closely monitored.

Meanwhile, so far in 2024 the Ashok Leyland stock has fallen by 3% vis-à-vis 6% gain in the Nifty Auto index. The bouts of profit booking in stock may be attributed to anticipated demand softness in a run-up to general election.