Ashok Leyland: Weak sales, rising costs squeeze operating margin

The 9% drop in Ashok Leyland Ltd’s June quarter truck sales may have been partly due to BS-IV transition and goods and services tax (GST) implementation issues.

This was also very untimely in that the regulatory changes came amid rising costs that accelerated at a faster pace than sales growth. Obviously, it dented the June quarter’s profitability severely.

Operating margin plunged into single digits—7.2% from 11.2% a year ago. Investors were disappointed as it contracted below a subdued average estimate of 8.3% by 13 analysts surveyed by Bloomberg.

The quarter’s profitability was wedged uncomfortably between a steep sales decline and high input costs.

After a smooth uphill ride for many quarters, Ashok Leyland’s market share has risen from 27% a couple of years ago to 35% now. However, industry-related challenges such as the emission norms, demonetisation and GST took a toll on the auto industry as a whole.

Dealers reported lacklustre enquiries and sales during the quarter. Fortunately, the price hikes taken by the firm earlier this year pushed up average realization by about 9% during the quarter. Net revenue, therefore, was flat at Rs4,238 crore, a tad better than what analysts had estimated.

Meanwhile, input costs surged during the quarter. The 22% rise in employee cost in absolute terms when compared with a year ago, translated into a 190 basis points (bps) expansion as a percentage to sales. One basis point is one-hundredth of a percentage point. Raw material cost, too, jumped on the back of rising commodity prices, even as higher discounts and support to dealers to clear stock took a toll on profitability.

As a result, Ashok Leyland’s operating profit of Rs306 crore was a substantial 37% lower than the year-ago period. Adding to the woes during the quarter was some losses on loans to subsidiaries.

In the final analysis, a host of negative factors weighed on the firm’s earnings. Net profit at Rs111 crore plunged to a little less than half that posted in the year-ago period. Unfortunately, after several decent quarters when India’s second largest truck maker plugged many gaps in its portfolio and streamlined its balance sheet to trim debt, the June quarter disappointed. Net profit was also below Bloomberg’s average estimate by about 29%.

The stock reacted sharply before closing 2.6% lower on Friday at Rs103 a piece, which discounts the earnings estimated for FY19 by a fair 12-13 times.

One hopes it is a temporary blip.

However, there are concerns at an industry level, too.

“We are cautious on the outlook as fleet operators are on the back foot, given the uncertainties on production and supply chain in many sectors due to GST. This is likely to keep utilization low for some time and, hence, demand for trucks, too, may be weak,” said Nitesh Sharma, an analyst at PhillipCapital India Pvt. Ltd.