Monday 26 August 2019

Ashok Leyland Valuation: What the Truck

Ashok Leyland is one of the top firms in the Commercial Vehicle segment in India. Near-term deterrents like new axle norms, implementation of the BS-VI standards and a very likely hike in vehicle registration charges may very well play the spoilsport. But if history is any indication, regulations do not have long-lasting impact. If the company can indeed cross these barriers, what will it be worth today?



The Company


Ashok Leyland needs no introduction. Roughly a fourth of the Commercial Vehicles on Indian roads are produced by the company.


I was looking for a candid description of the company. But the company website's "About Us" page does a wonderful job of describing itself. I am shamelessly reproducing it here, simply because it is too good.

Ashok Leyland, flagship of the Hinduja group, is the 2nd largest manufacturer of commercial vehicles in India, the 4th largest manufacturer of buses in the world, and the 10th largest manufacturers of trucks. Headquartered in Chennai, 9 manufacturing plants gives an international footprint - 7 in India, a bus manufacturing facility in Ras Al Khaimah (UAE), one at Leeds, United Kingdom and a joint venture with the Alteams Group for the manufacture of high-press die-casting extruded aluminum components for the automotive and telecommunications sectors, Ashok Leyland has a well-diversified portfolio across the automobile industry. Ashok Leyland has recently been ranked as 38th best brand in India.

Ashok Leyland has a product range from 2.5T GVW (Gross Vehicle Weight) to 49T GTW (Gross Trailer Weight) in trucks, 16 to 80 seater buses, vehicles for defence and special applications, and diesel engines for industrial, genset and marine applications. Ashok Leyland launched India’s first electric bus and Euro 6 compliant truck in 2016. Over millions of passengers use Ashok Leyland buses to get to their destinations every day and 7,00,000 trucks keep the wheels of the economy moving. With the largest fleet of logistics vehicles deployed in the Indian Army and significant partnerships with armed forces across the globe, Ashok Leyland helps keep borders secure. Pioneers in the Commercial Vehicle (CV) space, many product concepts have become industry benchmarks and norms.

Ashok Leyland has IATF 16949:2016 Corporate Certification and is also the first CV manufacturer in India to receive the OBD-II (on board diagnostic) certification for BS IV-compliant commercial vehicle engines, SCR (selective catalytic reduction), iEGR (intelligent exhaust gas recirculation) and CNG technologies. They are the first truck and bus manufacturer outside of Japan to win the Deming prize for our Pantnagar and Hosur plants. Driven by innovative products suitable for a wide range of applications and an excellent understanding of the customers and local market conditions, Ashok Leyland has been at the fore-front of the commercial vehicle industry for decades. The Company’s wide-spread customer base is served through an all-India sales and service network, supplemented by close to 3000 touch points.

A global network of over 550 touch points that facilitate on-road service for millions of vehicles. With technology-enabled customer engagement processes and knowledge on the specific applications of the product range, Ashok Leyland sales team are well equipped to fulfill customer’s needs. Ashok Leyland manages driver training institutes across India and has trained over 8,00,000 drivers since inception. On-site service training for technicians are provided by Ashok Leyland’s service training institutes located in 9 locations across India.



The Industry


The Commercial Vehicle industry in India has a 25-year old heritage. While it keeps evolving all the time, it is worthwhile to see what's in store for the short, medium and long term in the industry.

Short Term


Things do not look good in the short term at all.

The panic was probably started by the axle norm changes, followed closely by the NBFC crisis in 2018. Things quickly devolved and we had a credit crisis in 2019 (Especially in the PV and CV space), evident by falling Sales and closing down of dealerships.

This pain is expected to continue until the economy revives.

Medium Term


The biggest challenges to the Commercial Vehicle industry in the medium term will be the implementation of the BS-VI regulations by 2020 and a very likely hike in vehicle registration charges in that year or the next.

In fact, Mr. Satyakam Arya, CEO, Daimler Indian Commercial Vehicles has opined:

With the introduction of BS-VI, the cost hike will be much higher than the prediction of 5%-7%. We are trying to cover a 10-year journey in three years. The industry is in for a shock.”

While pre-buying of vehicles may offer some growth, an inevitable hike in prices and drop in demand is on the cards.

But all is not lost. An equally likely move is the introduction of the vehicle scrappage policy, which will kick-start a multi-year growth and/or revival in both the Passenger Vehicle and Commercial Vehicle space.

Long Term


Not very surprisingly, the energy dialogue has reached Commercial Vehicles too. Hybrid CVs are becoming a trend across the globe. While a completely electrified CV may be quite some ways away, the idea of it cannot be completely ruled out.

There are also talks about fleet monitoring, real-time alerts/notifications to the driver and surveillance have also begun. How applicable these are to India is still a question.



The Numbers


I have taken the following numbers from Ashok Leyland's latest Quarterly Financials, latest Annual Report and Screener.


Note: Standalone Vs Consolidated Numbers


I generally like to take the Consolidated numbers of a business and then remove a portion of the subsidiaries from the final value. But due to lack of availability of Consolidated numbers, I'm doing the opposite for Ashok Leyland: I am taking the Standalone numbers for the valuation and plugging in the total value of the subsidiaries in the end.

Note: Subsidiaries


Ashok Leyland has about 21 subsidiaries. I have used a Multiples Valuations (P/BV) to value them, based on thumb-rule Multiples for each industry.


If you have superficially analyzed Ashok Leyland's numbers before, you may have been put off by the seemingly massive Debt the company has on its books (A D/E Ratio above 2). BUT look closely. Almost all of this Debt is actually on the books of two of its financing subsidiaries: Hinduja Housing Finance and Hinduja Leyland Finance (Mostly Hinduja Leyland Finance). Since this Debt isn't part of the core operations, the "real" D/E Ratio of the company is only about 0.08. Don't judge a book by its cover!

Note: Risk-free Rate


India's Risk-free Rate (The 30-year GOI Bond Rate) currently stands at 6.92%:

(Source: WorldGovernmentBonds)

Note: Company Beta and Indexed Returns


As usual, I have calculated the Company Beta and Indexed Returns myself (Since Ashok Leyland is an aged company, I was able to do a 7-year Beta and Returns, perfect for a long term valuation):


So that was just jumping through the hoops with numbers. Now let's get creative.



The Assumptions


These are the assumptions I have made for Ashok Leyland's future:


Note: High Growth Period


Ashok Leyland is one of the pioneers in the Indian Commercial Vehicle space. It deserves the full 20-year High Growth Period and more.

Note: Sales Growth


I always say that I limit myself to the Sustainable Growth Rate, unless there's a very good reason to exceed it. In Ashok Leyland's case, it happens to be 8.73% and change. Surprised? Well, the company pays a ton in Dividends. In fact, the stock's current Dividend Yield is 5.15% -- more than what you'd get in most Savings Deposits.

Thankfully, the low figure of 8.73% also perfectly coincides with my expectation of Sales dwindling due to the whole barrage of headwinds we saw in 'The Industry' section. Post this, however, the scrappage policy and the post-BS-VI demand revival will push the growth to the company's long term average of 14.65% or so.

If we assume that this plays out, Ashok Leyland will be producing around ~Rs. 17,000 Crores in Revenues. We should note that (a) The CV space in India is somewhat crowded and (b) Growth cannot and will not last forever. So, I have assumed that growth will eventually taper down.

For the Terminal Period, I have assumed the company to grow at a modest 3.46% (Half of the Risk-free Rate) in perpetuity.

Note: Operating Margins


In line with our assumptions about how BS-VI and registration charges will play, I believe Margins will take a dip in the near future, before reviving to the long term average and finally moving towards the Industry Average (Thanks to: Prof. Aswath Damodaran's Useful Data Sets).

Note: Tax Rate


The Finance Ministry has indicated that they will eventually bring all companies in India under the 25% tax bracket. My assumptions also reflect the same, with the current tax moving towards 25% in about 10-15 years.

Note: Capital Turnover


While tackling short and medium term obstacles is not new for Indian industries, it often consumes resources. I have assumed that Ashok Leyland's Capital Turnover will be poor in the short term (1.24 is the average of their 3 poorest Capital Turnovers in the last 10 years), only to quickly jump back up (2.54 being the average of the 3 highest) and move towards the long term average.

Note: Depreciation


Depreciation remains fairly stable, although reduces ever so gradually, thanks to reduction in Physical Asset creation as the company matures.

Note: Cost of Capital


As mentioned before, I will be using the Company Beta-based CAPM Cost of Capital (13.61%) to discount all future cash flows.



The Diagnostics


The Diagnostics section will tells us if there's anything outlandish about the assumptions.


Green all over! We can move right ahead without any second thoughts.



The Cash Flows


Based on the assumptions I have made, this is how Ashok Leyland's Cash Flows will evolve:


A pictorial representation, instead, would look like this:


To learn more about Business Life Cycle, try this article.



The Value


I believe Ashok Leyland is fairly valued like below:


Note: Operating Lease


The company does have a small Operating Lease going on. The value of it is not substantial enough to warrant a special mention. But I have indeed considered it in valuing the company. You may notice it if you happen to download the model (Check out 'The Model' section of this post to get the download link).

Note: Margin of Safety


I have claimed a Margin of Safety of 30% because of the cyclical nature of the business and the possible long term threats we discussed above.

My assumptions impute a value of Rs. 81 per Share for the company, which is indicative of a ~33% undervaluation.

Please note that Risk is different for everyone. In fact, I generally use a lower Cost of Capital and Margin of Safety for my public valuations to avoid biases. But on a personal note, I always use a Discounting Rate of at least 15% and a Margin of Safety of at least 20% and up to 50% for riskier businesses. If I use a 15% Discounting and say 40% MoS this specific valuation, I will get the value of ~Rs. 63. In effect, you could say that the CMP is when I would even consider purchasing this stock (i.e. If I wanted to purchase the stock at all in the first place).



The Sensitivity of Value


'The Sensitivity of Value' tool gives us the different values for the company at different Cost of Capital and Terminal Growth assumptions:


For example, the 'Pessimistic Value' of the stock, ~Rs. 72, is probably a great level to consider purchasing the stock.



The Monte Carlo Simulation (Risk Analysis)


Disclaimer: Unfortunately, I've had a problem with the Excel Add-in I usually use for my Monte Carlo Simulations. I am determined to fix the issue and complete this section. If you're interested, re-visit this post at a later date. I will try my best to put this up soon.



The Model


If you do not agree with the assumptions I have made for the company, feel free to download the model and re-enter the assumptions as you see fit.

(Download Numbers and Narratives - Ashok Leyland)

If your value substantially differs from mine, I would love to pick your brain in the comments section below.



What the Truck...


If you've been an investor in Ashok Leyland already, you might have been asking yourself "What the Truck?" (Pun completely intended, of course). 

(Source: Screener)

The stock has had a meltdown from its highs of ~Rs. 164 just a year back to its CMP of ~Rs. 60. That's a steep 63% correction! The only time the stock corrected more (80%+) was during the 2008 financial crisis. Whew! Tough call.

Or was it, really? I have the full advantage of hindsight, sure. But if I had valued Ashok Leyland a year or so back, I'm quite sure I would still have arrived at a very similar value as I have done today (A single year shouldn't change the value by a lot unless there are drastic fundamental changes)--perhaps even a little lower. So a price tag of Rs. 164 would have indicated a 100% overvaluation! Heck, even at the lower price point of Rs. 120 (A good 6 months before the peak), the stock would have been overvalued by ~33% and change.

I'm talking about all this because I recently came across the blog post 'Lessons from trading on Yes Bank' by Zerodha. While this isn't directly related to Ashok Leyland, a line item indicated that almost 1.25 lakh shareholders in Zerodha hold the company with a loss of 40% or more.

While I can sympathize with their situation, there is no excuse for buying a blatantly overvalued stock or even worse -- ignoring the importance of valuation in investing. What more? Even after an impressive valuation is performed, there is still the need for claiming a considerable Margin of Safety.

I will never get tired of quoting Warren Buffett and this time is no different:

For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.

Let's do a quick thought experiment. Let's say that in 10 years, Ashok Leyland will trade at ~Rs. 314, a good 18% CAGR from the CMP. But if you'd actually purchased it near the peak all those years back, it would have merely doubled over the decade, implying a terrible return of 6.70% or so. Even at a ~Rs. 120 purchase price, the 10-year CAGR would be a ~10% -- lower returns than what's offered by most less risky Debt or Hybrid instruments.

The moral of the story is: If you violate these basic principles of investing, you will be left at the mercy of the market forces and the greater fools. Not a good place to be in, all things considered.

35 comments:

  1. This is really a holistic valuation of the stock. Thank you very much for your insight and unbiased future forecast of the stock. May i request you to kindly value Edelweiss which looks very attractive at this valuation. thanks and regards

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    Replies
    1. Thank you. Regarding Edelweiss, I used to track it. But way too many subsidiaries. The BFSI business is difficult to understand at it is. The complex holding structure only makes it that much worse. I have given by trying to understand Edelweiss' business.

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  2. Hello sir, thankyou for this wonderful article. I'm 27 and just started to learn. I would be really thankful if you can answer this question for me.

    Current book value of Ashok Leyland is ~₹40 & assuming growing earnings at a CAGR of ~18% after 10 years would be close to ~₹200 and In general it is a very common sight that CMP will trade 2x-2.5x book value which makes market price of Ashok Leyland to ~₹500. So if one accumulate at avg. Of ₹100 gets 5x current valuation after 10 years. Sorry if my understanding is completely wrong. Please guide.

    ReplyDelete
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    1. No model can point out how much a stock will quote at some time in the future. That's a function of supply and demand only. My example was just to show the damage a high purchase price can do.

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  3. Thank you very much for a beautiful article.
    Request you to come up with 2 big bulls (Reliance & HDFC Ltd) & NBCC.

    Thanks again.

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    Replies
    1. Too many subsidiaries with Reliance. But HDFC Bank is a good suggestion (I've been a Shareholder in the past too). Thank you.

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  4. Good work. Your blog is very interesting. It would be very helpful for people who are not very comfortable with numbers like myself to understand the valuation in a much simpler way. Hopefully I may eventually learn as how to value a company. Thank you.

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  5. wow....what a complete analysis....but in the excel sheet i have downloaded it....do u have a list as to where all we need to feed in input values to generate reasonable output and thus a reasonable valuation ?it would help me as i can use the sheet to generate outputs for other companies too....much appreciated thanks

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    Replies
    1. You can look at my very first valuation post here: https://valuationinmotion.blogspot.com/2018/04/numbers-and-narratives-simple.html

      I have tried to explain how to use my model to value a company.

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  6. Did the resignation of vinod dasari impact the company far too much?

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    Replies
    1. I don't think so, no. It has more to do with the whole bunch of headwinds the company is facing and is yet to face too.

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  7. Can you please do the similar analysis for yes bank.. I am one of the customer of zero chance who was lucky to miss tatamotors but not enough lucky to not to pick yesbank and Ashok Leyland. I have 2000yes bank shares at 250 and 2000 AL at 89

    ReplyDelete
    Replies
    1. At this point, Yes Bank is a turnaround play. A lot hinges of the management's take on how to do it. It will be next to impossible to guess anything.

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  8. Ashok Leyland looks interesting between 58 and 64/- because all the bad news is factored into the stock. Again any bad news further will make the stock weak. Note floating stock is huge. Vinod Dasari exit and joining Eicher motors was hard to digest. It happens in all companies and we have to accept it.

    ReplyDelete
    Replies
    1. As Warren Buffett said, we should seek out a company that would do great even if an idiot ran it. That is not to underplay the ability of a good management. Managements come and go. Good business economics goes on forever.

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  9. How do we know that Automobile sector will be most trustworthy to invest in this crucial time ?

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  10. Although I am not sure how to get this factor into valuation but I would like to pick your brains on this as you have studied Ashok Leyland here. What do you think would be the effect of the Western and Eastern Freight corridors would have on truck as well as Road/Highway companies. In addition to the two freight corridors that are being built, according to recent reports railways plan to build 3 more freight corridors which would eventually cover almost entire country. As we know freight transportation is cheaper on rails than on roads would it affect the valuations of likes of Ashok Leyland or Tata Motors(Maybe for the commercial vehicle entity)?

    ReplyDelete
    Replies
    1. That's a very good point. When Vinod Dasari was still at AL, he pushed for more investments on LCVs and Buses. LCVs are also one of their fastest growing segments, because nothing beats last-mile connectivity that a Mini Truck.

      I certainly think the freight corridors present a challenge. We all know railway lines have been very successful in other countries. I think, however, M&HCV players may move to a hub-and-spoke model. The freight corridors are point-to-point only and cannot compete with M&HCVs this way.

      Probably a sublime thing to consider is GOI's push for an energy revolution. If it happens at all, petrol prices may come down considerably, which translates to direct gains for trucking players. At the same time, since freight corridors are run on electricity, it could mean more running costs for them. Obviously this is in the far future, but just a valid point on why they may both complement and not necessarily compete with each other.

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  11. Well, I am one of those who invested a large chunk at 120. Big mistake. What do you think should be the strategy now - continue - as booking loss would be even terrible I suppose...

    ReplyDelete
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    1. If you like the company and would like to hold/buy more of it, then selling makes no sense. If you think the price can go further down or if you want to invest in something else entirely, then why not.

      But about the former, I must warn you. Market Timing is very difficult. It's true that AL has a lot of headwinds in the store for it, but that is also why it has corrected 63% plus from the top. It's difficult, at least in my view, to pick the bottom of these type of things. You almost never do.

      Delete
  12. Very well explained the basic of when to add in our pf

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  13. Hope you do HDFC bank valuation in the near future.
    Thanks

    ReplyDelete
  14. Sir..please mail me your articles...very useful analysis

    ReplyDelete
    Replies
    1. Hi.. you can subscribe to my blog using the box below. You will get my latest posts straight to your inbox.

      Delete
  15. Hi Sir,
    Thanks for the forensic analysis.
    Can you please provide some insight on the debt of Hinduja Leyland Finance on future price of AL.

    ReplyDelete
    Replies
    1. Many other Auto companies like M&M and TVS also have Financial subsidiaries that cater solely to Vehicle and allied financing. These businesses are not run on great profits, but mostly aimed at increasing the Sales of the Auto Parent. So, these 'Debts' are not that bad per se. To get a better view of the Debt positions of the core operations, look at the Standalone D/E Ratio and Interest Coverage Ratios.

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  16. Hi Dinesh,
    I am a follower of you in both Quora and VP forum, You are article are very insightful and thanks keep all the good works. By the how are you able to manage your time? I know you are a full time employee in CRISIL. How are you able to get time to answer every questions and comments?
    :)

    ReplyDelete
    Replies
    1. Thank you.

      I guess when you love doing something, time is not a constraint. On a serious note, I am not as free as I used to be a year or so ago. I wish I could continue writing as before. But work is very demanding.

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