Valuation in Motion: Ashok Leyland Valuation: What the Truck

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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.

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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.

This pain is expected to continue until the economy revives.

Medium Term

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

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%:

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.

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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:

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.

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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.

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). 

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.

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Dinesh Sairam

Dinesh Sairam

Dinesh: Investor | Risk Consultant | Finance Geek | Writer @Quora | Blogger | Poet | MBA from XIME
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