Ashok Leyland and Tata Motors - Buy or Sell? Kotak has this recommendation

Kotak Institutional Equity has increased Fair Value for Ashok Leyland, Tata Motors due to improving CV industry fundamentals. Over the past three years, profitability of fleet operators remained under pressure due to (1) subdued freight rates, (2) higher interest rates and (3) decline in overall utilization of trucks. As per Kotak’s estimates, a fleet operator makes profit at the truck utilization rate of >70% assuming stable interest rates and fuel prices.

Fleet operators’ profitability (after paying EMI) declined from Rs 440000 in FY2016 to loss of Rs 26000 in FY2020, resulting in sharp decline in truck industry demand. With sharp recovery in economic activity, fleet operators have turned profitable as of November 2020 led by increase in truck utilization rates, partly offset by sharp increase in fuel prices. At >70% utilization levels, Kotak expects truck replacement demand to remain buoyant, which augurs well for the domestic truck industry.

Kotak Institutional Equities maintain BUY rating on Ashok Leyland with revised FV of Rs 115 (from Rs95 earlier). Kotak has increased their FY2022-23E standalone EPS estimates by 5-9% led by 8-12% increase in their volume assumptions, offset by 30 bps cut in EBITDA margin assumptions due to RM pressures. Based on 16X December 2022E EPS (from 16X September 2022E EPS earlier) + Rs13/share value of Ashok Leyland’s stake in Hinduja Leyland Finance. Market share in the domestic LCV (light commercial vehicle) segment to rise over the next few years as new launches will increase from 34% to 65% over the next two-three years, which will help the company gain further market share.

With the launch of the new modular platform, the company will be able to adopt global standards and roll out products as per geographical requirements. This will also lead to cost savings as all the products will be rolled out from this platform and aid exports growth. Given multiple tailwinds, Kotak believes the stock is attractively valued as the company will achieve RoEs of >20% once CV volumes reach FY2019 levels (likely in FY2023E) and capex spend will be only Rs 5-9 bn annually over the next 4-5 years due to low capacity utilization. Kotak expects the company to have almost nil net debt by FY2024E.

Kotak maintains SELL rating on Tata Motors with revised FV of Rs 135 (from Rs120 earlier). They have increased our consolidated FY2023E EBITDA estimates by 5% led by higher volume assumptions for the domestic CV business. Kotak remains constructive on recovery in the domestic business led by (1) revival in the domestic CV industry and (2) strong growth in the domestic PV industry aided by successful launch of Altroz. However, we have a muted outlook for recovery in JLR volumes considering the weak global economy, a weak model launch pipeline and the Brexit event in CY2021E, which could have a material impact on the JLR business.