Kotak Institutional Equities downgrades Ashok Leyland to REDUCE from ADD earlier. They have cut face value for Ashok Leyland to Rs 125 from Rs 140 earlier and downgraded to REDUCE from ADD earlier on fair valuation.  Kotak Institutional Equities have cut our FV for Tata Motors to Rs 185 from Rs 200 earlier and maintain SELL rating due to growth concerns in JLR business owing to increase in competitive intensity in EV space and economic slowdown due to resurgence of coronavirus in EU nations. Ashok Leyland share price today is Rs 121.5, down Rs 1.75 or 1.4% while Tata Motors share price today is Rs 317, down Rs 3 or 0.9%.

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CV segment demand except bus segment has witnessed a strong sequential recovery on account of:

(1)    rise in economic activity aided by resumption of construction and mining activities
(2)    increase in freight rates aiding replacement segment demand
(3)     Strong traction in the e-commerce segment. However, we expect gross margins to remain under pressure led by a steep increase in commodity baskets especially steel and precious metals

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Kotak Institutional Equities expects gross margins of CV OEMs to remain under pressure in the coming quarters given the sharp increase in commodity prices. Steel prices (12-13% of ASPs) increased by 55% from Q1 FY21 levels, which is a cause of concern for the companies. Overall, Kotak Institutional Equities expect the RM basket (adjusted for prices hikes taken till date by the companies) to go up by 350- 400 bps from Q2 FY21 levels. Furthermore, Kotak Institutional Equities do not expect OEMs to completely pass-through the commodity price increase as it may negatively impact volume growth. As a result, Kotak Institutional Equities expect gross margins for CV OEMs to come off in the coming quarters.

Over the past three years, profitability of fleet operators remained under pressure due to:

(1)    subdued freight rates
(2)    higher interest rates
(3)    decline in overall utilization of trucks

Kotak Institutional pro forma analysis of Fleet operators’ profitability (after paying EMI) suggests a sharp decline in profitability over FY2016-20 period. However fleet operators have likely turned profitable as of March 2021 led by sharp increase freight rates partly offset by sharp increase in fuel prices. Freight income ex fuel cost has improved to Rs 1.6 per ton-km in March 2021 from Rs1.2 per ton-km in March 2020. At >70% utilization levels, we believe truck replacement demand to remain buoyant which augurs well for the domestic truck industry.

Over the past six months, we have witnessed a sequential recovery in M&HCV segment (except bus segment) led by:

(1)    gradual rise in economic activity
(2)    resumption of construction based activities
(3)     announcement of multiple infrastructure projects including highways, bridges as well as mining related activities by central and various state governments

Also, the SCV, Pick-up and I&LCV segments have seen robust growth led by revival in the rural economy and an upsurge in the e-commerce sector. E-way bill registrations continue to increase on a yoy basis, which is encouraging.

Overall, Kotak Institutional Equities expect the domestic truck segment to grow by 60-70% CAGR over the next two years led by:

(1)    recovery in road freight aided by recovery in economic activity
(2)    strong replacement demand
(3)    channel inventory build-up
(4)    a lower base effect