Ashok Leyland's (AL) Q3FY11 results were below expectation with profits declining to Rs434mn as against our expectation of Rs693mn. Margins during the quarter were impacted due to a one time charge of Rs260mn on account of bonus payments for FY10. Consequently, margins contracted by 390bps YoY to 7.5%. Additionally, higher capital charges led to a 59% de-growth in profit to Rs434mn.

Sequential drop in volumes: Volumes during the quarter were down 25% QoQ to 18.4k units. With new emission norms applicable from 1st Oct'10, preponement of sales in Q2FY11 led to a slowdown in volumes during the current quarter. Domestic MHCV goods segment volumes were most affected declining 42% QoQ. Demand traction from the State Transport Undertakings (STUs) supported MHCV Bus segment volumes which declined marginally to 5k units. Exports more than doubled to 3.5k units. With price hikes undertaken and increased contribution from defense sales, realisations improved 9.5% QoQ to Rs1.2mn/unit.

Margins lower due to higher employee expenses: Price hikes undertaken helped AL negate the input cost pressure. However, margins were lower by 390bps YoY to 7.5% due to 40% increase in employee expenses. Higher employee costs were due to ramp up at Pantnagar facility and a one time charge of Rs260mn on account of bonus payments for FY10. Capital charges were higher by 66% due to commissioning of Pantnagar facility and higher working capital requirement.

Outlook: While the management has reiterated a volume guidance of 95k units for FY11, we maintain our volume estimate for FY11 and FY12 at 89k and 97k respectively. Margins are expected to get a leg up in FY12 due to higher contribution from Pantnagar facility which enjoys fiscal benefits. We maintain our earnings estimates for FY11 and FY12 at Rs4.3 and Rs5.5 respectively.

VALUATIONS AND RECOMMENDATION

The stock is currently trading at 11.2x FY12E earnings. We reiterate our `BUY' rating on the stock with a price target of Rs76, discounting FY12E earnings 14x.