Ashok Leyland is mentioned as one of the promising mid cap auto stocks. It has rallied from a low of 14.90 in March this year to a high of 57.5 a week back.
The first problem I encountered was in the growth rate
The growth rate in revenues has been fluctuating in the following way- '10- 25%, '11-49%, '12-16%, '13-(7%), '14- (20%) (brackets imply negative numbers)
According to reports, analysts have estimated a 14% growth rate. An average of the past 5 years also suggests that the growth rate would be 13%. The negative growth rates in recent years are because of the economy in general doing bad especially infra sector which requires a backbone of transport which went down. Auto sales in general have gone down because of less buying power but the same reason cannot be incorporated to commercial vehicles segment which is where Ashok Leyland lies.
The cost of capital was the second major problem as there were very less competitors whom I could average out the sector beta. I have compared with only Eicher and didn't consider Tata Motors as that would include the presence of non commercial vehicles.
Ashok Leyland has a high Beta of 1.59 right now which I have dragged down to 1.2 in 10 years. This beta is available in the FCFF sheet with which you can play around. You can download the valuation here. I have taken a 10 year period for stable growth because the industry doesn't look like its going to reach a stable period soon. The losses will be recovered in the next couple of years because of the government's push into infrastructure and manufacturing which will couple the need for logistics.
The industry has declined considerably and will take time to retain its original share. I have given a 15% growth rate for this FY owning to positive sentiment bounding back in the company and the promise of structural reforms. Logistics will have a lag effect and the increase in demand will be felt later on. I have increased the growth in steps till it hits the maximum of 35% in 2019 and then slowly scaled it back to 10% over the next 5 years. For terminal value I have estimated a growth of 5% after 10 years which you can change if you believe the firm can get a higher growth rate.
The third problem and the most obvious problem with most valuations was identifying the reinvestment rate. Damodaran suggests two methods, sales to capital ratio or checking growth with a feasible ratio to find out the reinvestment rate with the formula Reinvestment rate = Growth Rate/ROC. I couldn't key in onto a certain sales to capital ratio because I had very few industries in my sample and the problem with ROC was that it varied not only across firms but across different years of the firm. I observed the different investments over the past years and noted on average the firm was investing more than a 100% of the EBIT(1-T). I maintained the same investment for a few years and slowly dragged down the reinvestment rate until 30% for terminal value.
After obtaining the terminal value of Rs 8885 cr, I subtracted the cash holdings and the debt. The debt was a substantial Rs 3883.91 cr which brought down the equity value to Rs 6215 cr. With the total shares outstanding this gave a value of Rs 21.84 per share.
The share price is grossly overpriced at this moment but before the spike in prices, during March when it was at Rs 11, this was definitely a buy. Right now, my advice to all those who own this stock and believe in value based investment, DUMP the stock!
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