Analysis: Ashok Leyland Ltd

The current section of the “Analysis” series covers Ashok Leyland Ltd, a part of the Hinduja Group, is one of the leading manufacturers of commercial vehicles in India. Ashok Leyland Ltd specializes in medium & heavy commercial vehicles and buses.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Ashok Leyland Ltd Research Report by Reader

Sales & Profit Growth:

Ashok Leyland has been growing its sales consistently at an excellent pace of about 16.4% year on year for the last 10 years (FY2010-19). It is important to note that this sales growth has been accompanied by improving profitability.

Operating profit margins (OPM) has been around 10% in FY2009-19. Similarly, net profit margins (NPM) have been marginally improving from 6% in FY2009-10 to 7% in FY2018-19, which is marginally less than required 8%.

Sales growth with improving profitability margins is a good sign for any investment opportunity.

Ashok Leyland has been paying taxes at a 21-28% rate in FY2010 and FY2019, which is slightly less from the standard corporate tax rate of 33%. Though the tax rates have been fluctuating widely in the past, however, now it seems to have stabilized around 21. This is another good sign.

Operating efficiency analysis of Ashok Leyland Ltd:

Net fixed assets turnover (NFAT) of the company has been improving from 1.7 in FY2009-10 to 5.0 in FY2018-19.

Inventory turnover ratio has improved from 5 in FY2009-10 to 11 in FY2018-19.

Improving asset and inventory turnover indicates that Ashok Leyland Ltd is able to use its capital more efficiently and generate higher sales from the same level of assets.

Receivables days have improved from 50 days in FY2010 to 30 days in FY2019. Improvement in receivables days indicates that the company has been able to collect the money from its customers faster, indicating its growing influence in the market.

The cumulative profits and cash flow data for the last 10 years (FY2010-19) show that Ashok Leyland Ltd has been able to convert its profits into cash flow from operations. PAT for these years is ₹7,732 cr. whereas the CFO over a similar period has been ₹15,009 cr. after working capital changes.

Self-Sustainable Growth Rate Analysis of Ashok Leyland Ltd:

Self-Sustainable Growth Rate (SSGR) of Ashok Leyland is mostly negative from 2010 to 2018 and then it improved to 7.2% in 2019. Sales growth has varied from 15 to 23% on a 3-year average basis, except for the negative growth in 2013 and 2014.

Analysis of SSGR indicates that Ashok Leyland Ltd can sustain a growth rate of only 7% from its core operations without getting more under debt burden. However, an investor would notice that Ashok Leyland has been growing at a pace of 15 to 23% over the last 10 years.

The growth beyond SSGR has been funded by raising additional debt and equity.

The debt levels of Ashok Leyland have increased from ₹2,280 cr in FY2010 to ₹4,690 cr in FY2014 and then reduced to ₹632 cr in 2019 as it started showing consolidated reports separately from 2014 where the debt shows increasing from ₹8,500 cr in 2014 to ₹19,168 cr in 2019.

The equity capital was raised from 133cr to 266cr by issuing 1:1 bonus shares in 2011.

During 2015, Company placed 185,200,000 equity shares through the process of Qualified Institutional Placement (QIP) and raised an amount of ₹666.72 crores. Consequently, the equity share capital of the Company increased from 266 crores to 285 crores.

During the year 2018, Ashok Leyland issued and allotted 80,658,292 fully paid equity shares of ₹1/- each to the equity shareholders of the erstwhile Hinduja Foundries Limited as per the Scheme of Amalgamation approved by National Company Law Tribunal.

During the year 2018, the company issued and allotted 569,175 shares to Mr. Vinod K Dasari, Chief Executive Officer and Managing Director upon exercise of stock options granted under Ashok Leyland Employees Stock Option Plan 2016. It also issued and allotted 37,27,000 shares to Mr. Vinod K Dasari, Chief Executive Officer and Managing Director upon exercise of stock options granted under Ashok Leyland Employees Stock Option Plan 2016. Consequent to the above, the issued and paid-up share capital increased to 293 Cr.

During FY2010-19, ₹3,982 cr. were spent into capital expenditure, thereby getting a positive free cash flow (FCF) of ₹11,027 cr. in the standalone results. However consolidated statement shows a capex of 2,453 Cr and negative FCF of 5,750 Cr. from 2014 to 2019.

Debt to Equity ratio of consolidated statement comes to 2.19, which is very high. For standalone, it is 0.35, which looks good.

In standalone results, the current ratio comes to be 0.87, which is, very less while in consolidated CR is 1.63, which looks good.

With good sales performance and improved profitability margins, Ashok Leyland Ltd has been paying out dividends consistently to its shareholders for FY2010-19 amounting to a total dividend payout of ₹11 per share. The company has been increasing its dividend payout with increasing profits. This is a good sign in any investment opportunity.

Share market too seems to have recognized it. The market capitalization of the Ashok Leyland has increased by ₹19,378 cr. (EPS increased from 1.6 to 7.5) against retained earnings of ₹17 per share over the last 10 years (FY2010-19). Management, thus, has generated a 35% return on retained earnings for the shareholders.

Ashok Leyland Ltd is currently (April 9, 2020) available at a P/E ratio of about 12.66, which offers some margin of safety in the purchase price.

Management Analysis of Ashok Leyland Ltd:

The salary of directors, board members, and senior management for the last 10 years is summarized below. It is in the range of 1 to 2%; however, it goes up to 7% in 2019 as stock options were exercised.

Still the total management salary 7% of net profit is well below statutory limits of 11% based on the net profit of 2019. It includes a major amount of options exercised.

Regards,

Jai Singh Baghel

Dr Vijay Malik’s Response

Hi Jai Singh,

Thanks for sharing the analysis of Ashok Leyland Ltd with us! We appreciate the time & effort put in by you in the analysis.

While analyzing the past financial performance data of Ashok Leyland Ltd, an investor would notice that the company has many subsidiaries and associate companies. As a result, Ashok Leyland Ltd provides both standalone financials as well as consolidated financials in its annual reports.

Ideally, we believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Consolidated financials of any company present such a picture.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

However, in the case of Ashok Leyland Ltd, one of the subsidiaries is Hinduja Leyland Finance Ltd, which is a non-banking finance company (NBFC).

An investor would appreciate that the business model of a manufacturing company and an NBFC are entirely different. Whereas a manufacturing company primarily relies on generating business value from its fixed assets and minimizing debt, the NBFCs treat cash as raw material and therefore, raise significantly high debt to increase their business operations.

Therefore, merging the financials of a manufacturing company and an NBFC is not a good proposition for an analysis.

As a result, in the case of Ashok Leyland Ltd, we have opted to analyse its standalone financials instead of the consolidated financials in our analysis.

Moreover, as per the FY2019 financial position, the standalone sales of the company are ₹29,055 cr against the consolidated sales of ₹33,197 cr i.e. representing 87.5% of total sales. Similarly, the standalone net profit after tax (PAT) is ₹1,983 cr against the consolidated PAT of ₹2,079 cr i.e. representing 95.4% of the total PAT.

Therefore, in the case of Ashok Leyland Ltd, if an investor analyses the standalone financials of the company, then she is able to analyse about 90% of the overall operations of the company. Nevertheless, an investor should appreciate that despite covering about 90% of the group operations, the standalone financials leave out about 10% of the business for which she should analyse the NBFC (Hinduja Leyland Finance Ltd) separately to supplement her analysis.

Such a piecemeal approach is essential because merging the financials of the manufacturing divisions of the Ashok Leyland Ltd with its NBFC operations leads to the creation of such consolidated financials, which are not meaningful to interpret.

With these assumptions in our mind, let us analyse the financial and business performance of the company over the last 10 years

Financial and Business Analysis of Ashok Leyland Ltd:

While analyzing the financials of Ashok Leyland Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 15%-20% year on year. Sales of the company increased from ₹7,407 cr. in FY2010 to ₹29,055 cr in FY2019. However, the sales have declined to ₹22,475 cr in the 12 months ending Dec. 2019 (i.e. Jan 2019-Dec. 2019).

In the last 10 years (FY2010-2019), the sales growth of the company has been highly fluctuating.

The company witnessed an increase in sales initially from ₹7,407 cr to ₹13,380 cr in FY2010-FY2012. However, then the sales declined to ₹10,301 cr by FY2014. Afterwards, the sales increased to ₹29,055 cr in FY2019 only to decline again to ₹22,475 cr in the 12 months ending Dec. 2019 (i.e. Jan 2019-Dec. 2019).

Such kind of sales performance indicates to an investor that the business performance of the company is exposed to cyclical factors.

While analysing the profitability of the company, an investor would notice that the operating profit margin (OPM) of Ashok Leyland Ltd has also fluctuated significantly over the years.

The OPM of the company improved from 10% to 11% over FY2010-FY2011. Subsequently, the OPM declined sharply to 1% by FY2014. Thereafter, the profitability of the company started improving and the OPM improved to 13% in FY2016. However, the fluctuations in the OPM continued with a decline to 9% in FY2017, increase to 11% in FY2019, and now again decline to 9% in the 12 months ending Dec. 2019 (i.e. Jan 2019-Dec. 2019).

When an investor notices such kind of cyclical performance in both the sales as well as profitability, then she acknowledges the need for a deeper understanding of the business of Ashok Leyland Ltd to understand the factors influencing the business performance of the company. This is because, once an investor has understood the key factors for Ashok Leyland Ltd, then she would be able to have a view about the expected future performance of the company.

In the case of the commercial vehicle industry, an investor would appreciate that it is cyclical in nature. This is because the sales of commercial vehicles are primarily dependent on the state of the economy, govt. spending on infrastructure etc., which usually follow a cyclical pattern of demand increase and decline.

The credit rating agency, CARE Ltd., has highlighted this cyclical aspect of the business of Ashok Leyland Ltd in its credit rating report for the company in April 2020.

The automotive industry is cyclical in nature as it derives its demand from the investments and spending by the Government and individuals. Domestic CV Industry experienced poor demand between FY13-15 in the backdrop of slow economic growth. Post FY15 the business sentiments showed signs of revival. The domestic Commercial Vehicle industry registered 17.6% growth during FY19 after reporting growth of 20% in FY18. However, growth has witnessed moderation significantly since the second quarter of FY20 on account of different factors…

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

CARE Ltd has highlighted that the automotive business is dependent on the spending and investment by Govt. and individuals, which results in its cyclical nature of the automotive industry including the commercial vehicle industry.

Ashok Leyland Ltd also intimated its shareholders about the cyclical nature of the commercial vehicle industry in its various annual reports. For example, the FY2003 annual report, page 20:

Business risks include cyclical nature of demand for CVs due to economic slowdown, risks of technological obsolescence due to stricter emission/safety norms and more intense competition.

The inherent cyclical nature of the commercial vehicle industry helps an investor understand the fluctuations in the sales growth of Ashok Leyland Ltd, which saw phases of increase and decrease in its sales over the last 10 years.

However, to understand more about the business model of the company and its fluctuating profit margins, an investor needs to analyse its annual reports.

An investor would acknowledge that annual reports of any company are the best resource to understand its business dynamics. Ashok Leyland Ltd has provided its annual reports for the past 18 years (from FY2002 to FY2019) on its website. An analysis of these annual reports highlights the key factors influencing the performance of the company over the years.

An investor would appreciate that fluctuating profit margins of Ashok Leyland Ltd indicate that it is not able to pass on the impact of the increase in its raw material costs to its customers. Ashok Leyland Ltd has faced this situation of inability to pass on the increase in input costs for a very long time. One of the key reasons for the inability to pass on the increased costs to the customers is the intense competition faced by the company in its business.

In the 2006 annual report, the company highlighted its inability to pass on the increased costs to the customers due to competition.

FY2006 annual report, page 37:

Concerns on input cost increases due to commodity price movements, coupled with cost increases arising out of improvements in product designs and upgradation to meet emission norms continue. Due to competitive pressures, these cost increases have not been fully passed on to the customers. The commercial vehicle industry in India will witness a higher level of competition following the proposed plans announced by automotive companies both Indian and foreign.

The company highlighted the intense competition in the industry to its shareholders again in 2007 when it said that many international competitors have entered the Indian market and opening up of the trade barriers has further increased the competition and custom duty is no longer protecting Indian players.

FY2007 annual report, page 55:

Competition in the domestic CV market has increased significantly with many multi-national companies setting up manufacturing base. Consequent to the policy of opening up the market, customs duty, as a trade barrier, is likely to lose its influence.

The company also highlighted to the shareholders that it is not able to pass on the increase in its costs to its customers.

FY2007 annual report, page 57:

The current year witnessed increase in commodity prices and consequent price increase claims by suppliers. In addition, there were cost increases on account of compliance with statutory regulations, which has not been fully passed on to the customers. The margin also suffered due to full impact of previous year’s input cost increases.

The precarious position of Ashok Leyland Ltd indicating its inability to pass on the increase in input costs to its customers, which is reflected in its annual reports of 2006 – 2007, is continuing in recent times.

In the conference call conducted by the company in February 2020 to discuss its Q3-FY2020 result, the company expressed helplessness at the extent of the cutthroat competition in the commercial vehicle industry.

While answering a question about the situation of prevailing discounts in the industry, the chief financial officer & whole-time director of the company, Gopal Mahadevan replied that the competitors of the company are willing to go to any extent of discounting to gain market share.

February 2020 conference call, page 21:

The discount levels are still high. So these are very average numbers. They defy any logic, to be honest with you, and they are at 5.25 lakhs on an average on a vehicle, and it is very, very difficult, they are about 5.25 lakh on a vehicle. They have gone by about 25000 on an average. But this quarter, we have witnessed some deals being taken off as which are going at 7 lakhs, etc. It is ridiculous to, I mean they are selling at 24 lakhs, 22 lakhs, 23 lakhs and say, “I will give a 7 lakhs discount.” I mean I do not make that kind of money.

So it is very desperate. I do not understand the game, I think competition is in the game of acquiring market share at any cost.

From the above discussion, an investor would appreciate that the commercial vehicle industry in India has been intensely competitive for long. The competition levels increased further in the last decade when the multi-national players entered in India.

An investor would appreciate that in the presence of the cutthroat competition, it is very difficult for the manufacturers to pass on the increase in raw material costs to the customers without the fear of losing market share. The importance of market share for the management of any company, including Ashok Leyland Ltd is reflected in the following comment by Mr. Gopal Mahadevan in the February 2020 conference call, page 21:

And for us, so let me tell you, market share is very, very important as the company. I mean that is why it is one of the most important metrics for our bonuses also. If we do not achieve market share, we do not get bonus. So for us, market share is very, very important. We want to grow. We want to be in a leading position. But we have to ensure that we are doing it in a methodical manner. That is all.

Therefore, an investor would notice that if a company in the commercial vehicle segment decides to pass on all the increases in the input costs, then it would lose its market share to its competitors who are willing to give higher discounts to gain customers.

As a result, investors would notice that during down-cycles phases, the companies bear the increased costs themselves and their profit margins fall. Only when the industry enters the up-cycle phase and the demand of the commercial vehicles increases, then the manufacturers are able to increase prices and in turn enjoy higher profits.

Therefore, investors would appreciate that due to the cyclical nature of the commercial vehicle industry and the intense competition to gain market share, the commercial vehicle manufacturers witness repeated periods of high sales growth with increasing profit margins followed by periods of declining sales with poor profit margins.

It is the basic nature of the commercial vehicle industry and therefore, an investor should always keep this aspect of the industry in mind whenever she analyses any commercial vehicle manufacturer. If she notices that the commercial vehicle manufacturers have witnessed a period of good sales growth with high-profit margins, then she should keep in mind that soon the industry would face the down-cycle and the sales growth, as well as profit margins, would decline.

Read: How to do Business & Industry Analysis of a Company

While looking at the tax payout ratio of Ashok Leyland Ltd., an investor notices that for most of the last 10 years (FY2010-2019), the tax payout ratio of the company has been less than the standard corporate tax rate prevalent in India.

One of the key reasons for the lower tax payout ratio is the availability of the tax incentives available to the company due to the location of its manufacturing plants. The plant of the company located at Pant Nagar in Uttarakhand has exemptions for both excise duty as well as income tax on the profits.

July 2014 placement document for the Qualified Institutional Placement (QIP), page 132 (Source: BSE)

The Pant Nagar facility also benefits from certain fiscal incentives from the state government and the GoI, e.g. we are exempt from excise duties levied on vehicles manufactured in the Pant Nagar facility until March 2020. In addition, 100% of the profits at the Pant Nagar facilities are tax exempt until Fiscal 2014 and 30% of its profits are tax exempt from Fiscal 2015 until Fiscal 2019.

As a result, of the tax incentives available to Ashok Leyland Ltd, the company has reported a lower tax payout ratio in most of the last 10 years (FY2010-2019).

Operating Efficiency Analysis of Ashok Leyland Ltd:

a) Net fixed asset turnover (NFAT) of Ashok Leyland Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Ashok Leyland Ltd in the past years (FY2010-19), then she notices that the NFAT of the company has seen the following trends:

• FY2010-FY2012: Increase
• FY2013-FY2014: Decrease
• FY2015-FY2019: Increase

An investor notices that the NFAT of any company represents how efficiently it uses its fixed assets to generate sales.

When an investor analyses the manufacturing capacity of Ashok Leyland Ltd, then she notices that the last major capacity addition was done by the company in FY2010, when its manufacturing capacity increased to 150,500 vehicles per annum.

FY2010 annual report, page 5:

With the commissioning of the modern, fully integrated plant at Pantnagar (Uttarakhand) in March 2010, additional capacity for 75,000 vehicles/year has been created. Overall annual capacity for the Company is now 1,50,500 vehicles (on a two-shift basis).

After almost 10 years, in 2020, the manufacturing capacity of the company is still the same 150,500.

Credit rating report of Ashok Leyland Ltd by CARE, April 2020, page 3:

ALL has seven manufacturing plants (total manufacturing capacity of 1,50,500 units) across five different locations, with the parent plant at Ennore….

Therefore, an investor would notice that over the last 10 years, the vehicle manufacturing capacity of Ashok Leyland Ltd has stayed constant at 150,500 vehicles per annum.

With a fixed manufacturing capacity, the NFAT of any company will depend on capacity utilization. In the years, when the company produces and sells a higher number of vehicles, then its NFAT increases. On the contrary, during the years in which it sells a lower number of vehicles, then its NFAT decreases.

The following chart from the FY2019 annual report of Ashok Leyland Ltd indicating the number of vehicles sold by the company in the last 10 years provides a good glimpse to the investor about the changing utilization levels of the manufacturing capacity of the company.

FY2019 annual report, page 49:

When an investor analyses the data of the vehicle sales by Ashok Leyland Ltd over the last 10 years with the data of the NFAT of the company over the last 10 years, then she notices that there is a direct correlation between the two.

• FY2010-FY2012: Vehicle sales: Increase | NFAT: Increase
• FY2013-FY2014: Vehicle sales: Decrease | NFAT: Decrease
• FY2015-FY2019: Vehicle sales: Increase | NFAT: Increase

Therefore, looking at the above data, an investor can understand the reasons behind the fluctuating NFAT of Ashok Leyland Ltd over the last 10 years (FY2010-2019).

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio of Ashok Leyland Ltd:

While analysing the inventory turnover ratio (ITR) of the company, an investor notices that the ITR of Ashok Leyland Ltd had been witnessing an increasing trend from 5.9 in FY2010 to 12.5 in FY2016 when it suddenly witnessed a sudden decline in FY2017 to 9.5.

After FY2017, the ITR of the company has again improved to 13.1 in FY2019.

When an investor reads the annual reports of the company to understand the reason for the decline of ITR in FY2017, then she gets to know that in this period, India has transitioned in vehicle emission norms from BS-III to BS-IV. As a result, Ashok Leyland Ltd was stuck with an inventory of BS-III vehicles that it could not sell before the deadline of March 31, 2017.

Therefore, the company had to modify some of the BS-III vehicles to BS-IV and export the rest of the vehicles to countries where such vehicles could be sold. For this interim period, the company had to keep those vehicles as an inventory, which resulted in an increase in inventory of the company from ₹1,625 cr in FY2016 to ₹2,631 cr in FY2017.

The company explained this situation to the shareholders in its FY2017 annual report, page 51-52:

Out of 9572 BS III vehicles identified for disposal, 2449 vehicles have been earmarked for export markets and balance 7123 vehicles have been identified for conversion from BS III to BS IV…..

….Since these vehicles are not saleable in India, pending conversion to BS IV these were classified as WIP in the accounts.

Therefore, in FY2017, due to the transition from BS-III to BS-IV, the presence of a large inventory of vehicles led to a decline in the inventory turnover ratio of the company.

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Ashok Leyland Ltd:

While analysing the receivables days of the company, an investor notices that the receivables days of the company used to about 30-35 days during FY2010-2012, which deteriorated to 48 days in FY2014. An investor would remember from the discussion above that FY2014 was one of the toughest periods for the company in which it reported a sharp decline in the profit margins.

An investor can appreciate that during the tough business phase (industry down-cycle); the company might have had to give incentives to buyers in terms of a higher credit period for selling vehicles. In addition, the customers would have delayed payments on existing sales due to a tough business environment.

As a result, an investor would notice that in FY2014, the receivables days of the company deteriorated to 48 days. However, afterwards, as the business environment for the commercial vehicle industry improved then the receivables days of the company declined to 20-22 days until FY2019.

Further Advised Reading: Receivable Days: A Complete Guide

Looking at the inventory turnover ratio as well as at receivables days of Ashok Leyland Ltd, an investor would notice that the company has been able to keep its working capital position under control. As a result, it has not witnessed a lot of money being stuck in the working capital.

An investor observes the same while comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2010-19.

Over FY2010-19, Ashok Leyland Ltd Limited reported a total cumulative net profit after tax (cPAT) of ₹7,732 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹15,009 cr. An investor notices that the company has very high cCFO when compared to the cPAT over the last 10 years (FY2010-2019).

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have the CFO higher than the PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Learnings from the above-shared article will indicate to an investor that the cCFO of Ashok Leyland Ltd is significantly higher than the cPAT due to following factors:

• Interest expense of ₹2,390 cr (a non-operating expense) over FY2010-2019, which is deducted while calculating PAT but is added back while calculating CFO.
• Depreciation expense of ₹4,224 cr (a non-cash expense) over FY2010, which is deducted while calculating PAT but is added back while calculating CFO.

Therefore, an investor would appreciate that during FY2010-2019, Ashok Leyland Ltd has kept its working capital requirements under check. As a result, it has been able to convert its profits into cash flow from operations.

The Margin of Safety in the Business of Ashok Leyland Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of Ashok Leyland Ltd, an investor would notice that the company has consistently had a low SSGR (negative to 0%) over the years. Only in recent years (FY2019), the SSGR has improved to 7%, which is primarily due to a recent increase in the net profit margin (NPM) of the company in FY2019 and the increase in NFAT of the company to all-time high levels of 5.21.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the NFAT and net profit margin (NPM) of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

An investor would notice that in FY2019, the NPM has increased to 7% and the NFAT has increased to 5.21, which is the highest level for the company over the years. It indicates that the company is making more money and using it efficiently. As a result, the SSGR has increased to 7% in FY2019.

However, an investor would appreciate that the company has been growing at a rate of 15-20% over the years. The historical low SSGR indicates that the company does not seem to have the inherent ability to grow at the rate of 15-20% from its business profits. As a result, investors would think that Ashok Leyland Ltd would have to raise money from additional sources like debt or equity to meet its investment requirements.

An investor would appreciate that in the first half of the last 10 years, the company was relying on debt to meet its growth requirements. As a result, it witnessed its debt levels increase from ₹2,280 cr in FY2010 to ₹4,690 cr in FY2014.

The debt of the company was increasing fast and in turn, was becoming disproportionate to the level promised by the company to its stakeholders like its lenders. As a result, the company had to raise equity money by way of a qualified institutional placement (QIP) in FY2015 to repay its debt and bring the leverage level under control.

FY2015 annual report, page 6:

During the year under review, your Company successfully placed 185,200,000 equity shares through the process of Qualified Institutional Placement (QIP) and raised an amount of ₹666.72 crore. The proceeds received through QIP were utilised for the purpose for which it was raised.

While reading the placement document for the above-mentioned QIP of Ashok Leyland Ltd (source: BSE), an investor notices that the debt levels of the company had breached the covenants (financial conditions) put by its lenders indicating that the debt position of Ashok Leyland Ltd was getting out of control.

QIP placement document of Ashok Leyland Ltd, July 2014, page 39-40:

The Company has breached certain covenants under some of its financing arrangements. The lenders may declare a default and enforce their remedies under these financing documents, and lenders under our other financing agreements that contain cross-default provisions could take similar actions. If such remedies are exercised, our financial condition and results of operations could be adversely affected.

(1) Bank of America Facility Agreement: The Company had breached the financial covenant on total gross borrowings to tangible net worth for the testing period ended March 31, 2012,…..

(2) DBS Bank Facility Agreement: The Company had breached the financial covenants being total debt to EBITDA and EBITDA to interest expense for the testing period ended March 31, 2014;

(3) Mizuho Corporate Bank Facility Agreement: The Company had breached the financial covenants on total debt to EBITDA (on consolidated basis) and EBITDA to interest expense (on consolidated basis) for the testing period ended March 31, 2014;………..

Similarly, as per the placement document, Ashok Leyland Ltd had also breached the covenants put by (4) Barclays Bank Facility Agreement, (5) Nova Scotia Asia Facility Agreement, and (6) Bank of Tokyo Facility Agreement as well.

An investor would appreciate that breaching the covenants (financial conditions) put in by the lenders is a serious situation and the company had to do something to rectify it. If the company continues to be in a position of breach of these covenants, then the lenders could declare a default by the company and in an extreme case, could ask the company to return the money that it had taken from them.

As a result, the fast increasing debt beyond the levels permitted by the lenders made Ashok Leyland Ltd raise money from equity and in turn, bring the debt & the leverage levels under control.

Nevertheless, since FY2015 onwards, the company has been able to keep its debt levels under check and in turn, has brought the debt levels down from ₹4,690 cr in FY2014 to ₹632 cr in FY2019.

An investor may believe that the debt level of the company in FY2019 (₹632 cr) is lower than the FY2010 levels (₹2,280 cr); however, as per the latest available balance sheet of Sept 30, 2019, the debt level of the company has increased again to ₹2,585 cr. (= 1,168 + 1,417)

Q2-FY2019 results of Ashok Leyland Ltd, page 4:

Nevertheless, if an investor only compares the debt level of Ashok Leyland Ltd from FY2010 to FY2019, then she notices that the company has managed to reduce its debt level over the last 10 years.

An investor reaches a similar observation when she analyses the free cash flow (FCF) position of the company over the last 10 years (FY2010-2019).

b) Free Cash Flow (FCF) Analysis of Ashok Leyland Ltd:

While looking at the cash flow performance of Ashok Leyland Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹15,009 cr. During this period it did a capital expenditure (capex) of ₹5,481 cr. As a result, an investor would note that over FY2010-2019, Ashok Leyland Ltd had a free cash flow (FCF) of ₹9,528 cr. ( = 15,009 – 5,481).

In addition to the above FCF, the company has also had non-operating income (other income) of ₹1,715 cr over the last 10 years and inflow from QIP of about ₹666 cr.

Therefore, in the last 10 years (FY2010-2019), Ashok Leyland Ltd had total surplus funds of ₹11,909 cr (= 9,528 + 1,715 + 666)

An investor notices that the company has used these surplus funds in the following manner:

• Reduce debt by ₹1,648 cr from ₹2,280 cr in FY2010 to ₹632 cr in FY2019 (2,280 – 632 = 1,648)
• Interest expense as per the profit and loss statement: ₹2,390 cr
• Dividends to equity shareholders: ₹3,355 cr (without dividend distribution tax) and
• About ₹3,165 cr as an increase in cash & investments. The cash & investments has increased from ₹845 cr from FY2010 to ₹4,010 from FY2019 (4,010 – 845 = 3,165). The increase in cash & investments primarily represents the money invested by Ashok Leyland Ltd in its subsidiaries, joint ventures, and associate companies etc.

It is advised that investors should always try to analyse the surplus cash generation by companies in the past along with its utilization so that they may trace the funds generated by the company over the years from its business.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of Ashok Leyland Ltd

On analysing Ashok Leyland Ltd and reading its publicly available past annual reports of 18 years (from FY2002 to FY2019), and reading other public documents an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Management Succession of Ashok Leyland Ltd:

An investor notices that the Hinduja group took over Ashok Leyland Ltd in 1987. Currently, Mr. Dheeraj Hinduja, aged 48 years, is the non-executive Chairman of the company.

FY2019 annual report, page 27:

As on March 31, 2019 the Board comprised of ten Directors. Of the ten directors, nine (90%) are non-executive directors and eight (80%) are independent directors including a woman director, with Mr. Dheeraj G Hinduja as Non-Executive Chairman

An investor would notice that the member of the promoter, Hinduja family is a non-executive member of the board of directors, therefore, the executive leadership of the company has been in the hands of professional managers.

Mr. R. Seshasayee handled the executive leadership of the company as the managing director of the company from April 1998 to March 2011 (Source: LinkedIn profile of Mr. R. Seshasayee)

Since April 2011 to March 2019, Mr. Vinod Dasari led the company as the managing director (MD) and chief executive officer (CEO) of the company (Source: LinkedIn profile of Mr. Vinod Dasari)

As Mr. Dasari left Ashok Leyland Ltd to join Royal Enfield, the company has appointed Mr. Vipin Sondhi as MD & CEO of the company from December 12, 2019. Mr. Sondhi was MD & CEO of JCB India for about 14 years before joining Ashok Leyland Ltd in November 2019.

December 12, 2019 press release:

12 December 2019, Chennai: Ashok Leyland, India’s leading commercial vehicles manufacturer today announced that Vipin Sondhi has been appointed as MD & CEO of the Company with immediate effect…

Vipin Sondhi formally joined the Hinduja Group in November 2019 from JCB, where he was the MD & CEO – India, South East Asia & Pacific and a member of their Global Executive Leadership Team. He was MD & CEO of JCB lndia for about 14 years…

Therefore, an investor would notice that over the years, Ashok Leyland Ltd has appointed non-promoters as executive leaders of the company in the positions of MD & CEO and member of the promoter (Hinduja) family is present on the board as a non-executive chairman.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

2) Project Execution by Ashok Leyland Ltd:

While analysing the past performance of the company, an investor notices that Ashok Leyland Ltd has been able to execute its capacity expansion projects at frequent intervals.

• FY2005: manufacturing capacity increased from 50,000 vehicles per year to 67,500 vehicles per year. FY2005 annual report, page 36:

Productivity improvements, lean manufacturing initiatives and outsourcing strategies have enabled the Company increase its vehicle build capacity to 67,500 units per annum with marginal investments.

• FY2006: manufacturing capacity increased from 67,500 vehicles per year to 77,200 vehicles per year. FY2006 annual report, page 35:

The Company has overcome production bottlenecks to a large extent and has achieved satisfactory productivity levels in all plants, following the recent wage settlements. This has enabled the Company to increase its vehicle manufacturing capacity to 77,200 units from 67,500 units.

• FY2007: manufacturing capacity increased from 77,200 vehicles per year to 84,000 vehicles per year. FY2007 annual report, page 58:

During the year, the Company incurred capital expenditure of Rs.6,135 million. This expenditure covers investments in capacity expansion / upgradation and R&D. During the year, the capacity increased from 77,200 vehicles to 84,000 vehicles.

• FY2009: manufacturing capacity increased from 84,000 vehicles per year to 100,500 vehicles per year. FY2009 annual report, page 47:

• FY2010: manufacturing capacity increased from 100,500 vehicles per year to 150,500 vehicles per year. FY2010 annual report, page 5:

With the commissioning of the modern, fully integrated plant at Pantnagar (Uttarakhand) in March 2010, additional capacity for 75,000 vehicles/year has been created. Overall annual capacity for the Company is now 1,50,500 vehicles (on a two-shift basis).

Similarly, the company could complete the plants for:

• Manufacturing bus bodies in UAE in December 2010
• Manufacturing construction equipment with JCB in October 2010
• Manufacturing plant for high pressure die casting components under Ashley Alteams India Private Ltd in FY2010
• Manufacturing plant for light commercial vehicles in a joint venture with Nissan.

Therefore, an investor would appreciate that the company has been able to complete its capacity expansion projects at frequent intervals to support its growing business.

3) Capital allocation decisions by Ashok Leyland Ltd:

While analysing the history of the company, an investor comes across many instances where Ashok Leyland Ltd invested shareholders capital into different ventures in order to generate returns for the shareholders.

An analysis of some of these decisions provides an insight into the capital allocation efficiency of the management of Ashok Leyland Ltd.

A) Investments in Optare Plc. UK:

In the FY2011 annual report, the chairman of Ashok Leyland Ltd intimated its shareholders that the company has bought out a 26% stake in Optare Plc. UK, which is a bus manufacturer.

FY2011 annual report, page 2:

Your Company acquired a 26% controlling stake in Optare plc, U.K. a reputed bus manufacturer with a proven experience in hybrid and electric vehicles. They manufacture a range of urban buses with integral architecture including the iconic Solo midi bus range. The acquisition will further strengthen the leadership position of your Company in the domestic market and is also expected to open up new frontiers in the developed markets.

The management of the company seemed very optimistic about the acquisition and expected that it would help them in both Indian and overseas markets.

Ashok Leyland invested about ₹50 cr to acquire 26% of Optare Plc in FY2011.

FY2011 annual report, page 66:

The next year, in FY2012, Ashok Leyland Ltd increased its stake in Optare Plc from 26% to 75.1%.

FY2012 annual report, page 45:

During the year, your Company along with the investment arms have increased their stake to 75.1% (from earlier 26%) in Optare plc UK.

An investor would think that if Ashok Leyland Ltd had paid about ₹50 cr to acquire a 26% stake last year (FY2011), then now in FY2012, to increase the stake to 75%, it would have to pay roughly double the money spent to buy 26% stake. This is assuming that the value of the business of Optare is not changed over this period.

However, as the company disclosed that it has taken an additional stake in Optare along with its investment arms (separate subsidiaries) and it did not publish consolidated financials until FY2014; therefore, an investor is not able to determine the amount of money invested by the company to purchase total 75.1% stake in FY2012.

In FY2012, an investor can only get to know from the standalone financials that Ashok Leyland Ltd invested only ₹8 cr additional in Optare. This is because, as per the FY2012 annual report of Ashok Leyland Ltd, its investment in Optare stood at about ₹58 cr.

FY2012 annual report, page 66:

Further analysis of the FY2012 annual report, reveals that the additional stake to Ashok Leyland Ltd seems to be allotted by Optare as a part of some restructuring exercise.

FY2012 annual report, page 69:

In lieu of 19,55,57,828 Ordinary Shares in Optare plc of face value of British Pence 1 each, the Company was allotted an equal number of New Ordinary Shares with face value of British Pence 0.1 each and Deferred Shares with face value of British Pence 0.9 each pursuant to a restructuring exercise by Optare plc. The value of shares received has been recorded at lower of cost and fair value.

Moreover, upon looking at the details of further transactions between Ashok Leyland Ltd and Optare in FY2012, it seems clear that the company was taking over many of the liabilities of previous shareholders of Optare.

As per the FY2012 annual report, page 86, Ashok Leyland Ltd gave loans of ₹37 cr to Optare.

In addition, Ashok Leyland Ltd gave guarantees of about ₹97 cr to/on behalf of Optare Plc.

FY2012 annual report, page 84:

As a result, an investor would note that by FY2012, Ashok Leyland Ltd had invested ₹58 cr in equity, ₹37 cr in loan to Optare, and given an additional guarantee of ₹97 cr to Optare.

Due to the absence of consolidated financials in FY2012, an investor is still not able to understand the complete picture of the transaction.

The investor gets a better picture of this transaction with Optare Plc in FY2014 when Ashok Leyland Ltd merged its investment arms with itself.

FY2014 annual report, page 23-24:

Your Company wanted to merge its investment arms, and as the first step these entities viz., Ashley Holdings Limited, Ashley Investments Limited and Ashok Leyland Project Services Limited were merged into one of the group operating entities viz., Ashley Services Limited. The appointed date of the merger was from 1 st April 2013 and it was approved by the Honourable High court of Madras on 15 th July 2013. In a subsequent development, Ashley Services Limited (ASL), which became a Wholly Owned Subsidiary of Your Company was merged with the Company itself.

Therefore, the investment arms of Ashok Leyland Ltd were merged with the company and as a result, the standalone financials now could reflect the total investment done by Ashok Leyland Ltd along with its investment arms in Optare.

FY2014 annual report indicates that until then, Ashok Leyland Ltd had invested a total amount of ₹329 cr in its equity shares and ₹50 cr as loans.

FY2014 annual report, page 66:

FY2014 is also an important year in the history of Ashok Leyland Ltd because, from FY2014, the company started reporting consolidated financials. As a result, the investors could now assess the performance of subsidiaries of the company. (Please note that the website of Ashok Leyland Ltd provides the annual reports of its subsidiaries only from FY2015 onwards. Until FY2014, only the annual report of Ashok Leyland Ltd is provided).

Investors noticed that in FY2014, the three Optare group companies disclosed in the annual report has reported net losses. FY2014 annual report, page 118 (₹ Lac):

• Optare plc* (183.57)
• Optare UK Limited (303.64)
• Optare Group Limited (3,589.95)

Put together, the three Optare companies had reported a loss of about ₹40 cr in FY2014.

In FY2015, Optare Plc and its subsidiaries reported a net loss of ₹30 cr (FY2015 annual report, page 144).

An investor realizes that despite high hopes on the acquisition in FY2011 and subsequent additional investments in Optare via equity and loans as well as guarantees, the Optare group companies were reporting losses until FY2015.

In FY2016, Optare Plc along with its subsidiaries reported a loss of ₹92 cr (FY2016 annual report, page 147).

As a result, it does not come as a surprise to the investor that when she notices that in FY2016, Ashok Leyland Ltd acknowledged the poor fate of this investment and in turn, provided about ₹150 cr for impairment/loss on its investments in Optare.

FY2016 annual report, page 42:

Your Company, after studying its intrinsic value of investments in Joint Ventures (JV)/Associates/Subsidiaries has made an impairment provision of ₹ 107 Crores towards Albonair Germany, ₹ 150 Crores towards Optare Plc, UK and ₹ 5 Crores towards Albonair India.

The impairment provision done by Ashok Leyland Ltd serves as an acknowledgement that the investment in Optare has turned bad and it is not working out as planned. This seems normal as businesses need to invest in growth opportunities and many times, these decisions may not work as expected. Whether the acknowledgement of impairment would have taken 5 years (from FY2011 to FY2016) or it should have come earlier all the while when Optare was making losses, can be a subject of debate. However, it is better late than never.

However, what comes as a surprise to the investor that despite acknowledging that the investment in Optare has turned bad, Ashok Leyland Ltd put an additional ₹169 cr in Optare in FY2016 in the form of loans.

FY2016 annual report, page 106:

This looks like a situation of throwing good money after bad money, which is not good capital allocation.

In FY2017, Optare Plc along with its subsidiaries reported another loss of ₹100 cr. (FY2017 annual report, page 201).

As a result, Ashok Leyland Ltd had to make provisions/acknowledgement of loss of additional ₹526 cr for its investments/loans/obligations for Optare Plc.

FY2017 annual report, page 50:

Your Company, after studying its intrinsic value of investments in Joint Ventures (JV)/Associates/Subsidiaries has made an impairment provision of ₹121 Crores towards Albonair GmbH and Albonair India, in addition, ₹526 Crores has been provided towards Optare Plc. for the loans and obligation.

In FY2018, Optare Plc along with its subsidiaries reported another loss of ₹90 cr. (FY2018 annual report, page 179.

By this time, an investor would acknowledge that the losses in Optare year after year, stop looking surprising to the investor now. However, what comes as a surprise that in FY2018, Ashok Leyland Ltd further invested ₹248 cr in Optare Plc.

FY2018 annual report, page 44:

Your Company has invested in cash ₹ 248 Crores in Optare Plc., ₹ 494 Crores in Hinduja Leyland Finance and ₹ 4 Crores in Ashok Leyland Defence Systems. Thus, in all your Company had invested ₹ 746 Crore in cash in Joint Venture (JV) / Associates / Subsidiaries during the year.

This again seems like a situation of throwing good money after bad money. Despite a continuous streak of losses of Optare Plc, in FY2018, Ashok Leyland Ltd instead of attempting to recover its investments had put in additional commitment in Optare and increased its stake in the company from 75.11% to 99.08%.

FY2018 annual report, page 16:

During the year under review, the Company has increased its stake in Hinduja Leyland Finance Limited from 57.20% to 61.85% and in Optare PLC from 75.11% to 99.08%.

The increase in the stake of Ashok Leyland in Optare Plc in FY2018 seems to be due to the conversion of the loan worth ₹263 cr into equity.

FY2018 annual report, page 127:

In FY2019, Optare Plc along with its subsidiaries reported another loss of ₹85 cr. (FY2019 annual report, page 246).

However, an investor notices that in FY2019, Ashok Leyland Ltd invested an additional ₹18 cr in Optare Plc.

FY2019 annual report, page 52:

Your Company has invested ₹124 Crores in Hinduja Leyland Finance Limited, ₹43 Crores in Ashok Leyland (UAE) LLC, ₹18 Crores in Optare Plc, ₹10 Crores in Albonair (India) Private Limited, ₹6 Crores in Ashley Aviation Limited, ₹1 Crore in Ashley Alteams India Limited and ₹1 Crore in other Companies. Thus, your Company has invested ₹203 Crores in cash in Joint Venture/Associates/Subsidiaries during the year.

By now, an investor realizes that what started in FY2011 as a small investment of ₹50 cr in Optare Plc for taking 26% stake has by FY2019, ballooned into losses of about ₹1,000 cr for the shareholders of by Ashok Leyland Ltd. The shareholders have lost almost all the money put by Ashok Leyland Ltd in Optare Plc by way of equity or loans and are now holding 99.08% of the company.

Despite a significant amount of investment of money and management time, Optare Plc has never reported profits at least since FY2014 when Ashok Leyland Ltd started reporting consolidated financials and the shareholders started to know the performance of its subsidiaries.

However, instead of cutting down their losses and attempting to recover whatever little can be done from Optare; the management is continuously putting in more money in Optare year after year. It seems like a case of continuously throwing good money after bad money.

Moreover, when the investor analyses the February 2020 conference call of Ashok Leyland Ltd to discuss the results of Q3-FY2020, then she notices that the management of the company is looking to throw an additional ₹80-90 cr. after Optare. The management of Ashok Leyland Ltd is still trying to turnaround the company.

Q3-FY2020 results conference call, February 2020, page 9:

Gopal Mahadevan: Yes. The investments in subsidiaries is the main subsidiary where we have a challenge is in Optare, and there, we spent about £10 million per annum approximately. So, that is about 80 Crores, 90 Crores. Now we are trying to turn around the company.

To an investor, Optare Plc seems like a case where the previous shareholders of Optare have handed over the bag to the shareholders of Ashok Leyland Ltd and exited the company.

It remains to be seen whether the management of Ashok Leyland Ltd is now able to turnaround Optare Plc despite spending & losing hundreds of crores of rupees and about a decade of management’s time. Or how much more time and investment, the management of Ashok Leyland Ltd throws behind Optare Plc before they realize that sometimes, it is better to cut your losses and move ahead.

Further advised reading: How to identify if Management is Misallocating Capital

B) Investments in Albonair GmbH:

While reading the FY2008 annual report, an investor notices that Ashok Leyland Ltd acquired 100% shares of Albonair GmbH, Germany.

FY2008 annual report, page 29:

Your Company has made an investment in Albonair GmbH for development of vehicle emission treatment / control systems and products..…… Over the longer term, these cost effective systems are also expected to find application in Europe and the USA. The venture has already commenced operations……

In FY2008, Ashok Leyland Ltd invested ₹0.16 cr in the equity shares of Albonair GmbH (FY2008 annual report, page 63):

Cash flows from Investing activities includes acquisition of 100% shares in Albonair GmbH (cost Rs. 1.59 million)

In addition, in FY2008, Ashok Leyland Ltd gave a loan of about ₹4.7 cr to Albonair GmbH (FY2008 annual report, page 82).

In FY2009, Ashok Leyland Ltd gave an additional loan of ₹25 cr to Albonair GmbH (FY2009 annual report, page 52).

An investor would remember from the above disclosure of Ashok Leyland Ltd that Albonair GmbH was acquired primarily to serve Europe and USA markets. Therefore, in FY2010, Ashok Leyland Ltd incorporated a new company Albonair (India) Private Limited to cater to China and India markets.

FY2010 annual report, page 5:

During 2007, your Company established Albonair GmbH for development of vehicle emission treatment / control systems and products. In order to cater to the emerging markets in China and India, Albonair (India) Private Limited was incorporated during the year.

Moreover, in FY2010, Ashok Leyland Ltd gave additional loans of about ₹50 cr to Albonair GmbH (FY2010 annual report, page 57).

During FY2011, Ashok Leyland Ltd invested an additional ₹60 cr in equity shares of Albonair GmbH and ₹4 cr in shares of Albonair (India) Private Limited.

FY2011 annual report, page 68:

In FY2012, Ashok Leyland Ltd gave additional loans of about ₹48 cr to Albonair GmbH (FY2012 annual report, page 84).

In FY2013, Ashok Leyland Ltd gave additional loans of about ₹60 cr to Albonair GmbH (FY2013 annual report, page 86).

An investor would note that Ashok Leyland Ltd did not use to report consolidated financials until FY2014. As a result, investors were unaware of the financial performance of its subsidiaries before FY2014.

In FY2014, when Ashok Leyland Ltd reported its consolidated financials for the first time, then the investor got to know the financial performance of Albonair GmbH and Albonair (India) Private Limited.

While reading the FY2014 annual report, the investor realizes that during the year, Albonair GmbH had made a loss of ₹70 cr whereas Albonair (India) Private Limited had reported a loss of ₹0.6 cr. (FY2014 annual report, page 118.

In addition, in FY2014, Ashok Leyland Ltd reported that it had given additional loans of about ₹28 cr to Albonair GmbH. Moreover, Ashok Leyland Ltd also disclosed that it has invested about ₹150 cr in the equity shares of Albonair GmbH whereas it has repaid ₹150 cr of loans to Ashok Leyland Ltd. The impact of the last transaction of loan repayment and investment into equity shares seems like conversion of loans given by Ashok Leyland Ltd to Albonair GmbH into equity shares of Albonair GmbH. (FY2014 annual report, page 65-66).

The impact of the above transactions seems that in FY2014, Ashok Leyland Ltd gave additional ₹28 cr to Albonair GmbH whereas previous loans of ₹150 cr were converted from loan to equity, indicating that that ₹ 150 cr of loan is probably not going to come back.

In addition, in the FY2014 annual report, Ashok Leyland Ltd made another important disclosure. It said that it has not included Albonair companies along with some other subsidiaries in the consolidated financials because; it is keeping them under “held for sale” segment.

FY2014 annual report, page 23:

In doing so, three of the subsidiaries viz., Avia Ashok Leyland Motors Limited s.r.o, Albonair GmbH and Albonair India Pvt. Ltd. India have been excluded from the consolidation, as these entities are “held for sale” viz., these entities are kept for sale within the next 12 months.

This disclosure indicated that the management of Ashok Leyland Ltd had decided that it is going to sell both Albonair GmbH and Albonair (India) Pvt. Ltd within the next 12 months.

This may be due to the losses reported by Albonair GmbH despite a significant amount of investments done by Ashok Leyland Ltd in it. Albonair GmbH was acquired by Ashok Leyland Ltd in FY2008, the company has made investments of hundreds of crores of rupees in Albonair and invested almost 6 years of management time, and it was still making losses.

The conversion of loans of ₹150 cr given by Ashok Leyland Ltd to Albonair GmbH into the equity of the company in FY2014 may be an attempt to clean up the balance sheet to present a better picture to the prospective buyer.

However, it seems that Ashok Leyland Ltd could not find any buyer for Albonair Gmbh.

In FY2015, Ashok Leyland Ltd invested another ₹25 cr in the equity shares of Albonair GmbH (FY2015 annual report, page 133).

Ashok Leyland Ltd did not consolidate Albonair companies in its consolidated financials in FY2015 as well, as it kept them under “held for sale” segment.

FY2015 annual report, page 128:

Albonair GmbH and Albonair (India) Private Limited (subsidiaries of the Holding Company) have been “held for sale” and therefore, not considered for the preparation of the Consolidated Financial Statements.

It seems that Ashok Leyland Ltd could not find any buyer for Albonair GmbH again and therefore, in FY2016, it reclassified it from “held for sale” to “held for use” and included it in the consolidated financial statements.

FY2016 annual report, page 146:

Albonair GmbH and Albonair (India) Private Limited are classified from ‘Held for sale’ to ‘Held for use’.

However, in FY2016, Albonair GmbH along with its subsidiaries reported a loss of about ₹18 cr. (FY2016 annual report, page 161).

As a result, of the poor financial performance, after almost 8 years of the initial investment, Ashok Leyland Ltd acknowledged that its investment in Albonair GmbH is not producing expected results. Therefore, it recognized an impairment/acknowledgement of loss of ₹107 cr on its investments in Albonair GmbH. It also recognized a loss of ₹5 cr for its investment in Albonair India Pvt. Ltd.

FY2016 annual report, page 46:

Your Company, after studying its intrinsic value of investments in Joint Ventures (JV)/Associates/Subsidiaries has made an impairment provision of ₹ 107 Crores towards Albonair Germany, ₹ 150 Crores towards Optare Plc, UK and ₹ 5 Crores towards Albonair India.

However, an investor noticed that in FY2016, Ashok Leyland Ltd invested an additional ₹40 cr in Albonair GmbH.

FY2016 annual report, page 46:

Your Company has invested in cash ₹ 46 Crores in AL John Deere, ₹ 40 Crores in Albonair Germany, ₹ 6 Crores in Gulf Ashley Motor, ₹ 5 Crores in Ashok Leyland Defence Systems and ₹ 3 Crores in Ashley Alteams. Thus in all your Company had invested ₹ 100 Crores in cash in Joint Venture (JV)/Associates/Subsidiaries during the year.

Thereafter, in FY2017:

• Albonair GmbH reported a further loss of ₹21 cr (FY2017 annual report, page 201).
• Ashok Leyland Ltd recognized additional impairment/loss of ₹121 cr on its investments in Albonair GmbH.

FY2017 annual report, page 50:

Your Company, after studying its intrinsic value of investments in Joint Ventures (JV)/Associates/Subsidiaries has made an impairment provision of ₹121 Crores towards Albonair GmbH and Albonair India,..

• However, Ashok Leyland Ltd invested an additional ₹29 cr in Albonair GmbH and ₹5 cr in Albonair India.

FY2017 annual report, page 50:

Your Company has invested in cash ₹144 Crores in Hinduja Leyland Finance Limited, ₹29 Crores in Albonair GmbH, ₹25 Crores in Ashok Leylend John Deere Construction Equipment Company Private Limited, ₹5 Crores in Albonair (India) Private Limited…..

In FY2018, Ashok Leyland Ltd gave financial guarantees of ₹72 cr to/on behalf of Albonair GmbH (FY2018 annual report, page 127).

In FY2019, Albonair GmbH made a loss of ₹0.46 cr and Albonair India Pvt. Ltd made a loss of ₹2.23 cr (FY2019 annual report, page 246).

Moreover, in FY2019, Ashok Leyland Ltd, invested ₹10 cr in Albonair India Pvt. Ltd.

FY2019 annual report, page 52:

Your Company has invested ₹124 Crores in Hinduja Leyland Finance Limited, ₹43 Crores in Ashok Leyland (UAE) LLC, ₹18 Crores in Optare Plc, ₹10 Crores in Albonair (India) Private Limited….

In the conference call in February 2020, while discussing the Q3-FY2020 results, the management of the company indicated that it is still looking at investing about 3-4 million pounds (i.e. about ₹27-36 cr) per annum in Albonair.

Q3-FY2020 results conference call, February 2020, page 9:

But the company is still far from being profitable. But what we are trying to do is to reduce the cash inflow. Other than that, I do not see any investment happening in Albonair as of now, maybe 3 million, 4 million. But other than that, I do not see any of our other subsidiaries taking any cash.

Therefore, in the case of Albonair companies as well, it may seem to an investor that the management of Ashok Leyland Ltd is continuing with a loss-making acquisition where it has invested hundreds of crores of rupees and about 12 years of management time. However, even after all these investments, the company is not able to generate any return to the shareholders of Ashok Leyland Ltd and is making losses.

The management of Ashok Leyland Ltd acknowledged in the past that the investments in Albonair are not working as per expectations. The management has already provided for/acknowledged losses on its investments in Albonair. It tried to sell Albonair by keeping it in “held for sale” for two years in FY2014 and FY2015. However, it could not find any buyer for Albonair.

Nevertheless, instead of cutting its losses, Ashok Leyland Ltd is throwing good money after bad money and is looking forward to investing more money in Albonair every year.

Further advised reading: How to identify if Management is Misallocating Capital

C) Investment in a joint venture with John Deere, USA:

In FY2009, Ashok Leyland Ltd entered into a joint venture with John Deere, USA to manufacture construction equipment.

FY2009 annual report, page 5:

A Joint Venture Agreement was signed on September 30, 2008 with John Deere, USA for manufacture and marketing of Construction Equipment. The Joint Venture is scheduled to commence production by early 2010 and will initially roll out backhoes and four-wheel-drive loaders.

In FY2010, the company invested ₹29 cr in the joint venture and a 48-acre land was acquired on the outskirts of Chennai.

FY2010 annual report, page 44:

FY2010 annual report, page 21:

Subsequent to the incorporation of the company, 48 acres of industrial land has been acquired at Gummidipoondi on the outskirts of Chennai. Initial start up plan has been prepared and activities are proceeding as per the plan. Construction of the first shop has started and initial products are expected to roll out by February 2011.

In FY2011, the manufacturing facility was completed and the plant was inaugurated.

FY2011 annual report, page 41-42:

A 48-acre manufacturing facility at Gummidipoondi, on the outskirts of Chennai was inaugurated in October 2010. The first product – the backhoe loader — is undergoing field trials and is expected to be launched by third quarter of 2011-12.

By FY2011, the company has invested incremental ₹13 cr in the JV and the total investment stood at ₹42 cr.

FY2011 annual report, page 66:

Then the sequence of making additional investments in the JV started.

• In FY2012, Ashok Leyland Ltd invested ₹18 cr in the JV (FY2012 annual report, page 84).
• In FY2013, the company invested ₹50 cr in the JV (FY2013 annual report, page 47).
• In FY2014, the company invested ₹43 cr in the JV (FY2014 annual report, page 65).
• In FY2015, the company invested ₹33 cr in the JV (FY2015 annual report, page 29).

While looking at the business performance of the JV in the annual reports of the company, an investor notices that the JV never made a profit since the day it had started operations. Every year, in its annual reports, Ashok Leyland Ltd declared that its shares of expenses from the JV are higher than its share of the revenue.

FY2015 annual report, page 85:

As a result, it does not come as a surprise that in FY2016, the company decided to stop all the activities in the JV and proceeded for its liquidation.

FY2016 annual report, page 160:

The financial statement of Ashok Leyland John Deere Construction Equipment Company Private Limited (‘Entity’) used for consolidation has been prepared based on liquidation basis considering the fact that there is a significant curtailment of business operations impacting its continuity and thereby adversely affecting the appropriateness of “ Going concern “ as an assumption. Subsequent to the year end, an agreement has been executed on 21st April, 2016 amongst the joint venture partners and the entity for business liquidation subject to approval of the Board and Shareholders.

In addition, Ashok Leyland Ltd acknowledged the loss of the money invested in the JV and as a result, it acknowledged that it had to suffer a loss of ₹233 cr on the investment in the JV.

FY2016 annual report, page 46:

Thus in all, your Company has impaired ₹ 558 Crores during the year. Further, your Company has disposed off the shares in Ashok Leyland John Deere at a loss of ₹ 233 Crores.

However, the series of losing money in the JV did not end there.

Ashok Leyland Ltd invested more money in the JV:

• In FY2016, the company invested ₹46 cr in the JV (FY2016 annual report, page 46).
• In FY2017, the company invested ₹25 cr in the JV (FY2017 annual report, page 50).

In the FY2019 annual report, Ashok Leyland Ltd intimated its shareholders that the JV with John Deere has initiated voluntary liquidation.

FY2019 annual report, page 22:

During the year, Ashok Leyland John Deere Construction Equipment Company Private Limited (ALJD) reduced its paid-up capital from ₹5,150,363,000 to ₹355,842,460 and returned the money to the shareholders. Further, ALJD has initiated voluntary liquidation process and has appointed a liquidator under Insolvency and Bankruptcy Code, 2016.

Therefore, an investor would acknowledge that the joint venture of Ashok Leyland Ltd with John Deere to manufacture construction equipment proved a failure from the start as the JV could never make money from the start and finally after losing hundreds of crores of rupees of the shareholders, Ashok Leyland Ltd decided to wind it up.

Losing money in construction equipment business should not come as a surprise to investors as in the analysis of another manufacturer of construction equipment (Escorts Ltd); we learned that the construction equipment division of Escorts Ltd despite being in existence since 1971 still goes through long periods of continuous losses. In 2017, Escorts Ltd intimated its shareholders that its construction equipment division turned EBITDA positive for the first time after suffering losses for consecutive 22 quarters.

Investors may read the complete analysis of Escorts Ltd in the following article: Analysis: Escorts Ltd

D) Joint venture with Nissan for light commercial vehicles:

Ashok Leyland Ltd entered into a joint venture with Nissan Motor Co. Ltd in FY2008 to manufacture light commercial vehicles (LCV). The company expected to start selling LCVs by FY2011.

FY2008 annual report, page 48:

To become a full range player, the Company has entered into a joint venture with Nissan Motors Co. Ltd., Japan to develop and produce light commercial vehicles for both the domestic and export markets. The two organizations have been working closely over the past few months and the alliance is expected to roll out its first product by 2010-11.

In FY2009, the Ashok Leyland Ltd invested about ₹11 cr as equity in the three companies formed as JV with Nissan (FY2009 annual report, page 40) and in addition, provided advances of about ₹12 cr (FY2009 annual report, page 51).

However, during this period, the world was facing a global financial meltdown and it was not a wonder that both Nissan and Ashok Leyland Ltd had a relook on their plans.

In FY2010, the companies decided to postpone the plans to create a new manufacturing plant for LCV and instead, decided to produce LCVs from their existing manufacturing facilities. In any case, due to low demand, the existing manufacturing capacities had spare capacity.

FY2010 annual report, page 21:

Due to the slowdown in the economy and in the commercial vehicle industry, the JV modified its manufacturing strategy to optimise investments. This new strategy helped leverage the surplus capacities available at the two parent companies, with the ability to increase JV production capacity at the appropriate time. The JV is expected to roll out its first LCV product in April 2011.

In FY2010, Ashok Leyland Ltd invested an additional ₹63 cr in the Nissan JVs.

FY2010 annual report, page 44:

In FY2011, Ashok Leyland Ltd invested a significant amount of ₹174 cr in Nissan JVs.

FY2011 annual report, page 68:

In FY2012, Ashok Leyland Ltd invested about ₹57 cr in the Nissan JVs.

FY2012 annual report, page 84:

After deferring the creation of a dedicated manufacturing plant for LCV in FY2010, now in FY2013, the companies finally decided to create a dedicated plant for LCVs.

FY2013 annual report, page 44:

The Joint Venture Company, in which your Company is an equal partner with Nissan, is preparing for a new manufacturing facility near Chennai dedicated for LCV.

As a result, Ashok Leyland Ltd had to invest an additional ₹80 cr in the JV.

FY2013 annual report, page 47:

During the year, your Company invested ₹80 Crores in AL-Nissan JV and ₹50 Crores in AL-John Deere JV.

In FY2014, Ashok Leyland Ltd invested another ₹107 cr in the Nissan JV (FY2014 annual report, page 65).

Simultaneously, the management communicated to the shareholders in the annual report that the JV with Nissan is going strong and adding great value.

FY2014 annual report, page 21:

Your Company’s joint venture with Nissan Motors continues to go strong, creating value for our customers through contemporary, superior products.

However, it was a different story that the JV has never made a profit until now. Every year, as per the details disclosed by Ashok Leyland Ltd in the annual reports about its share of revenue and expenses from the JV, it turned out that the expenses were always higher than the revenue.

More importantly, in the FY2014 annual report, the company declared its consolidated financials for the first time and an investor came to know that in FY2014, Nissan JV had made a lost ₹174 cr. (FY2014 annual report, page 118).

Ashok Leyland told its shareholders about the intense competition present in the LCV market. An investor could get the impression that the competitive intensity in the LCV market has reached unsustainable levels.

FY2014 annual report, page 5:

In the Light Commercial Vehicle (LCV) segment, ‘DOST’ model suffered decline in sales volume due to aggressive discounting and unsustainable finance schemes offered by the competition.

Nevertheless, all the positive talks of the management about the JV seemed contrary to the actual financial position of the JV when the investor noticed that in FY2015, the JV had a loss of whopping ₹791 cr.

FY2015 annual report, page 129:

Further advised reading: How to identify if Management is Misallocating Capital

It seemed that Nissan had had enough in the JV and did not see any future.

Disputes arose between the Ashok Leyland Ltd and Nissan. (Source: The Hindu)

• Nissan alleged that one of the JV companies has not paid it a sum of ₹2.3 cr and therefore, it served a termination notice.
• Ashok Leyland Ltd filed a court case again Nissan alleging that Nissan was producing its own branded cars from the JV manufacturing facilities instead of the light commercial vehicles (LCVs).

Despite the allegations and counter-allegations, one thing was sure that the JV is not creating the value that it was supposed to do.

Therefore, it did not come as a surprise that in FY2015, Ashok Leyland Ltd acknowledged that the investments in the JV have performed poorly. As a result, Ashok Leyland Ltd recognized a loss of ₹214 cr on its investments in the JV.

FY2015 annual report, page 29:

Your Company, after studying its intrinsic value of investments in Nissan JV using independent valuer has made an impairment provision of ₹ 214 crore out of total investment of ₹ 509 crore in the three Nissan JV entities.

In fact, the situation of the underperformance of the investments in the JV was such that while Ashok Leyland Ltd recognized a loss of only 42% of its investments in the JV (214/509 = 42%), Nissan took a complete 100% loss on its equal investments (it was an equal investment JV).

Nissan thought it better to cut its losses and sold its entire stake in the JV to Ashok Leyland Ltd for ₹1 (ONE RUPEE).

FY2017 annual report, page 50:

Consequent to the purchase of the stake from the JV partner at a purchase consideration of ₹1 for all the three said entities and the subsequent finalisation of business strategy for LCV business……

The sale of the entire stake by Nissan in the LCV joint ventures at ₹1 to Ashok Leyland Ltd when it had invested more than ₹500 cr in the JV seemed like a step where Nissan acknowledged the futility of putting more good money after bad money. Instead, Nissan thought it better to cut its losses and move out from a JV, which was not producing any value to its shareholders.

We had seen in multiple above cases that Ashok Leyland Ltd seems to drag its feet on the investments that had not generated any significant value to its shareholders. Instead, we noticed that Ashok Leyland Ltd keeps on putting additional money in those failed ventures in the hope that it may create some value at some time in the future.

This is in complete contrast to the response of Nissan that we saw in the case of LCV joint venture with Ashok Leyland Ltd where it did not put more money in the JV when it realized that the JV is not generating any value after putting a significant amount of investments of money and management time.

Nevertheless, in FY2015, when the JV had made a loss of ₹791 cr, Ashok Leyland Ltd put in additional ₹37 cr in the JV. FY2015 annual report, page 29:

Your Company has invested in cash ₹37 crore in the AL-Nissan JV, ₹ 12 crore in Albonair GmbH….

In FY2016, the LCV company made a loss of ₹61 cr. (FY2016 annual report, page 161)

In FY2017, Ashok Leyland Ltd acquired the stake of Nissan at ₹1 and renamed the LCV entity from Ashok Leyland Nissan Vehicles Limited to a new name Ashok Leyland Vehicles Limited.

In FY2017, the LCV entity reported a loss of ₹2.5 cr. (FY2017 annual report, page 242).

In FY2018, the LCV business reported a profit of 134 cr for the first time, almost 10 years after its conception in FY2008. (FY2018 annual report, page 214).

However, subsequently, Ashok Leyland Ltd merged the LCV companies with itself. As a result, from FY2018, it is not possible to ascertain whether the LCV segment is making profits or losses. This is because, in its segmental result, Ashok Leyland Ltd clubs all the commercial vehicles in a single segment and does not provide a separate break-up for light commercial vehicles.

As a result, the results of the LCV division will be clubbed with the medium & heavy commercial vehicles division and an investor would find it difficult to ascertain the financial performance of the LCV division.

E) Avia Ashok Leyland Motors s.r.o:

In FY2007, Ashok Leyland Ltd intimated its shareholders that it has acquired the truck business unit of AVIA a.s. in Prague, Czech Republic. Ashok Leyland Ltd wished to use this acquisition to enter into European markets.

FY2007 annual report, page 54:

During the year under review, Ashok Leyland acquired Avia Truck Business Unit (TBU) in Czech Republic, formerly owned by the Daewoo Group and later by Odien Capital Partners, a private investment firm. Rechristened AVIA Ashok Leyland Motors s.r.o. (AALM), this associate company marks the first significant instance of establishing an overseas presence through the acquisition route. AALM is a strategic beachhead and will drive the Company’s growth wide and deep into Eastern Europe, Western Europe and other second hemisphere markets.

An investor notices that the Avia truck business unit had changed many hands. It had been with the Daewoo group at one point in time. After that, it was owned by Odien Capital. Investors would notice that many times, the business units that change so many hands are the ones that are very difficult to run. As a result, in the past, different owners had bought these units, tried their hand at running them and if failed, then they sell it to some other willing investor who wishes to try her luck.

Therefore, after changing multiple owners, the truck business unit of Avia now landed in the hands of shareholders of Ashok Leyland Ltd.

By FY2009, Ashok Leyland Ltd had made the following additional investments in the Avia unit:

• Loans & advances: ₹217 cr (FY2009 annual report, page 52),
• Financial guarantees of ₹212 cr (FY2009 annual report, page 53)

By FY2011, the company increased its commitment to Avia unit further by putting in about ₹130 cr in its equity shares. (FY2011 annual report, page 66).

However, all the great hopes with the business came crashing down in FY2012, when Ashok Leyland Ltd recognized losses of ₹145 cr on its investments in Avia unit.

FY2012 annual report, page 76:

By FY2014, the losses/provisions for the Avia unit had reached almost ₹250 cr.

FY2014 annual report, page 52:

*The carrying value of ownership interest in Avia Ashok Leyland Motors s.r.o. is net of diminution in its value aggregating ₹24,996.46 lakhs (including ₹744.32 lakhs provided upto March 31, 2013).

Moreover, when Ashok Leyland Ltd presented its consolidated financials for the first time in FY2014, then investors got to know that in FY2014, the Avia unit had reported a loss of ₹84 cr. (FY2014 annual report, page 118).

Therefore, it does not come as a surprise when investors notice that in FY2014, Ashok Leyland Ltd put Avia unit up for sale.

FY2014 annual report, page 23:

In doing so, three of the subsidiaries viz. Avia Ashok Leyland Motors Limited s.r.o, Albonair GmbH and Albonair India Pvt. Ltd. India have been excluded from the consolidation as these entities are “held for sale” viz., these entities are kept for sale within next 12 months.

Further advised reading: How to identify if Management is Misallocating Capital

4) Intra-group transactions of Ashok Leyland Ltd:

While analysing the financial performance of the company, an investor notices that Ashok Leyland Ltd has been involved in transactions with other entities of the Hinduja group (i.e. its associate and fellow subsidiaries).

We believe that an investor should focus on some of these transactions.

A) The merger of Hinduja Foundries Ltd with Ashok Leyland Ltd:

While analysing the FY2017 and FY2018 annual report, an investor gets to know about the merger of Hinduja Foundries Ltd (HFL) with Ashok Leyland Ltd.

FY2017 annual report, page 17:

During the year under review, the Board of Directors of the Company at their meeting held on September 14, 2016, approved the draft scheme of amalgamation of Hinduja Foundries Limited (HFL) with the Company and their respective shareholders and creditors, under Sections 391 to 394 of the Companies Act, 1956 subject to regulatory approvals. The Appointed Date for the scheme of amalgamation was October 1, 2016.

In FY2018, the amalgamation of Hinduja Foundries Ltd with Ashok Leyland Ltd was completed when Ashok Leyland Ltd granted its shares to the previous shareholders of Hinduja Foundries Ltd.

FY2018 annual report, page 14:

During the year under review, the Share Allotment Committee at their meeting held on June 13, 2017 had issued and allotted 80,658,292 fully paid equity shares of `1/- each to the equity shareholders of the erstwhile Hinduja Foundries Limited (Transferor Company)…

As per the closing share price of Ashok Leyland Ltd on BSE on June 13, 2017 (₹95.10), the company paid a price of about ₹767 cr to acquire the equity stake in HFL. Alongside, Ashok Leyland Ltd took over all the liabilities of HFL including its debt of about ₹460 cr. it had at the end of FY2016.

Thereby, an investor would acknowledge that effectively, the shareholders of Ashok Leyland Ltd paid an enterprise value of ₹1,227 cr to acquire the business of Hinduja Foundries Ltd (767 + 460 = 1,227).

When an investor looks at the financial performance of Hinduja Foundries Ltd until March 2016, then she notices that the company has not made any profits for the last 5 years (after FY2011). From FY2012 until FY2016, the company had reported a total loss of ₹1,052 cr. In addition, during H1- FY2017, the company reported another loss of ₹61 cr.

Moreover, an investor realizes that the business of HFL does not seem to have the ability to repay its debt on its own. An analysis of the FY2016 annual report of HFL indicates that it had raised equity of about ₹400 cr in the year to meet its urgent obligations like repayment of the debt, capital expenditure, working capital requirements etc.

FY2016 annual report of Hinduja Foundries Ltd, page 86:

During the current period the Company has raised equity share capital of ₹39,984 Lakhs (comprising 134,400,000 equity shares of ₹10/- each at a premium of ₹19.75/- per equity share) through issue of 11,200 Global Depositary Receipts (GDR)….… have been utilized for repayment of a portion of its outstanding debt, for capital expenditures, for working capital and for general corporate purposes as may be permissible under applicable law.

Even before FY2016, in FY2013, Ashok Leyland Ltd had to support Hinduja Foundries Ltd (HFL) by investing in ₹300 cr.

FY2013 annual report, page 47:

Further your Company invested ₹300 Crores in Hinduja Foundries Ltd. and another ₹187 Crores in Hinduja Energy (India) Ltd. In all, your Company invested ₹862 Crores by way of investment in Associate / Group / Joint Venture Companies.

Overall, HFL seems like a business that seems to have lost its ability to make profits, is reporting large losses every year, and has a debt of ₹460 cr yet to be repaid to the lenders that it has no ability to repay from its business operations.

HFL seemed to be surviving by taking money from its shareholders including Ashok Leyland Ltd and other Hinduja group companies.

In such a scenario, an investor may feel that the equity value of ₹767 cr to such a business is high. (Please note that valuation of any business is highly subjective and different investors may use different ways to value a business).

An investor may believe that HFL may have certain assets that can be sold by Ashok Leyland Ltd to recover some of its investment.

While reading FY2017 annual report, an investor notices that Ashok Leyland Ltd had put a land parcel owned by HFL located at Hyderabad, under the category “held for sale” at a value of ₹123 cr.

FY2017 annual report, page 111:

The freehold land at Hyderabad has been vested with the Company during the year pursuant to business combination of erstwhile Hinduja Foundries Limited (Refer Note 3.21). The Company intends to dispose off the surplus freehold land, and has estimated its fair value (less cost to sell) based on present market prices, which is more than the carrying amount. The Company expects to complete the sale in the next few months.

However, analysis of subsequent annual reports indicates that Ashok Leyland Ltd was not able to find any buyer for the land. As a result, it reclassified the land from “held for sale” to fixed assets of the company.

FY2018 annual report, page 99:

Freehold land at Hyderabad of ₹12,300 lakhs was vested with the Company during the previous year pursuant to business combination of erstwhile Hinduja Foundries Limited. This has been reclassified to Property, Plant and Equipment as the Company is in the process of identification of a potential buyer.

In addition, an investor would appreciate that HFL had been in a tough financial position for at least the last 5 years, as it had not made any profits after FY2011. The company had to raise equity to repay its lenders and run its operations. If the land at Hyderabad were an easily saleable property, then HFL would have itself sold it before the merger to improve its financial position.

As per shareholding details of HFL on March 31, 2017 (Source: BSE), the total promoters shareholding of 53.25% is comprised of:

• 20.74% Hinduja Automotive Limited (Also the promoter entity of Ashok Leyland Ltd),
• 24.94% Hinduja Foundries Holding Limited
• 7.57% Ashok Leyland Ltd

Looking at the above information, an investor may believe that the key promoters of HFL (Hinduja Automotive Limited and Hinduja Foundries Holding Limited) were tired of managing the tough foundry business and in turn, handed it over to the shareholders of Ashok Leyland Ltd. In return, the promoters of HFL got shares of Ashok Leyland Ltd, which is an overall much profitable business than the foundry business.

Moreover, after reading the history of Ashok Leyland Ltd, an investor may note that the company has got itself rid of the tough foundry business in FY2006 when it sold its casting unit to Ennore Foundries Limited (previous name of HFL).

FY2006 annual report, page 38:

The Company sold its castings unit at Hyderabad (Ductron Castings Unit) to Ennore Foundries Limited for a consideration of Rs. 620 million. The gain on sale amounting to Rs. 302 million is shown as extraordinary income for the year 2005-06. Ductron Castings Unit, now part of Ennore Foundries Limited, continues to supply castings to the Company.

Therefore, a minority shareholder of Ashok Leyland Ltd would feel that a tough business that her company has already got rid of in the past, which was a very profitable decision, is now again being thrust upon her after 10 years and in a much worse shape (accumulated of more than ₹1,000 cr and a large debt to be repaid).

No wonder that many minority shareholders were not happy with this amalgamation and voted against this proposal.

As per the FY2017 annual report, page 33, about 21% of total shareholder voted against the amalgamation proposal.

However, as is common in the corporate world, most of the time, the promoters are able to push through their proposals despite significant opposition from minority shareholders.

Therefore, we believe that whenever investors analyse any company that is a part of a large business house with many operating companies, then she should be aware that she might have to face such situations where the promoters will keep on doing corporate restructurings.

Such restructurings may be related to moving cash/funds from one group company that has surplus funds to another that urgently needs funds. Other restructurings may be related to shifting business divisions from one company to another as they deem fit.

An investor should understand that the promoters have the tendency to look at the entire group of companies as their one possession. They tend to move around money and assets as they deem fit to produce maximum value for themselves. Many times, their decisions may not present the best opportunities for the minority shareholders of individual businesses.

However, the minority shareholders do not have a lot of say to control these decisions of the promoters.

As a result, it is advised that the investor while analysing and investing in the companies of large business houses, should keep her eyes open to the possibilities of such movement of funds and assets from one group company to another.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

B) Increasing stake in Hinduja Leyland Finance Ltd:

In the recent past, investors faced another instance where Ashok Leyland Ltd attempting to buy out the promoters of the Hinduja group from another group company, Hinduja Leyland Finance Ltd (HLFL).

On March 18, 2020, Ashok Leyland Ltd intimated stock exchanges that it plans to buy out about 19% stake in HLFL from existing shareholders for up to ₹1,200 cr (Source: BSE)

…we wish to inform you that the Board of Directors of the Company, at the meeting held today, have approved to acquire upto 19% additional equity shares in Hinduja Leyland Finance Limited (“HLFL”), from the existing shareholders, in tranches, for a consideration not exceeding Rs.1200 Crores…

As per the credit rating rationale of ICRA for HLFL dated February 4, 2020 (page 3), on September 30, 2019, Everfin Holdings (an affiliate of Everstone) held a 7.0% stake in HLFL and the balance is majorly held by Hinduja group entities (92.4%).

As of September 2019, Ashok Leyland Limited (ALL) and other Hinduja Group entities held a stake of 92.4% in HLF while Everfin Holdings (private equity) held a stake of 7.0%.

Therefore, when Ashok Leyland Ltd announced that it plans to buy 19% stake from existing shareholders of HLFL whereas the private equity investor held only about 7% stake, then it became clear to the market/investors that Ashok Leyland Ltd is giving exit to other Hinduja group entities (probably the promoters) by buying out their stake too from HLFL.

Moreover, this transaction comes at a point of time in March 2020 when the commercial vehicle industry has been in down-cycle for about a year as represented by a sharp decline in sales and profits of the company in last 12 months (Jan. 2019 to Dec. 2019) when compared to previous periods. In addition, the ongoing disruption in business and general life due to the Coronavirus pandemic, the business environment were expected to take some time to recover.

In such a situation, investors expected Ashok Leyland Ltd to conserve cash and not to spend it for buying out promoters from HLFL.

As a result, the market gave a strong negative response to the announcement by Ashok Leyland Ltd. (Source: Economic Times)

The decision resulted in significant fall in the stock price of the company the day after the March 18 announcement, with the shares crashing more than 26 per cent to hit one year lows. On Friday, the stock fell a further 9 per cent to Rs 44. During the conference call held on March 19, investors raised several questions on the timing of acquisition given the need to conserve cash, valuations of the deal, and the rationale to buy partial stake of the promoters.

As a result, on March 21, 2020, the management of Ashok Leyland Ltd reacted with reducing the size of the buyout of HLFL stake from 19% to 6.99%. (Source: BSE)

However, in a meeting held today, the Board of Directors of Ashok Leyland, after considering the feedback on the proposal from minority stakeholders, decided to restrict the acquisition of shares by Ashok Leyland to 6.99% of the paid-up capital of HLFL at a price of Rs.119/- per share aggregating to Rs.390.49 Crores from Everfin Holdings (an affiliate of Everstone Capital) and Hinduja Group who had purchased the initial tranches of HLFL shares from Everfin.

An investor would appreciate in the previous case where Ashok Leyland Ltd had bought out promoters from Hinduja Foundries Ltd (HFL), many minority shareholders had voted against the deal; however, the buyout of promoters from HFL could not be prevented and the company went ahead with the merger.

However, in the current episode related to Hinduja Leyland Finance Ltd (HLFL), the minority shareholders could prevent Ashok Leyland Ltd from buying out promoters’ stake in HLFL by showing strong resentment to the decision by first selling shares in the market and questioning the management in the conference call.

Nevertheless, an investor notices that in the announcement on March 21, 2020, Ashok Leyland Ltd stated that it would still buy shares of HLFL from the Hinduja group who had purchased the initial tranches of HLFL shares from Everfin.

…from Everfin Holdings (an affiliate of Everstone Capital) and Hinduja Group who had purchased the initial tranches of HLFL shares from Everfin.

The management of the company had explained the reason for the same in February 2020 conference call with investors on page 10:

But the reason we did that was only because we wanted to be committed to Everstone, and we have acquired the shares. At the moment, Hinduja Group London has offered to bail us out even though they did not want to. So they have taken the first 2 tranches, I do not remember the number of shares. But that is all that is to the transaction. I hope this clarifies.

In February 2020 conference call, the management said that they had a commitment to Everstone to buy out their shares. The further response of the management indicates that Ashok Leyland Ltd did not have money to buy out shares from the Everstone. The Hinduja group did not want to help Ashok Leyland Ltd. However, they finally relented and helped Ashok Leyland Ltd in fulfilling its commitment to Everstone by buying the first 2 tranches of HLFL shares from Everstone. As a result, Ashok Leyland Ltd included buying these shares of HLFL from the Hinduja group in its March 21, 2020 announcement.

An investor acknowledges the commitment given by Ashok Leyland Ltd to Everstone as the company had disclosed its obligation/commitment to in relation to the shares of HLFL held by a third party in the placement document for QIP in 2014 (page 43):

In relation to an agreement relating to the subscription of the shares of its subsidiary HLFL, the Company has given an undertaking pursuant to which, the Company is required to provide the counter-party an exit option within 54 months from the date of subscription by the counter-party to the shares of HLFL, at a particular price in accordance with the terms agreed between the parties.

However, when an investor analyses the response of the management of Ashok Leyland Ltd in the February 2020 conference call, then it seems that Ashok Leyland Ltd was facing a cash crunch to meet its obligations and the Hinduja group had to pitch in to save it despite being unwilling to do so initially.

An investor notes that such a situation of cash crunch and taking help from others to meet its contractual obligations goes completely against the impression of a position of very high liquidity strength presented by Ashok Leyland in its annual reports by presenting a net cash position after adjusting all the debt in its annual reports.

While reading the recent annual reports of Ashok Leyland Ltd, an investor notices that both in FY2018 as well as in FY2019, the company had presented a net cash position. In FY2018, the company said that after adjusting all the debt, it had surplus cash of ₹2,915 cr and in FY2019; the company had surplus cash of ₹731 cr.

FY2019 annual report, page 119:

An investor is surprised when a company reporting a net cash position of hundreds of crores of rupees in the annual reports mentions that it had to be bailed out by the promoter group against their initial willingness to help it in meeting its contractual obligations.

In such a situation, it becomes natural for an investor to question the financial strength represented in the annual report.

An investor would remember from the numerous instances in the corporate world where the supposedly strong balance sheets were suddenly found to be lacking in the acclaimed fundamental strength.

• Cox & Kings defaulted despite having high cash & investments: An investor may also recollect the case of Cox & Kings, which defaulted recently on repayments of a few hundred crores rupees despite having cash & investments of thousands of crores rupees. (Source Moneycontrol: Defaults raise a curious case of mismatch at Cox & Kings)
• Instances of Yes Bank, DHFL, IL&FS etc. where the annual report/balance sheet never showed any weakness whereas the actual position was companies was near bankruptcy.

Therefore, it is advised that an investor should be cautious and increase the level of her due diligence when she hears the management of the company that originally claims strong liquidity position but later says that they had to be bailed out by the promoter group to meet their contractual obligations.

In addition, going ahead, an investor should keep a close watch on the investments done by Ashok Leyland Ltd in HLFL both by way of additional infusion of capital as well as buying out existing shareholders.

Regarding the assessment of the quality of business of HLFL, the following article will help the investor:

Can we Assess a Bank/NBFC’s Financial Position from its Reported Financials?

C) The merger of investment arms of Ashok Leyland Ltd:

From the above discussion on Optare Plc, an investor would remember that in FY2012, Ashok Leyland Ltd along with its investment arms had increased its stake in Optare Plc from 26% to 75.1%.

FY2012 annual report, page 45:

During the year, your Company along with the investment arms have increased their stake to 75.1% (from earlier 26%) in Optare plc UK.

An investor would also remember that in FY2014, Ashok Leyland Ltd merged its investment arms with itself.

FY2014 annual report, page 23-24:

Your Company wanted to merge its investment arms, and as the first step these entities viz., Ashley Holdings Limited, Ashley Investments Limited and Ashok Leyland Project Services Limited were merged into one of the group operating entities viz., Ashley Services Limited. The appointed date of the merger was from 1 st April 2013 and it was approved by the Honourable High court of Madras on 15 th July 2013. In a subsequent development, Ashley Services Limited (ASL), which became a Wholly Owned Subsidiary of Your Company was merged with the Company itself.

An analysis of these investment arms and their merger provides some insights to the investor.

An investor notices that until the merger of these investment arms, Ashok Leyland Ltd used to classify them as “Associate” indicating that it had less than 50% holding in these companies. In addition, Ashok Leyland Ltd used to provide a large amount of funds to these companies so that these companies can make investments/acquire a stake in other companies.

FY2013 annual report, page 86:

From the above table, an investor would notice that Ashok Leyland Ltd has classified its investment arms: Ashley Holdings Limited and Ashley Investments Limited as associates.

• In FY2012, it invested about ₹350 cr in these investment arms and
• In FY2013, it invested ₹304 cr in these entities.

As these investment arms are classified as associates (<50% shareholding), therefore, an investor might be right to assume that the remaining shareholding of these investment arms maybe with other entities of the Hinduja group or with some entities that have strong confidence of Hinduja group.

As mentioned earlier, these investment arms were used by Ashok Leyland Ltd to make investments on behalf of the Hinduja group like the one in Optare Plc, which is discussed above.

When these investment arms were merged with Ashok Leyland Ltd in FY2014, then an investor notices the following sequence of corporate actions:

• Ashley Holdings Limited, Ashley Investments Limited, and Ashok Leyland Project Services Limited were merged into one of the group operating entities viz., Ashley Services Limited
• In a subsequent development, Ashley Services Limited (ASL), which became a Wholly Owned Subsidiary of Your Company
• was merged with the Company itself

Therefore, an investor would notice that in the first step, the investment arms were merged with a group company, Ashley Services Limited (ASL). The fact that ASL is a group company of the Hinduja group, therefore, an investor is not able to ascertain what would be the shareholding of ASL. However, she may be safe to assume that it would definitely have other additional shareholders apart from Ashok Leyland Ltd. This is also true because these other additional shareholders would represent the stake of other group entities in the investment arms (Ashley Holdings Limited and Ashley Investments Limited).

The second step when Ashley Services Limited (ASL), which became a wholly-owned subsidiary of Ashok Leyland Ltd, is the most important step in this transaction.

When ASL became a wholly-owned subsidiary of Ashok Leyland Ltd., it effectively meant that Ashok Leyland Ltd bought out the “other additional shareholders” from the investment arms.

The following section from the financials of Ashley Services Ltd up to June 30, 2013 (page 9), provided by Ashok Leyland Ltd on its website under the scheme of amalgamation section (Source) provides the details of the investments held by Ashley Services Ltd.

(P.S. the quality of the scan copy of the document uploaded by Ashok Leyland Ltd could have better).

The above data shows that the investment arms, now a part of Ashley Services Ltd, held investments in Optare Plc., Albonair GmbH, Ashok Leyland Wind Energy Ltd, Hinduja Leyland Finance Ltd, LCV joint venture entities with Nissan etc.

Looking at the above investments, an investor may assume that the merger of investment arms with Ashok Leyland Ltd meant giving an exit to the “other additional shareholders” by buying out their stake from investments like Optare Plc, Albonair GmbH etc. that they had participated in by being shareholders in the investment arms (Ashley Holdings Limited and Ashley Investments Limited).

An investor gets an impression of the money paid by Ashok Leyland Ltd for buying out “other additional shareholders” from the investment arms when she notices that in FY2014, the company had given an advance of ₹237 cr to Ashley Services Ltd (ASL) for purchase of share capital.

FY2014 annual report, page 83:

An investor would notice that when this merger transaction took place in FY2014 when the Optare Plc group companies had reported losses of ₹40 cr. An investor would remember that in the subsequent years, Optare Plc kept on reporting large losses. Ashok Leyland Ltd had to continuously keep on investing additional money in Optare Plc, which is continuing even to this day.

Therefore, an investor may consider the merger transaction of investment arms with itself as a transaction in which Ashok Leyland Ltd gave an exit to the other group companies of the Hinduja group from their investments in companies like Optare Plc., Albonair GmbH etc.

In addition, in these maze of transactions, an investor finds it very difficult to assess whether the above mentioned ₹237 cr was the effective value at which Ashok Leyland Ltd ended up buying out stakes of these other group entities in Optare, Albonair or there was more to this transaction.

When an investor assesses the disclosure about the increase in investments done by Ashok Leyland Ltd in FY2014, then she notices that the increase in investments due to merger of Ashley Services Limited (ASL) is only ₹189 cr instead of the advance of ₹237 cr given by Ashok Leyland Ltd.

FY2014 annual report, page 23:

In total, investments have gone up by ₹452 Crore during the year. Out of this amount, ₹189 Crore is on account of merger with Ashley Services Limited.

It may be a case that Ashok Leyland Ltd has paid ₹237 cr to acquire investments worth ₹189 cr. Alternatively, there might be more angles to this merger transaction.

It may be that these other group entities could recover their invested value or even made a profit depending upon how much money/value Ashok Leyland Ltd paid to them for making Ashley Services Limited (ASL) its wholly-owned subsidiary.

It may be a possible scenario that these other group entities could safely exit the investment in Optare, Albonair GmbH and other such investments at a profit or at no loss, whereas the shareholders of Ashok Leyland Ltd ended up bearing the loss of hundreds of crores of rupees in Optare Plc., which is continuing even till this day.

It is advised that an investor may contact the company directly to get further clarifications about who were the other investors in the investment arms and what was the consideration paid to them to buy them out for making Ashley Services Limited (ASL) a wholly-owned subsidiary company of the company. Investors may also seek additional clarifications from the company to assess whether these “other shareholders” made profits on their investments done via the investment arms.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

D) Large investments in Hinduja Energy (India) Ltd:

While reading the past annual reports of Ashok Leyland Ltd, an investor comes across the name of Hinduja Energy (India) Ltd (HEIL) for the first time in FY2013 annual report, when the company disclosed that it has invested ₹187 cr in HEIL.

FY2013 annual report, page 47:

Further your Company invested ₹300 Crores in Hinduja Foundries Ltd. and another ₹187 Crores in Hinduja Energy (India) Ltd. In all, your Company invested ₹862 Crores by way of investment in Associate / Group / Joint Venture Companies.

As per the FY2018 annual report, HEIL is classified by Ashok Leyland Ltd as a “fellow subsidiary”, indicating that Ashok Leyland Ltd does not have any direct control over the management of HEIL.

FY2018 annual report, page 199:

Fellow subsidiaries

• Gulf Oil Lubricants India Limited
• Hinduja Energy (India) Limited
• DA Stuart India Private Limited

Upon reading other annual reports, an investor notices that Ashok Leyland Ltd provided more financial assistance to HEIL after FY2013.

An investor notices that over the years, Ashok Leyland Ltd acted as a banker to HEIL where it could take large amounts of loans from Ashok Leyland Ltd whenever it wanted.

While reading the FY2018 annual report, an investor notices that in FY2017, Ashok Leyland Ltd had given a loan of ₹615 cr to HEIL and in FY2018, it gave a loan of ₹463 cr.

FY2018 annual report, page 201:

What comes as a surprise to the investor is that the loan of ₹615 cr given by Ashok Leyland Ltd to HEIL in FY2017 appears in the FY2018 annual report, but it is not present in the FY2017 annual report in the related party transactions.

An investor notices that in the FY2017 annual report, such a large amount of loan appears as an inter-corporate deposit in the cash flow from investing activities with a similar behaviour that the loan was taken and repaid during the year.

FY2017 annual report, page 161:

An investor may seek clarifications from the company directly to ascertain whether the inter-corporate deposits shown in the above cash flow for ₹706 cr in FY2017 and ₹501 cr in FY2016 were to Hinduja Energy India Ltd (HEIL).

If yes, then what was the reason that HEIL was not shown as a group entity/fellow subsidiary in FY2016 and FY2017. Whether it is a situation, where HEIL became a fellow subsidiary only in FY2018 or it was a case of oversight where the team in charge of preparing the annual report missed including the name of HEIL in the list of related parties.

Alternatively, if these loans are not to HEIL, then the investor may seek details of the counterparties who are benefiting at the cost of shareholders of Ashok Leyland Ltd by taking the economic benefits of these loans.

An investor would notice that similar large inter-corporate deposits of ₹780 cr have appeared in FY2019 annual report in the cash flow from investing activities at page 164:

An investor would note that these inter-corporate deposits are present in the consolidated financials of Ashok Leyland Ltd. It indicates that these are not to the subsidiaries of the company like Hinduja Leyland Finance Ltd. These inter-corporate deposits are given by Ashok Leyland Ltd to entities that are outside its subsidiary structure.

An investor would acknowledge that Ashok Leyland Ltd carries loans from banks on its books on which it pays interest every year. As a result, these inter-corporate deposits to third parties indicate that the shareholders of Ashok Leyland Ltd are themselves bearing the costs to give these loans/deposits to third parties who in turn enjoy the economic benefits of these loans/deposits.

An investor may argue that these inter-corporate deposits may not be interest-free and Ashok Leyland Ltd may be getting interest on these loans from the third parties. In such a case, an investor should acknowledge that Ashok Leyland Ltd should direct its focus on the core activities of its business instead of earning interests on inter-corporate deposits.

In case, the investor finds out that Hinduja group is using these inter-corporate deposits to transfer the money available with Ashok Leyland Ltd for the benefit of other group companies that are in urgent need of the money, then an investor would remember that it is similar to the case of National Peroxide Ltd (a Wadia group company).

In the case of National Peroxide Ltd, the Wadia group used lending and investment transactions to shift money from National Peroxide Ltd to its other group companies that needed cash like Go Airlines (India) Limited, Bombay Dyeing Limited etc. In the analysis of National Peroxide Ltd, an investor would learn that the Wadia group made National Peroxide Ltd take debt from lenders and then made the company lend it further to other Wadia group companies.

An investor may read the complete analysis of National Peroxide Ltd in the following article: Analysis: National Peroxide Ltd

E) Ashley Aviation Ltd:

While reading the FY2019 annual report, an investor comes to know about a transaction in which Ashley Leyland Ltd has acquired shares from other individual shareholders in Ashley Aviation Ltd to make it a wholly-owned subsidiary of the company.

FY2019 annual report, page 20:

During the year under review, in pursuance to the approval received from the Ministry of Civil Aviation, the Company has acquired the balance shares from individual shareholders of Ashley Aviation Limited making it a wholly-owned subsidiary (100%) of the Company.

In the FY2019 annual report, on page 52, an investor notices that during the year, Ashok Leyland Ltd has invested an amount of ₹6 cr in Ashley Aviation Ltd

Your Company has invested ₹124 Crores in Hinduja Leyland Finance Limited, ₹43 Crores in Ashok Leyland (UAE) LLC, ₹18 Crores in Optare Plc, ₹10 Crores in Albonair (India) Private Limited, ₹6 Crores in Ashley Aviation Limited….

An investor would appreciate that Ashok Leyland Ltd would have used part or the full amount of this investment of ₹6 cr to buy out the individual shareholders of Ashley Aviation Ltd.

On the same page in the FY2019 annual report, an investor notices that Ashok Leyland Ltd has impaired its investments in Ashley Aviation Limited.

There had also been impairments to the tune of ₹7 Crores during the year Ashok Leyland (Chile) SA ₹4 Crores, Ashley Aviation Limited ₹3 Crores.

From the above disclosure, an investor would notice that the company has realized that its investment in Ashley Aviation Ltd has lost its value and as a result, it is recognizing a loss of ₹3 cr on its investments in Ashley Aviation Ltd.

However, in the face of this acknowledgement of loss on the investments of the company in Ashley Aviation Ltd, the additional investment of ₹6 cr by Ashok Leyland Ltd to buy out individual shareholders of Ashley Aviation Ltd seems very counter-intuitive.

In the face of it, it may seem that Ashley Aviation Ltd has done poor business performance resulting in loss of investment of its shareholders. However, now, Ashok Leyland Ltd is taking over this poorly performing company by putting in more money.

This seems like an attempt to bail out the individual shareholders of Ashley Aviation Ltd.

Before becoming the wholly-owned subsidiary in FY2019, as per the FY2018 annual report, Ashley Aviation Ltd was an associate company of Ashok Leyland Ltd with 49% shareholding (FY2018 annual report, page 215).

An investor may assume that if Ashok Leyland Ltd has less than 50% shareholding in Ashley Aviation Ltd but still the company is named after prevalent Hinduja names of “Ashley”, then most probably, the other shareholders in Ashley Aviation Ltd might be from Hinduja group.

An investor may contact the company directly to understand the dynamics behind the transactions of the company with Ashley Aviation Ltd. She may also seek details of the individual shareholders of Ashley Aviation Ltd who have been bought out by Ashok Leyland Ltd using shareholders’ money so that she may arrive at her conclusions.

On a similar note, an investor while reading the annual reports notices in the fixed assets details table that Ashok Leyland Ltd has purchased an aircraft worth ₹60 cr and given it on lease to someone.

FY2018 annual report, page 89:

An investor may seek clarifications from the company about the need to purchase the aircraft and then give it on lease to someone. The investor may seek details of the counterparty to whom the aircraft has been given on lease as well as what value this transaction of purchasing the aircraft is adding to the shareholders of Ashok Leyland Ltd.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

F) The curious case of treatment of Hinduja Tech Ltd and Rajalakshmi Wind Energy Ltd:

While reading the FY2018 annual report, an investor notices a strange disclosure by Ashok Leyland Ltd about Hinduja Tech Ltd (HTL) in which it had a 62% stake. The company told its shareholders that Hinduja Tech Ltd (HTL) is not considered its subsidiary despite holding a 62% stake in HTL as per some contractual arrangement between the shareholders. Instead, HTL is considered a joint venture.

FY2018 annual report, page 178:

An investor may seek further details about Hinduja Tech Ltd from the company and the details about the contractual arrangements between the shareholders that allow the other shareholder who has put in only 38% (100-62) of the equity investment but is enjoying equal (50%) stake in the management control of HTL (treatment as a joint venture).

Whereas, the shareholders of Ashok Leyland Ltd despite investing 62% of the equity money, are controlling 50% of the management control.

Similarly, in the case of Rajalakshmi Wind Energy Limited (previously named Ashok Leyland Wind Energy Limited), the company disclosed that it is not including its transactions with the company in the annual report despite holding 26% stake in it because the company does not have a significant influence on it.

FY2018 annual report, page 178:

Rajalakshmi Wind Energy Limited (erstwhile Ashok Leyland Wind Energy Limited) where the Parent Company holds 26% (with effect from October 1, 2016) is not treated as associate under Ind AS as the Group does not exercise significant influence over the entity.

Investors may seek clarifications about the same from the company.

Moreover, while reading the annual reports, an investor notices that Ashok Leyland Wind Energy Ltd is the company in which Ashok Leyland Ltd had incurred a loss of about ₹43 cr when it sold its stake in FY2015.

FY2015 annual report, page 76:

5) Managerial remuneration of Ashok Leyland Ltd:

While reading the FY2019 annual report, an investor notices that the CEO & MD of the company took home a total remuneration of about ₹137 cr. (= 131.21 + 5.81).

FY2019 annual report, page 64:

An investor notices that the biggest part of the remuneration is stock options of about ₹110 cr.

Among the stock options, an investor notices that the maximum number of the stock options (7,454,000) is priced extremely generously at an exercise price of ₹1/- per option.

Stock options at an exercise price of ₹1/- per option, is almost the most generous proposition that can be offered by any company to its employees next only to handing over free shares to them.

In addition, when an investor analyses the details of the options available to the employees of Ashok Leyland Ltd, then she gets to know the total number of options and their respective exercise prices.

FY2019 annual report, page 70:

From the above table, an investor notices that in the ESOPs plan of Ashok Leyland Ltd, the different tranches of options are put at different exercise prices.

5,845,875 options are available to employees for exercise prices of ₹80/-, ₹83.5, and ₹109/-. However, a very large portion of options, (7,454,000, 56% of all the options) are available at an exercise price of ₹1/-.

Moreover, an investor notices that all the generously prices options (7,454,000 at ₹1/-) are allotted to one single person, the CEO & MD of the company. Whereas all the remaining employees of the company have been competing for the balance 44% of options that too priced at ₹80/- to ₹109/-.

Then, then investor realizes that the company has treated its CEO exceptionally generously.

From one perspective, it does not come as a surprise to the investor when she notices that in 2019, many of the minority shareholders had voted against the remuneration of CEO & MD when the proposal was put to the vote of the shareholders. In total, 14.16% of shareholders had rejected the proposed remuneration of the CEO for FY2019.

FY2019 annual report, page 36:

While discussing the management succession planning above, an investor notices that the CEO & MD of the company, Mr. Vinod Dasari, was in this position from April 2011 to March 2019 after which he left Ashok Leyland Ltd to join Royal Enfield.

An investor may look at the capital allocation, merger, amalgamation, buyout, investment decision and business performance of the company during FY2011 to FY2019 to make her conclusions about the managerial remuneration paid by Ashok Leyland Ltd to its CEO & MD during this period.

Further advised reading: Are professionally managed companies safer for shareholders?

6) Using accounting assumptions to show higher profits:

While reading the past annual reports of Ashok Leyland Ltd, an investor comes across certain instances where the company used some accounting assumptions and conventions to report higher profits than the actual financial position.

These instances relate to adjusting the loss in the value of assets etc. directly in the balance sheet instead of charging it to the profit and loss statement (P&L) and changing policies related to depreciation and amortization.

In FY2003, the company disclosed that with the permission of Honorable Madras High Court, it has adjusted losses up to ₹160 cr due to loss of value of investments, fixed assets, work-in-progress (WIP) and other expenses directly against its reserves, in effect, bypassing the P&L.

Adjustment against Securities (Share) Premium Account:

Shareholders, at the Extraordinary General Meeting held on January 18, 2003, had approved the Board’s proposal to adjust against the Company’s Securities (Share) Premium Account, a sum not exceeding Rs.160 crores representing Miscellaneous Expenditure not written off, the estimated future diminution in the value of certain investments, and estimated future diminution in value of certain fixed assets and capital work-in-progress. This proposal was confirmed by the Hon’ble Madras High Court, and the other procedures have been fully completed. The necessary adjustments have been incorporated in the accounts for the year ended March 31,2003.

An investor would note that the company may not be legally wrong in bypassing these losses/expenses from the P&L as it has done the same with due permission of the court of law. However, practically, an investor would appreciate that a loss incurred by the company is the loss of value of the money of the shareholders irrespective of the manner in which the company represents it.

As a result, in FY2003, the company bypassed the expenses of about ₹160 cr from the P&L and adjusted them directly in the balance sheet.

FY2003 annual report, page 22:

If the company had followed the convention of charging the loss of investments/fixed assets/WIP and other expenses in the profit & loss statement, then its profits would have been lower to that extent. However, Ashok Leyland Ltd decided to bypass the impact of these expenses on the P&L by taking legal approval.

As a result, an investor would acknowledge that the net profits of the company reported by the company in its P&L show a higher value to the extent of these expenses charged directly to the balance sheet (securities premium account).

In FY2010, Ashok Leyland Ltd changed its accounting policy for depreciation/amortization that led to a higher net profit of about 21 cr due to this policy.

FY2010 annual report, page 54:

The Company has, during the year, changed its accounting policy to charge depreciation / amortisation on straight line method on a pro-rata basis in respect of additions to / deletions from, the fixed assets in the manner prescribed in Schedule XIV to the Companies Act, 1956. This is different from the basis hitherto followed of charging depreciation / amortisation for the full year on additions made in the first half of the year, for six months on additions made during the second half of the year and not charging depreciation in respect of assets disposed off during the year. The impact of the said change for the year is a higher net profit of Rs.2,080.59 lakhs and a corresponding lower charge of depreciation / amortisation reflected in Schedule 2.4 to the Profit and Loss Account.

It is advised that whenever an investor comes across such instances where the profits of any company are higher due to accounting assumptions, then she may adjust the reported profits of the company in her assessment to ascertain the financial position of the company.

Further advised reading: How Companies Inflate their Profits

7) Instances of lack of compliance with the statutory norms:

While reading the placement document released by Ashok Leyland Ltd for its QIP in 2014 (Source: BSE), an investor notices that there have been instances from the end of the company as well as the promoters (Hinduja group) where they missed on complying with the applicable statutory norms.

A) Violations under Companies Act, entering related party transactions without Govt. approval:

As per the QIP placement document, page 203, Ashok Leyland Ltd had violated a few provisions of the Companies Act including entering into related party transactions without government approval.

The MCA noted certain violations of Companies Act including delays in share allotments in certain of our Joint Ventures and delays in the filing of certain statutory forms and reporting certain events to the MCA. The MCA also noted that certain related party transactions were entered into without requisite government approval.

B) Promoters did not intimate the pledge of shares of the company:

QIP placement document, page 51:

Further, under the Listing Agreements and regulations issued by the SEBI, our Promoter is required to intimate the Company in case of any change in the number of shares held by the Promoter in the Company or creation of pledge on the shares held by the promoter in the Company. The Company had submitted the initial disclosure to the stock exchanges regarding the equity shares of the Company pledged by the Promoter in February 2009. Thereafter, the Promoter had pledged additional shares of the Company, in 2011, but inadvertently failed to inform the Company about the change in the number of shares of the Company pledged by the Promoter.

C) Part of the land on which the factory of the company is built in Bhandara is classified “Forest Land”:

Ashok Leyland Ltd disclosed in its QIP placement document that a part of the land on which its factory in Bhandara is constructed is still classified as “Forest Land”.

QIP placement document, page 52:

A portion of our manufacturing facility located at Bhandara, Maharashtra, is built on land, the title of which is yet to be transferred to us. Pursuant to two lease deeds dated March 22, 1982 and August 3, 1982, respectively, approximately 231 acres of land was transferred by the MIDC to us. A portion of the surrounding land remained classified as “forest land” in revenue records (“Forest Land”). In 1985, we constructed a building on approximately 16 acres of such Forest Land.

It seems that it is due to land still being classified as “Forest Land” that the part of the factory land at Bhandara is yet to be transferred in the name of the company even in 2019 despite the factory being constructed there in 1985.

FY2019 annual report, page 106:

A portion of the Buildings in Bhandara valued at ₹950 lakhs is on a land, the title for which is yet to be transferred to the Company

An investor may contact the company about any progress on the conversion of the land from “Forest Land” to industrial/commercial and the transfer of the same in the name of the company.

In addition, the QIP placement document also mentions an instance where the Central Bureau of Investigation (CBI) has filed a charge sheet in a criminal case involving five employees of the company for fabricating the quality standard reports for supplying buses to Delhi Transport Corporation.

QIP placement document, page 52:

A charge sheet has been filed by the Central Bureau of Investigation (the “CBI”) against five employees of the Company, accusing such employees of conspiring with a laboratory to fabricate certain quality standard reports in connection with the supply of buses to the Delhi Transport Corporation.

An investor may contact the company for updates on the investigation and legal proceedings in this case.

8) Error in the annual report:

While reading the annual report of Ashok Leyland Ltd for FY2019, an investor notices that while presenting the data of shareholding of the promoters in the annual report, the company had made an error in calculating the change in the percentage shareholding of the promoters during the year.

FY2019 annual report, page 58:

In the above table, an investor would notice that during FY2019, as disclosed by the company, the shareholding of the promoters had declined from 40.02% to 39.91% i.e. a decline of 0.11%.

However, in the column for the “% change during the year” the company has mentioned “0.00” indicating as if there has not been any change in the percentage of shareholding of the promoters during the year.

The Margin of Safety in the market price of Ashok Leyland Ltd:

Currently (May 10, 2020), Ashok Leyland Ltd is available at a price to earnings (PE) ratio of about 13.95 based on the last four quarters standalone earnings from Jan 2019 to Dec 2019. The PE ratio of 13.95 provides a little margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

• Further advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Further advised reading: Hidden Risk of Investing in High P/E Stocks

Analysis Summary

Overall, Ashok Leyland Ltd seems a company that has been growing its business at a rate of 15-20% year on year for the last 10 years (FY2010-2019). However, the business performance of the company over this period has been cyclical. The company’s performance has alternated between good periods and poor performance periods.

The dependence of the commercial vehicle industry on the general economic environment and govt. expenditure along with intense competition between the domestic and multinational players has led to cyclically fluctuating business performance of the company.

Despite intense competition, the company has been able to keep its capital expenditure and working capital under control. As a result, it has seen its profits convert into cash flow from operations. Moreover, the company has reported a free cash flow over the last 10 years.

At times, the capital expenditure and investment requirements of the company increased and it ended up breaching the debt-related covenants put by its lenders. Then in FY2014, the company resorted to raising equity via a QIP. However, since then, the debt level of the company has been under control.

Ashok Leyland Ltd has been led by professionals where the promoter family-member has assumed the role of non-executive chairman of the company. The company has been able to source talent in-house as well as from outside to lead the company.

The management of Ashok Leyland Ltd has shown good project execution abilities, as they are able to complete the frequent capacity expansion programs for the core medium & heavy commercial vehicles as well as the light commercial vehicles. In addition, the management has been able to execute multiple other plants like construction equipment plant, die-casting plant etc.

When an investor analyses the capital allocation decisions of the management of Ashok Leyland Ltd, then she notices that at times, the company has shown sub-optimal capital allocation.

In multiple cases, the company kept on continuing with certain business initiatives, which seem to have lost their appeal many years ago. These businesses are running into losses year on year and a few of them have never made profits since their inception. However, the company has continued with them and has been infusing precious capital of shareholders in these businesses year after year. Businesses like Optare Plc and Albonair GmbH are such examples.

At other times, the ventures have failed to create value to the shareholders like the construction equipment joint venture (JV) with John Deere, USA, or Avia truck business unit. In the case of the light commercial vehicles joint venture, the JV partner quit the business by foregoing all of its investment of about ₹500 cr by selling its stake to Ashok Leyland Ltd for a token ₹1. One of the reasons for Nissan leaving the venture is the high losses run by the JV due to intense competition in the LCV industry, which seems to have increased to unsustainable levels.

Ashok Leyland Ltd is a part of the Hinduja group and as is commonly seen in large business group houses with many operating businesses, in the case of Ashok Leyland Ltd as well, investors notice quite a few intra-group transactions of investments and business division transfers.

There have been instances where the group entities pushed their loss-making investments by merging them with Ashok Leyland Ltd. It included the foundry business of Hinduja Foundries Ltd and various investments done through the investment arms like Ashley Holdings Limited and Ashley Investments Limited.

Recently, there was a big hue & cry from minority investors when the group attempted to off-load its stake in Hinduja Leyland Finance Ltd (HLFL) to Ashok Leyland Ltd. As a result, the company had to reduce the proposal of the purchase of shares of HLFL and limited it to the stake owned by the third-party private equity firm.

There have been instances where an investor questions the judgment of the management of putting more money in an associate company, Ashley Aviation Limited to make it a wholly-owned subsidiary by buying out other individual shareholders when it is simultaneously recognizing a loss on its previous investments in Ashley Aviation Limited.

Ashok Leyland Ltd has also purchased an aircraft and given it on lease to somebody. An investor may wish to know the reasons for the company buying an aircraft and leasing it to other parties and the value it has been adding to the shareholders to Ashok Leyland Ltd.

The company seems to have taken exceptionally good care of its CEO & MD as it allotted more than half of all the ESOPs to the CEO at a generously low exercise price of ₹1/- per option. An investor notices that rest all the employees of the company have to compete for the remaining 44% of the options, which are priced at a much higher price ranging from ₹80-109/-.

No wonder that about 14% of the shareholders had voted against the proposal of remuneration of the CEO & MD of the company in 2019.

Previously, on occasions, Ashok Leyland Ltd has resorted to accounting assumptions and conventions to show higher profits. These are primarily related to bypassing expenses and diminution of assets/investments from the P&L and directly adjusting it to the balance sheet by taking the approval of shareholders and the court of law. At times, the company has changed its accounting policies related to depreciation/amortization that has led to higher profits in the P&L.

In the past, there have been occasions where the company could not comply with certain provisions of the Companies Act including entering into related party transactions after seeking relevant govt. approvals. On one occasion, it seems that the promoters did not intimate the company about the pledge on the shares created by them. At one instance, the CBI has charge-sheeted the employees of the company for fabricating the quality standard reports with the laboratory. An investor may keep a close watch to follow the developments related to these instances.

Going ahead, an investor should monitor whether the company is able to revive from its currently declining sales and profitability. The investor should watch for the investments done by the company in its subsidiaries, joint venture, and group entities. The investor should monitor the managerial compensation paid by the company to its senior-most employees.

An investor should keep a close watch on all the intra-group transactions that the company may enter with the promoter group.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Ashok Leyland Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.