Hinduja merger adds to Ashok Leyland's debt woes

Ashok Leyland

  Last month, Ashok Leyland announced the merger of loss-making Hinduja Foundries with itself. Until Thursday’s close, the company’s stock was down 4.43 per cent on the Bombay Stock Exchange since it first announced the proposal.

The tumble reflects the growing fear among investors that the merger would negatively impact the functioning of Ashok Leyland, the country’s second largest commercial vehicle manufacturer, which has just completed a three-year restructuring exercise to cut its debt from Rs 6,400 crore to around Rs 1,595 crore. The merger will add Rs 512 crore to its debt burden.

For Ashok Leyland, acquiring Hinduja Foundries, offers the promise of greater synergy with its suppliers. It is also seen as a chance to secure its casting requirements. The  foundry gets 35 to 36 per cent of its revenues from Ashok Leyland and is one of its critical suppliers, accounting for 80 per cent of its requirement for cylinder blocks and heads. Ashok Leyland moved to acquire Hinduja Foundries as the latter’s weak financials posed a threat to its operations and in turn its own supplier agreements.

“Though materiality this deal deviates from the management’s stated objective of streamlining Ashok Leyland’s balance sheet and focused capital deployment strategy, we believe this might be a one-off case, rather than a reversal of intent to build a leaner company,” says a report by Motilal Oswal Securities.

Gopal Mahadevan

  Gopal Mahadevan, chief financial officer, Ashok Leyland, is upbeat about Hinduja Foundries’ growth prospects. He says once the two companies start functioning as one, it will remove all the barriers to growth for the company and allow it to tap Ashok Leyland’s customer base and expand its exports.  Mahadevan says the merger will also boost the commercial vehicle maker’s bottom line in three years.

“Hinduja Foundries has been making money at the operating level over the past couple of months, and despite the current losses at the net level, gross margins are sufficient to achieve a turnaround in the future,” he says.

The deal would result in tax benefits for Ashok Leyland. It would get 30 to 35 per cent tax reprieve for merging with a loss-making company. Hinduja Foundries’ accumulated loss was around Rs 1,100 crore at the time of the deal.

Key concerns
In turning around Hinduja Foundries, the most important challenge is its high operations and overhead costs. While several steps have been taken to rein in this expense, including shutting down its castings unit in Hyderabad and offering voluntary retirement scheme to its employees, more such measures are needed.

After the merger, which is expected to be complete by April 2017, Hinduja Foundries will become a division of Ashok Leyland, although it will continue to have its own management and a board. The company has appointed D M Reddy as the new managing director, and once the merger process is over, he will head the division.

Hinduja merger adds to Ashok Leyland's debt woes

  Crucially, though, the merger will allow Hinduja Foundries to take advantage of Ashok Leyland’s expertise in turning around companies.  “It was not a subsidiary, so Ashok Leyland could not manage it earlier. Now after the merger, it will have a say in its management,” says Mahadevan.

But the foundries business will still continue to enjoy a certain level of independence. Over 85 per cent of its customers are not in direct competition with Ashok Leyland and growing this business will be as important for the new management as for the earlier one.

Ashok Leyland, meanwhile, will sharpen its focus on its truck, bus, after-market service, power solution, defence and light-commercial vehicle business. It also plans to step up its efforts to improve operational efficiency, cut down raw material costs, expand its front-end team and incorporate new technology wherever required.

Growth areas
Of these, the company has identified three key growth areas: exports, defence and after-sales service. To hedge against cyclical challenges, it aims to increase the share of exports in its revenue to 30 per cent from 10 per cent over the next five years. For this, in addition to its existing markets in Africa, West Asia and the Indian sub-continent, it has set its sights on the markets in Southeast Asia as well. It plans to start exporting to countries in that region soon.

For its defence business, the goal is to reach a turnover of $1 billion over the next three to five years, from the current $750 million. The after-sales market contributes around five per cent to its revenue and the company wants to increase it to 10 to15 per cent. Given its low penetration (12 per cent of the addressable market), the potential for growth in this segment is huge. To increase its reach, the company plans to bring more mechanics, besides retailers and dealers, under its fold.

However, even as Ashok Leyland forges ahead on many different fronts, it is unlikely to achieve a quick turnaround for Hinduja Foundries.