HFL merger a concern for Ashok Leyland investors

MUMBAI: The decision to merge Hinduja Foundries with Ashok Leyland may not be in the interest of minority shareholders of India's second largest commercial vehicle maker as the deal lacks sound rationale.

This is likely to weigh on valuation of Ashok Leyland which is already witnessing moderation due to softening demand of medium and heavy commercial vehicles (MHCV) in the past three months. The stock has shed nearly one-fifth of its market cap in two months.

Hinduja Foundries (HFL) derives nearly 35-36% of revenues from supplying components to Ashok Leyland.

As per ETIG calculation, based on the swap ratio of 0.4:1, Ashok Leyland will have to issue 8 crore new shares for the acquisition. This would lead to about 2.8% equity dilution.
HFL has a debt of Rs 450 crore, which will increase net debt to equity ratio of Ashok Leyland to 0.3 times from 0.2 times before merger. HFL has accumulated losses of Rs 1,000 crore.This is likely to depress Ashok Leyland's projected earnings per share ( EPS) for FY17 and FY18.

Analysts reckon that the merger would lead to EPS dilution in the range of 7-11%. However, accumulated losses of the previous years will help Ashok Leyland to bring down its tax rates.

In a conference call, Ashok Leyland's management said the deal would help HFL to reduce the over head cost, fetch better interest rate and plan its production. These efforts are likely to turn HFL to turn EPS accretive in the next 2-3 years.

But several reasons are likely to raise investors' concerns. Firstly ,a turnaround of the HFL could have achieved without an actual merger with Ashok Leyland.

It must be noted that Hinduja group recently raised its holding in HFL to 83% from 54%. Post-merger, Hinduja's stake in Ashok Leyland will jump to 51.3% from 50.4%. This is likely to leave a sour taste.

Critics say Ashok Leyland could have worked in coordination with the HFL. Secondly , given the higher fixed cost structure of HFL, EPS accretion in the next 2-3 year will be a steep target. This is likely to drag the earnings of Ashok Leyland.