The board of Ashok Leyland (ALL) approved the amalgamation of Hinduja Foundries (HFL), a Hinduja group company (in the business of grey iron castings & supply of automotive components) with Ashok Leyland, subject to statutory approvals. Based on the swap ratio, the amalgamation will result in dilution of ~2.8% for Ashok Leyland, and increase promoter stake from 50.4% to 51.3%. HFL is one of the largest producers of cylindrical blocks & heads, with tractor segment contributing 55% of company’s revenues & ALL contributing ~35%. As of FY16 (12 month), HFL’s revenues stood at | 577 crore, EBITDA loss of | 155 crore & PAT loss of | | 171 crore. Although the impact of the deal might be low (equity dilution offset by tax saving resulting from accumulated loss of ~| 1046 crore of Hinduja Foundries), the deal is a deviation from managements’ recent years practice of strengthening balance sheet. Assuming, the deal gets all the regulatory/ statutory approvals, the impact of the deal will be EPS accretive in FY18 due to tax shield provided by accumulated loss of Hinduja Foundries. However, if the turnaround in HFL is not as per management outlook, the deal could be a drag on ALL’s earnings & return ratios in FY19E.

Valuation : Although, the deal does not fit into the company’s strategy of improving balance sheet, we believe the growth triggers outweigh the potential negative impact of the deal. We value core business at 8x EV/EBITDA (earlier 9x) to factor in the negative potential drag on earnings & return ratios post FY18E. Based on SOTP valuation, we arrive at a target price of | 95. We have a BUY recommendation on the stock. The upside risk to our estimates could be the implementation of the scrappage policy to discard 15+ year vehicles