The coronavirus pandemic resultedin a precipitous drop in Commercial Vehicle sales, which now appear to behitting a bottom. The Indian commercial vehicle spacehas been facing slowdown for quite some time due to the slowing economy, evenbefore the pandemic set in. Going forward, however, the domestic CV market islikely to experience strong growth momentum with the Government keen onreviving the economic growth.

However, there are indications thatshow that the domestic CV industry isnear the bottom of the cycle, and growth trajectory would improve hereon,although the pace of the recovery is uncertain currently. The Government hasbeen taking measures to revive demand, which has seen a gradual recovery inJuly and August. Rise in NHAI award activity and faster execution of largemetro projects and highways indicate visible pick up in the infrastructurespace. Significant growth in FMCG volume indicates dilution of the dampening effectof demonetization and GST.

Growth in e–commerce space is also aiding growth to a largeextent for the LCV segment. LCV demand is picking up, with production levelsramping up quicker compared to M&HCV segment.

Post declining~48 per cent in FY20 and ~35 per cent in FY21E (1HFY21 down ~75 per cent Y-o-Y),monthly new goods M&HCV sales in India fell ~70 per cent from FY19 highs.Market analysts believe replacement demand (replacement cycle of 6-8 yearsduring CV downcycles) would alone be sufficient to help the industry grow onits present base with 40-45 per cent of the road freight market being cateredto by organized players.

Thus, reportssuggest that the industry would need ~60 per cent volume growth in FY22E toreach FY13-15 average annual volume of 0.19mn units. Factoring in ~50 per centindustry growth in FY22E and expecting FY19 volume levels only by FY25E, analystssay that this implies ~31 per cent volume CAGR in FY21-25E.

This would beled by absorption of oversupply by demand revival and lower truck population. Despitecapital cost of trucks increasing ~20 per cent in 1HFY21 led by BS6 shift +lower discounts, demand improvement with rising freight rates signifies improvingstate of business, say analysts.

A look at marketreports shows a cumulativeoversupply in the road freight market to the tune of ~26 per cent in FY17-21E. Thiswas led by a combination of weaker demand vs. higher discounting-led new trucksales, axle load limit enhancement, steep price hike of 12-15 per cent led byBS6 transition, and Covid-led disruption. Thus, analysts expect oversupply toget absorbed by the system in FY22-25E with freight demand reviving (railfreight demand up 17 per cent Y-o-Y in October and down ~09 per cent in 1HFY21)and tonnage adjusted supply significantly shrinking in FY22-23.

Moreover, market experts do notforesee any major cost escalation driver for fleet owners in the coming yearsamidst freight rates stabilizing currently post Covid-led turbulence inApril-June.

Axle-load limit riseled to decline in blended tonnage

In mid-FY19, the ~20-25 per centincrease in axle load limit helped truckers carry loads on existing truckshigher by similar extents, thus proportionately enhancing systemic supply ofexisting trucks too. This resulted in sharp decline in demand for ~25-35T GVWmodels and, correspondingly, the demand shifted towards the 12-25T category.

Experts explain that on thinvolumes in 1HFY21, reversal in mix of higher tonnage trucks would be driven bydemand coming from tippers for infra/mining sector. As per their interactionsat the field level with various truckers, demand is currently driven by cement/metals,mining/infra projects, consumable/perishable goods, electronics/consumerdiscretionary, and rising auto demand.

In times of steady demand,profitability/payback period for a fleet owner is favourable for a highertonnage truck as fixed cost/ton is lower. Thus, post the decline in blendedtonnage coinciding with CV downcycle, market experts expect blended tonnage mixfor industry to slowly improve back towards 23-25T in the next 2-3 years.

With no major regulatorychange-led cost escalation in the next 2-3 years, ~12 per cent demand CAGR in FY21-24Ewould result in disciplined freight rates vs. steady TCO amidst lower interestrates, steady fuel and tyre prices. Also, introduction of mandatory fast-tagsat highway toll centres would put a cap on expenses and save time.

FY22E revival to beled by replacement demand

ScrappagePolicy

Apart fromimplementing BS VI emission standards to curb pollution, a major decision hasbeen made to take out CVs which are more than 20 years old from the road.Called the Scrappage Policy, which has got all the pertinent approvals and onlyleft with approval from GST council, it could create an additional demand of~0.7-1.0 lakh vehicles p.a. if this gets implemented, say industry experts.

Organized truckers own in excessof ~50 trucks and cater to industries like cement, metals, FMCG, autos, etc., andhave a defined replacement cycle of 6-8 years as per corporate contracts. Theircost pass-through clauses help them to face tough times so that they can sailthrough lower utilization. These truckers constitute ~40 per cent of the market.

Led by sheer high capital cost ofthe 25+ GVW trucks, the higher-end trucks are in majority owned by organizedfleets. So, industry experts believe bulk of the oversupply in the system hasbeen created in the 7-16T segment with lower capital cost and, thus, affordableby many small fleet owners. Experts say that if one were to assume industryvolume of 0.18mn in 2022, it would be the same as average of FY14-15 new trucksales, thus indicating replacement demand would be good enough to drive arevival.

With FY22-23E new truck salesexpected to be lower than the industry figures in FY07-08, according to marketestimates, it would help in supply absorption, lowering truck fleet populationand, in turn, improving utilization. As per industry practices, large/organizedfleet owners typically outsource additional truck needs from fringe truckerspost fully utilizing their owned trucks. Thus, with 40 per cent of the fleetsupply being fully utilized through the organized route, the rest 60 per centof the fleet gets utilized by ~50 per cent at its peak, making systemic fleetutilization of ~70 per cent in the best of days.

During downcycles, the utilizationof fringe truckers fall to levels of sub-20 per cent, with hardly any need foroutsourcing as large truckers operate on owned assets.

During the FY20-21E cyclicaldownturn, reduction in demand of consumable goods resulted in lower demand ofICVs and ~12-16T haulage trucks and led to higher mix of tippers. Tractor-trailersgot impacted by axle-load limit increase as demand shifted towards multi-axledtrucks in the ~26-37T segment.

In the current upcycle, expertsexpect revival in demand for ICVs with consumable/perishable goods demandreviving with reducing impact of Covid. Also, with axle-load limit increasegetting absorbed in the market in the past couple of years, demand for 37T+tractor-trailers (higher RoCE generating segment) is also set to revive.

LCVs more resilientin downcycles

Though FY21could be a soft year for domestic LCV industry, the LCV segment is set to dowell over the medium term due to increased thrust on infrastructure and ruralsectors and higher demand from consumption-driven sectors and e-commerce andlogistics providers. Replacement demand could be another trigger, experts claim.

LCVs contribute 6-8 per cent ofdomestic road freight and, if combined with goods pick-ups, would contribute~10 per cent of freight demand. Catering to intra-city/town distribution mainlyfor spaces like perishables and FMCG, LCVs witness lower volatility across the CVcycle than M&HCVs. Market analysts expect a ~20 per cent volume CAGR inFY21-24E, implying that FY19 volume levels would be back by FY24E.

Within LCVs, the trend of risingmix of 2-3.5T models is picking up. The market is here is seeing intensecompetition, with M&M being the leader and AL trying to expand its sharethrough its new launches (Ashok Layland recently launchedthe ‘BADA DOST’ – the first producton the brand new LCV platform that is ‘Made in India).

ASPs form ~20 per cent ofM&HCVs and volumes are similar to M&HCVs, say market experts. So, thevalue mix of LCVs in the CV space is ~10 per cent, which is why they don’tcushion industry revenue size during adverse times.

Whatcould go wrong?

Cyclical nature of the CV industry

The CV industry is largely dependent on the economic growthin the country. So, the recent slowdown in the economic growth has led tode-growth in the CV industry. The impact of the Covid-19 pandemic would furtherprolong the slowdown and delay the recovery in economic growth.

Moreover, the CV players faced supply constraint towards theend of FY20 leading to nearly zero inventory at the end of Mar’20. They are nowin the process of re-building the inventory.

Delays in implementing scrappage policy

The Government of India is pondering on the idea ofimplementing scrappage policy in FY21, which has got the approval of PMO and isawaiting approval from the GST council. Under the proposed policy, fleetoperators will be incentivized for replacing their old fleet in terms of lowerGST rate and discounts offered by OEMs.

If the government decides to scrap vehicles older than 20years, it is expected to create an additional demand of ~0.7-1.0 lakh unitsp.a. However, there is lack of clarity regarding the timeline as well as theimplementation of the policy.

Highly Competitive Industry

Tata Motors, industry reports suggest, opted for aggressivepricing strategy to claw back its lost market share. Discounting as a tactichas worked for Tata Motors and it managed to increase its market share.

Further, market watchers believe that with the roll out of BSVI vehicles in April 2020, Indian CV space will see many foreign playersbecoming aggressive due to their technological advantage and experience overlocal players. This may further increase the intensity of the competition.

Rising Crude Oil Prices

Crude oil price is a critical factor in total cost ofoperation for CV operator. Despite the fall in global crude prices, domesticprices for diesel have not fallen much as the Government of India has increasedtaxes on them. Sharp increase in the price of diesel could be a threat to thegrowth in the overall logistics industry, which may in turn dampen the CV salesgoing forward.

Conclusion

The CV market was alreadybeginning a cyclical downturn before the onset of the coronavirus-inducedrecession, and companies had started preparing for weaker demand. However, asthe pandemic spread, factories and dealerships closed and sales collapsed morequickly than manufacturers could have prepared for. But, not all seems lost asvarious government initiatives are seeing a revival in demand.

Tata Motors Vs AshokLeyland Vs VECV

Among the leaders in the goodsM&HCV space – Tata Motors and Ashok Leyland – the former has been regainingmarket share in the 35T plus segment continuously from the lows of FY19 alongwith maintaining steady market share in the 25-35T segment. In the rest of the segments,VECV has been gaining share during the time the industry has been hit hard byCovid. Recent company reports, however, suggest Ashok Leyland’s market sharereviving to ~30 per cent from ~27 per cent now, largely at the cost of VECVshare normalization as Ashok Leyland has a far better portfolio in the tractor trailersegment.

VECV is more of an ICV/MDV playerand, thus, would underperform on an overall basis during an upcycle when demandwould be driven by tippers, tractor-trailers and multi-axle models.

Source: Ambit Capital

Systemic fleet utilization trends in past two years

• Best days of systemic utilization were in FY19: During1HFY19, blended systemic utilization levels were at ~65-70 per cent, with truckoutsourcing constituting close to ~50 per cent of the market demand andorganized fleet utilization at 80-90 per cent. Moderate purchases were made byfringe truckers with normal replacement demand in the organized segment.

• Moderation in utilization in FY20: In 2HFY19-2HFY20,overall utilization levels were at 55-60 per cent, with outsourcing needfurther reducing as demand started declining in sync with the economy. Thus,fringe truckers were bleeding profusely and demand from them came to a standstillin this period. Replacement demand from organized truckers was slightly impactedby supply of 1-2 year old used trucks despite hefty discounts of 20-25 per centby players to liquidate BS4 inventory.

• Bottoming of demand led by Covid: In the1QFY21,systemic utilization declined to as low as ~15 per cent, with nil demand for outsourcing,and organized players operating at 25-30 per cent of capacity. Subdued demandcoincided with very limited supply of labourers (reverse migration), resultingin abrupt rise in freight rates by 1.5-2x. Thus, many large fleet owners madeprofits, despite weak demand, till June.

• Gradual improvement in demand from 2QFY21:Since July, demand has slowly started normalizing, with utilization improvingto ~45 per cent levels now and nominal usage of outsourced trucks usage. Freightrates have stabilized, labourers are back, fuel prices have stabilized, anddemand is improving every passing month. Discounts post BS6 transition hasshrunk from ~25 per cent to 8-10 per cent levels and there is 10-12 per centprice hike led by BS6 shift.

• Fringe truckers to return with a lag: Channel/expertinteractions suggest road freight market cannot sustain without presence offringe truckers in the longer run as organized fleet owners would not wish tobe asset-intensive beyond a certain level in order to minimize leverage risk. Thus,with demand cycle improving, organized fleet owners would again startoutsourcing excess needs to the fringe truckers at optimum pricing. Though,gradually across cycles, experts expect the mix of fringe truckers to reducefrom ~60 per cent and converge to global standards of 20-25 per cent.

Source: Ambit Capital

Risks for the CV sector in India

• Major second wave of Covid in India, impacting FY22 CVindustry revival.

• India real GDP growth at sub-5 per cent for a prolonged periodpost FY22.

• Major increase in interest rates in FY22-23E post being benignin FY21.

• More than ~10 per cent increase in key input commodity pricespost the 10-15 per cent rise in raw material cost Vs 1HFY21 levels.

• Worsening of availability of finance.

• Source: Ambit Capital

Catalysts for the CV sector in India

• Used 1-2 year-old truck supply in the market post moratoriumperiod ended largely got absorbed, according to industry players/fleet owners.

• Fixed cost restructuring by focusing on digital marketing andless travelling/marketing expenses helping CV players to improve EBITDAM.

• Gradual revival in industrial/mining/infra activities alongwith shrinking supply of trucks to bode well for fleet utilization.

• Discipline in freight rate movements amidst falling discounts,rising fuel rates, and sub-50 per cent overall fleet utilization levelscurrently.

• Scrappage policy, if at all, with favourable contours.

Source: Ambit Capital