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CVs: Replacement growth! - Views on News from Equitymaster
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CVs: Replacement growth!
Sep 22, 2005

In an earlier article, we had analysed various factors that affect the demand for commercial vehicles (CVs). In this article, we shall try to look at another important factor the replacement demand that affects the demand for CVs, especially during the downturn. Is replacement demand important?
Generally, the demand in any automobile segment consists of two parts. First being the new demand (first time buyers or additional purchases) and the second being the replacement demand. Though the period for which the commercial vehicles remain in the system cannot be predicted (especially in India), based on our interaction with managements of different companies, we understand that the average replacement age of a CV is in the range of 8 years to 12 years. This replacement cycle is prime importance to the industry especially in times of downturn as it enables to determine the cushion levels (or the minimum potential demand).

Domestic
sales
FY91 151
FY92 155
FY93 162
FY94 170
FY95 181
* units in 000s
Age of the vehicle: 10 years
Domestic sales* Replacement* Replacement as %
of Domestic sales
FY01 137 136 99.5%
FY02 147 140 95.1%
FY03 191 146 76.5%
FY04 260 153 58.8%
FY05 318 163 51.2%
* units in 000s# Replacement demand based on assumed scappage of 10%

As evident from the table, in FY01 and FY02 the entire domestic demand has come on account of the replacement cycle. It should be noted that during FY98 to FY02, the demand for commercial vehicles was on a decline due to a number of factors. During the period FY95 to FY97, the corporate sector was aggressively expanding (the first phase of significant expansion post liberalization) and the demand for CVs was strong. However, inadequate investment in infrastructure sectors like power and transport, mismatch in capacity creation and its utilisation and decline in the production of capital goods coupled with global factors like Asian crisis and September 11 attack affected the demand during FY98 to FY02. Had it not been for a strong demand for CVs in FY91 and FY92, the performance of the industry during FY01 and FY02 would have been worse.

As the economy started emanating positive signs and there was increased thrust on road infrastructure, the CV industry registered a CAGR of 29% during FY02-FY05. As a result of this, the importance of replacement demand became subdued. This was in spite of a steady demand for CVs during FY94-FY96.

What is in store?

Potential replacement demand
Replacement cycle* FY06 FY07 FY08
8 years 130 117 146
10 years 180 200 130
12 years 153 163 180
* units in 000s

The importance of the above potential demand has to be viewed in line with the expected state of the economy and the industrial activity. Going forward, with structural changes taking place in the economy and the industrial activity expected to remain buoyant, we believe that fears of potential cyclical downturn are overdone in spite of below par performance during the current fiscal. Having said that, the exponential growth witnessed during the past three years is not sustainable. We expect the domestic CV industry to grow at a compounded rate of 6% to 7% in the next three years.

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