Commercial Vehicles: Northbound! - Views on News from Equitymaster

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Commercial Vehicles: Northbound!

Sep 28, 2002

The Indian automobile sector has witnessed mixed fortunes over the last five years. While volume growth has been impressive in the two-wheeler and passenger car segments during this period, the same is not the case with commercial vehicle category (CV). After posting record volumes in FY97, the industry has been suffering on account of sluggish industrial sector and slower economic growth. Consider the industry characteristics in brief. Demand for CVs is directly linked to agricultural and industrial production. Therefore, it is cyclical in nature and moves in line with the economy. The CV cycle can be best explained as below. As output increases, both agricultural and industrial, goods have to transported from/to/within the country. Transportation between four metros viz. Delhi, Mumbai, Calcutta and Chennai account for a bulk of goods movement. As simple economics states, when demand rises, price tend to follow suit. In case of the Indian transportation sector, the barometer is freight rates.

When freight rates are lucrative, transport operators’ profitability improves thus directly resulting in increased demand for CVs. After the initiation of the road construction projects, there has also been a marked change in industry dynamics. Demand for multi-axle and above 16 tonne CVs have spurted. In FY02, as high as 42% of total CV sales in the country were multi-axle vehicles. High powered and high tonnage vehicles benefit transport operators in many ways. Economies of scale in the form of lower operating cost per tonne mile and better turnaround time are the two key benefits. Due to lack of proper road infrastructure, demand for higher tonnage CVs has remained lacklustre over the years. In this context, the government’s thrust on improving road infrastructure is a big positive for CV manufacturers. We expect this as one of the key growth drivers in the long run.

Demand for CVs and strengthening of freight rates are also a function of input costs, especially diesel prices. When tonnage demand is sluggish, transporters generally find it difficult to pass on any rise in input cost. The situation reverses when demand exceeds supply. But even here, the bargaining power of road transportation sector is limited due to competition from railways. But as road infrastructure improves, we expect CV manufacturers to benefit in a big way with Railway slowly losing its competitive advantage, to a certain extent. Issues like cross subsidization and slow turnover time for Railway would result in increase preference for road transportation in the long run.

Having looked at the industry fundamentals, consider the industry trend and the key players. After growing at a steady rate of 5% CAGR between FY71-FY90, CV demand spurted in the next seven year. Volumes grew at a CAGR of 12% between FY90-FY97. With economy growing at more than 7% in FY96 and FY97, CV sector witnessed record volumes of 102,473 and 123,575 units respectively. However, since then, it has been a rough ride. Lack of investment (both private and public), slow progress of reforms and slowdown in the industrial sector have limited growth prospects. Since FY97, CV sales have declined as much as 40% in volume terms. Coming to the player, Telco and Ashok Leyland are the two dominant players with a market share of 67% and 33% respectively. Players like Volvo are predominantly niche players and are yet to make a mark in the segment.

What does the future hold for the sector? CV volumes have been on an rise since September 2001. Is this the sign of things to come? One of the key reasons for the recovery in demand was the sharp rise in agricultural output in FY02. The Indian economy is estimated to have grown by around 5.4% last year on the back of a 7.5% growth in agricultural sector. With industrial sector also growing at a higher rate in recent months, freight rates have strengthened even further. As per media reports, freight rates for the Delhi-Mumbai sector has gone up by around 4% in the last one month. The scenario is similar for other key sectors as well. These are positive signs.

However, one needs to wait and watch whether the trend sustains for the rest of the year given the fact that agricultural sector is expected to register negative growth in FY03. Though industrial sector has shown some recovery, with IIP up by around 2.6% for the first five months, such low growth rates may not translate into higher CV demand. With crude prices also strengthening, the government is already contemplating of another round of revision in petrol and diesel prices. This could actually postpone fresh purchases in the immediate term.

However, the long-term fundamentals remain intact. Better economic growth prospects and infrastructure spending would be the key drivers of growth. The Supreme Court had banned CVs, which are more than 15-20 year old, from plying in the National Capital Region (NCR). Going forward, similar rulings can be expected in other regions. As a result, replacement demand would also act as a catalyst. Given this backdrop, there is lot more in the offing for the CV sector.

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