Slowdown looming in CV industry as headwinds gain pace:ICRA

Ashok Leyland BSE | NSE 29/05/12 Are Mutual Funds betting on Ashok Leyland? Other Stocks in this news Eicher Motors | SML Isuzu |

ICRA has come out with its quarterly review on Indian commercial vehicle industry for December 2011. As per the research firm slowdown imminent as headwinds gain momentum.

After registering a strong 30%+ growth over the past two fiscals, the growth in the Commercial Vehicle (CV) industry has somewhat slowed down during the current year. During April-November 2011, the domestic CV industry posted a growth of 21.0% on YoY basis riding on a strong 31.4% growth in LCVs and a fairly muted 9.5% in M&HCVs. Steadily rising interest rates, contracting industrial output and a considerable increase in vehicle prices coupled with high-base effect of previous years are the main factors impacting growth. The operating environment for fleet operators has been deteriorating over the past six months. All factors that influence the viability appear to be weighing against the profitability and cash flows of operators. The sharp rise in overall cost of ownership combined with considerable rise in operating costs and an almost stagnant freight rates in a confluence are displaying signs of pressures on fleet operators. Our channel check suggests that several operators have postponed their expansion plans in view of rising interest rates and expectation of slowing industrial growth. Capacity utilisation is gradually declining and freight rates continue to remain stagnant despite rise in operating expenditure for operators. On the financing front, some of the financiers have also started tightening lending norms in addition to the rise in interest rates. Overall, the near term risks against M&HCV demand has increased significantly, though structurally, the demand over a longer period remains intact, subject to normalization of economic activity over the next 2-3 quarters.

Given the current environment where the growth in industrial activity is at a two year low and the operating environment for fleet operators is gradually weakening, we expect the industry to defer capacity addition. As a result, the outlook for the near term appears to be subdued, resulting in a slowdown in new vehicle sales. Among segments, M&HCVs which tend to be more influenced by the macro-economic indicators is likely to register a weaker performance over the near term as against the steadily growing LCV segment. The proliferation of the hub-n-spoke model, improving last mile connectivity and last but not the least the strong demand originating from rural segment is likely to drive demand in the LCV segment over the medium term. We expect the M&HCV industry to grow by 3-4% in FY12 and LCV industry by 17-18% in FY12. We maintain our long-term growth outlook for M&HCV with a CAGR (%) of 9.5-11.5% and for LCV with CAGR of 11-13% over the next five years. In terms of the competitive landscape, while some of the established but smaller OEMs have expanded their product portfolios and market coverage, the competition from new players is unlikely to hurt the strong market position of incumbents in the near term as the former go through a phase of developing credible track record for their products and create market reach, an imperative for the CV industry.

Over the past few months, the macro-economic environment in India has weakened considerably led by a whole host of factors. The sharp rise in interest rates as a result of the considerable credit tightening measures to overcome accelerating inflationary pressures, contraction in industrial activity and an overall decline in business optimism have collectively resulted in moderation in GDP during the current year. These factors combined with relatively subdued pick up in infrastructure spending have started weighing on the demand for new CVs especially the heavy commercial vehicle segment. In the recent months, the index of industrial production (IIP) which serves as a proxy for the CV sector has contracted sharply and has registered one of its lowest growths in the past two years.

Our channel check suggests that there is a definite slowdown in freight availability led by some of the core manufacturing sectors. The impact is more visible in certain segments like container movement, mining, automobiles (led by slowdown in passenger vehicle segment) and heavy industries such as steel. Given the high sensitivity to industrial activity and weakening operating metrics for fleet operators, we expect the industry to witness a subdued demand as capacity addition takes a back seat.

Rise in ownership cost + stagnant freight rates act as double whammy for operators
The operating environment for fleet operators has been deteriorating over the past six months. All factors that influence the viability appear to be weighing on the profitability and cash flows of operators. The sharp rise in overall cost of ownership combined with considerable rise in operating costs and an almost stagnant freight rates in a confluence are displaying signs of pressures on fleet operators.

Our channel check indicates that freight rates across major routes have only risen to the extent of diesel price increases and the rise has not been enough to compensate for the inflation in other operating costs. Freight rates from Southern & Eastern regions have remained marginally weak, while those from Northern & Western markets continue to hold on.

In such a scenario when pressure is building up on small fleet operators, large organized players continue to exhibit a relatively stable earnings profile. Most of the organized players cater to institutional clients on long-term contracts that ensure pass through of operating costs especially variation in fuel prices. Additionally, the organized logistics players largely depend on market-sourced fleet which considerably reduces the risk during periods of slowdown and adds to their bargaining power while negotiating on freight rates.

Slowdown in demand for M&HCVs is imminent
During YTD FY12, the M&HCV segment has grown by 8.3% in line with our earlier estimate wherein we had expected it to slowdown but not witness a hard landing like the previous downturn. Despite firming up headwinds, the segment has been more resilient as load availability continued to remain stable during the first half. However, since the beginning of the current quarter, there are initial signs of slowdown which coupled with pressures on operator's cash flows post a relatively weak outlook for M&HCV demand in the near term. Within the segment, MAVs, tractor trailers which tend to have higher dependence on industrial activity have been impacted more, while ICVs have continued to exhibit fairly stable growth.

Emergence of hub-n-spoke model is playing out
The trucking segment in India is witnessing interesting trends, while the M&HCV segment is witnessing steady increase in share of heavy duty, long haulage trucks owing improvement in road and highway infrastructure, the LCV goods segment is seeing increasing share of sub 1T segment with the emergence of the hub-n-spoke model and increasing demand for last mile connectivity. As shown along side, higher tonnage trucks (16T+) offer higher profitability (benefits of operating leverage) as operating costs (besides fuel) are similar to lower tonnage vehicles. Besides improving highway infrastructure, the trend towards higher tonnage trucks has also been supported by the introduction of newer, advanced platforms/vehicles by both incumbents as well as foreign OEMs.

ASHOK LEYLAND LIMITED

Performance Update: ALL has largely followed the overall trend in industry volumes; however over past few months, the company has underperformed as compared to overall industry growth. ALL is traditionally strong in high tonnage segment, wherein the growth has moderated due to macroeconomic headwinds related to rising financing cost, fuel cost and slowdown in overall economic activity. Additionally, ALL has been a strong player in the Southern market, which has been impacted by elections in Tamil Nadu (in Q1FY12), Telangana issue and ban on iron ore mining in Karnataka.

ALL's market share in goods segment, which fell sharply during Q1 FY12, has shown improvement during current quarter. The growth was largely driven by strong recovery in 12T-16.2T and 16.2T-25T segment, which has grown at 28.9% and 31.1% respectively on QoQ basis (16.6% and -24.3% on YoY basis). By end of current fiscal, the management is hopeful to achieve ~25% market share in domestic M&HCV segment supported by strengthening its presence in Northern/Eastern India.

The tractor-trailer segment is facing strong headwind on account of slowdown in transportation of industrial commodities and moderation in foreign trade, while the tipper segment (>25T), which derives demand from the construction and infrastructure projects witnessed robust growth. Over past few months, bulk purchase by fleet operators has slowed down and there is increasing activity towards retail sales where ALL has relatively modest presence. Moderation in freight rates especially in southern/eastern region negatively affects customer sentiments, especially for large fleet operators. In bus segment, despite decline in volume, ALL has maintained its market share ~40%.

Eicher Motors Limited

Revenue Growth - Eicher Motors Limited (EML) reported another strong quarter with strong growth across its motorcycle (standalone) and VE Commercial Vehicles (VECV, 54.4% subsidiary) business. At consolidate level, on YoY basis, the company has reported strong growth of 32.1% largely driven by strong performance of VECV which constitutes ~80% of its overall revenue. VECV is a strong player in domestic 5-12T segment, and it is gradually making inroad into largely duopolistic HCV segment. However, Volvo trucks volumes continued its decline reporting -36% YoY to 139 units affected by sharp decline in mining activity.

Profitability - Operating margin improved by 277 bps to 10.4% on YoY basis, largely supported by lower raw material cost. Sharp decline in trading activity due to decline in Volvo Truck's sales has resulted in sizeable reduction in raw material expenses. Net margins have remained fairly stable around 8.5% over last three quarters.

Key Development - In Q3 CY11, VECV launched low floor city bus and the company has received order for 20 such buses from Gujarat Government.

Performance Update: VECV is amongst established player in the domestic CV industry with strong presence in 5T-12T segment, and the company is aggressively pursuing its goal to establish itself as key player in domestic M&HCV industry which is largely dominated by TML and ALL. VECV is leader in 7.5T - 12T segment, and it is gradually making inroads into largely duopolistic HCV segment. The company has also strengthened its position in passenger segment wherein it has registered growth of 27.7% on YoY basis against 6.6% growth witnessed by passenger CV industry during Q3 CY11.

SML ISUZU LIMITED

Revenue Growth - SML ISUZU Limited (SML) continued its growth momentum registering a 24% growth in top line during Q2 FY12. The growth was supported by volume growth as well as improvement in realization. On QoQ basis, SML volume grew by 3.3% whereas revenue growth was 3.7%.

Profitability - Barring an exception of Q1 FY11, the operating margin of SML has remained in the range of 7.5%-8.5% over last seven quarters. On YoY basis, the company has reported improvement of 26 bps in OPM to 8.5% whereas on QoQ basis, OPM improved by 101bps largely on account of improved operating leverage.

Development - In July 2011, SML launched its first truck in 12T-16T segment, which will be marketed under badge of ISUZU. The truck was initially launched in Tamil Nadu, with a price tag of ~Rs 14 lakh for fully built truck (with Cab and Cargo body).

Performance Update: SML is a small player in domestic CV industry with market share of 1.7% (H1 FY11); however, in certain segment (5T-12T) the company has strong presence. The company offers its products mainly in the 5.0-7.5 ton (T) and 7.5-12.0T goods and passenger carrier CV segments, which together accounted for 14.8% of the total CV industry volumes in H1 FY12 (14.9% in H1 FY11). Recently, the company has also forayed into higher tonnage bus segment wherein it is supplying products designed by ISUZU. The sales mix is fairly balanced between Goods and Passenger segment.

As per estimates, industry bus sales in the 5.0-12.0T segment are derived in an equal proportion from three user segments - schools & colleges, office staff and route permits/ STUs. SML, however, derives around 60-70% of its bus sales from the school bus segment with the buses built on the Mazda platform. The remaining bus sales are to other user segments including tourist and staff transportation and STUs. Overall, the school/ college bus user-segment is considered relatively safer by financiers making it less vulnerable to shocks arising from lack of finance availability.

SML had a respectable market share in the 5.0-12.0T school bus segment with its competitors being TML, M&M and VECV. However, over past few quarters, in 5-12T segment, SML is gradually losing market share to its competitors, especially VECV who has been aggressively targeting 5-12T bus segment.

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