Infrastructure-led demand to drive CV market in FY 2019

The domestic commercial vehicles (CV) industry is expected to grow in the range of 9-11 per cent in FY 2019 supported by the pickup in infrastructure projects, improved industrial activity, healthy demand from consumption-led sectors, etc, says ICRA report.

The domestic CV industry ended FY 2018 on a strong note, witnessing a growth of 20 per cent in volume terms over the prior year. The recovery was driven by a combination of factors including pent-up demand post demonetisation and GST and macro-economic recovery as reflected by recovery in both industrial and infrastructure development. During FY 2018, stricter enforcement of overloading norms in select states, especially in North India, also contributed to the growth momentum. Additionally, sectors like auto carriers, 3PL players, cement, steel and oil tankers also contributed to growth. The momentum has continued in FY 2019 as well with YoY growth of 57 per cent in 2M FY 2019, driven by healthy demand from various sectors and a low-base effect. In FY 2018, the growth was supported primarily by M&HCV (Truck) and LCV (Truck) segments, which grew by 19.4 per cent and 29.5 per cent respectively in unit terms. Apart from low-base effect, the strong growth in the truck segment has been supported by pick-up in infrastructure projects, particularly in the roads, urban infrastructure and affordable housing segment. In contrast to trucks, the demand for buses contracted sharply during FY 2018 by 13.7 per cent with no order inflows from State Transport Undertaking (SRTUs), which represent a sizeable part of the bus market in India.

Going forward, ICRA expects the domestic CV industry to grow in the range of 9-11 per cent during the current fiscal supported by the pickup in infrastructure projects, improvement in industrial activity, and with healthy demand from consumption-led sectors and the rural market. Based on ICRA’s channel check demand for tipper and construction trucks continues to be driving growth across various markets. Nevertheless, the growth momentum is likely to witness some moderation, especially in the M&HCV (Truck) segment because of sizeable capacity addition witnessed by the industry in the prior year, rising pressure on earnings of small fleet owners due to increasing diesel prices, and adverse impact of relaxation in overloading norms and other regulatory changes.

Ongoing replacement cycle to drive LCV demand
After witnessing almost three years of subdued demand, LCV sales started recovering from FY 2017 onwards and registered healthy growth in FY 2018, supported by replacement-led demand, improvement in financing environment and pick-up in rural demand. ICRA believes that the segment is on a structural uptrend and with recovery on the back of improvement in liquidity situation. Consumption-driven sectors, E-commerce and Express Cargo focused logistic companies would remain key growth drivers for the segment apart from rural demand. Over the medium-term, the segment would also benefit from roll-out of GST and its impact on logistics sector and preference for hub-and-spoke model. Accordingly, ICRA expects the LCV (Truck) segment to register a growth 10-12 per cent in FY 2019.

M&HCV’s growth momentum to continue till FY 2020
In FY 2018, the M&HCV (Truck) segment grew by 19 per cent in volume terms, led by ICVs (7.5-12T) and HCVs (16.2T+), while MCVs degrew.

Within the HCV segment, the growth was driven primarily by 37T haulage trucks and tractor trailers. With changing transportation landscape and increasing preference for hub-and-spoke model, demand for trucks is gradually shifting either in favor of bigger trucks (for long-haul transportation) and ICVs and LCVs (for short-haul transportation). As a result, the demand for 12-16T trucks is shrinking and getting restricted to select applications like agriculture produce and building materials.

ICRA expects the growth momentum to continue in FY 2019 as well, with M&HCV (trucks) expected to grow in the range of 7-9 per cent. This would continue to be supported by pick-up in infrastructure projects, particularly in the roads, urban infrastructure and affordable housing segment, which augurs well for tipper and construction truck demand. However, although growth prospects remain strong, the sharp rise in diesel prices compounded with frequent increase in third-party insurance premiums, tyre and toll charges, etc are likely to put pressure on earnings of fleet operators, impacting their viability and fleet expansion plans over the near term. Apart from viability pressures, recent relaxation of overloading norms in certain states, and the Government's recent proposal to increase truck axle load by 20-25 per cent, also has potential to disrupt the ongoing CV upcycle.

Over the medium term, growth in the industry would also be supported by impending implementation of BS-VI emission norms from April 2020 onwards. With significant changes to be implemented to meet the tightening norms, CV prices are expected to increase by 8-10 per cent, which will trigger pre-buying and augment CV sales in FY2020. Additionally, GoI’s plans on phasing out old diesel vehicles through proposed vehicle modernization program would trigger replacement-led demand over the long term.

Replacement-led demand driving bus segment in FY 2019
In contrast to FY 2017, bus sales had contracted sharply during FY 2018 (down 14 per cent YoY), primarily because of lower order inflows from State Transport Undertaking (SRTUs) owing to lower budgetary allocation from centrally sponsored schemes and their weak financial profile. Accordingly, SRTU sales, which accounts for almost 30-35 per cent of bus sales in India have contracted sharply during FY 2018.

Apart from shortfall in demand from SRTUs, the uncertainty in the implementation of bus body code was the other reason for lower bus sales as customers had to make up their mind and choose between FBVs or building vehicles through body builders. Within the bus segment, the decline in sales up to 12t segment was relatively low because demand for school buses, last-mile connectivity and feeder routes continued to offset the impact of lower SRTU orders.

However, growth is expected to recover in FY 2019 with domestic bus sales to grow 12-14 per cent, aided by expectation of replacement-led demand following a year of sharp contraction in bus sales. The segment’s prospects remain favorable over the medium-term driven by GOI’s focus on improving urban as well as rural transportation and initiatives such as smart cities. The bus segment has also benefitted from healthy demand from online aggregators and staff carrier segment besides schools & college which remain a stable source of bus market in India. Additionally, fleet replacement cycle is gradually reducing with rising customer expectations, which is also likely to reduce average fleet age and spur replacement-led demand.

Profitability indicators of CV OEMs to remain stable
The domestic CV industry is expected to register a growth of 9-11 per cent in FY 2019. Coupled with increase in vehicles prices to incorporate the impact of regulatory changes (ie emission norms and introduction of air blower) and recovery in commodity prices, the revenue growth of CV OEMs is likely to be stronger. Furthermore, some of the companies would also report higher growth in other business segments viz defense supplies and scale-up in new segments or markets.

However, profitability margins of CV OEMs are likely to remain between 7-8.5 per cent range in the near-term because of rising raw material prices and elevated discount levels owing to stiff competition. In addition, rising content per vehicle because of regulatory changes may be passed on only gradually by OEMs. Over the medium-term, the key sensitivity to profitability indicators of CV OEMs would continue to be increasing competitive pressures (as foreign OEMs scale-up volumes on back of new model launches and expanding sales network) and higher investments in developing new models and technologies (to meet next level of emission norms).

CV OEMs to raise capital expenditure
With recovery in domestic demand, the CV industry’s capacity utilisation improved to 57 per cent in FY 2018 and is likely to improve further to 67-74 per cent by FY 2020 as no major capacity addition is expected in the near-term. However, as utilisation levels are on an improving trend, select players including Ashok Leyland Ltd (ALL) and VE Commercial Vehicles Ltd (a joint venture between the Volvo Group and Eicher Motors Limited) have announced capacity addition plans.

In addition to capacity enhancement, majority of capital expenditure of CV OEMs will be spent on new product development, addressing portfolio gaps, technology upgradation related to next level of emission norms and investments in sales network. With an eye of growing their international business, some of the CV OEMs are also contemplating setting-up assembly units overseas. ICRA estimates that CV OEMs will spend approximately Rs 31-35 billion per annum (on aggregate basis) over the medium-term in the aforementioned areas.

Courtesy: ICRA Limited, an investment information and credit rating agency