Indian CV Industry: Going the Right Way!

Rakesh Batra, Partner and National Automotive Leader, Ernst & Young

Strong growth rates of 52% and 98% in October and November 2009, respectively, have taken everyone by surprise. What is surprising is the contrast in growth rates during the preceding months, which was negative for FY09 and the first quarter of the current fiscal. The situation began to improve in the second quarter with the domestic CV industry showing positive growth after four quarters of de-growth. The third quarter has exceeded all expectations of growth, although more due to last year's significantly low base.

Let's take a look into the past.

The Indian CV industry witnessed spectacular growth between FY03 and FY07, growing at a CAGR of more than 25%. A favourable macroeconomic environment, increased industrial activity and easy financing, among others factors, were the major drivers of growth in the domestic market. Exports accounted for around 10% of total volumes during this period.

In 2004, the rule, commonly known as the Golden Pass, under which trucks were allowed to carry extra loads over and above the limit permitted by the law, on payment of meagre penal charges, was withdrawn. This resulted in a spurt in the growth of CVs in the goods carrier segment.

A CAGR of more than 25% for five years was followed by a correction. In FY08, easy financing, a significant growth driver, declined appreciably. Interest rates began to rise, adversely impacting borrowing costs, and subsequently, the total cost of ownership. With as many as 90 out of 100 vehicles being sold on finance, the liquidity crunch was a big blow to the demand. Non-banking finance companies (NBFCs) virtually stopped lending to first-time users and small fleet operators. It is estimated that total credit disbursements in the CV industry declined by 33% in FY09 as compared to FY08.

The global slowdown adversely affected global and domestic demand in FY09. Industrial activity declined and GDP growth projections were lowered with every revision. The third quarter of FY09 was the worst for the Indian automotive industry in recent times, with sales of CVs falling by 48% in the domestic market. Exports also declined by 40% during the same period.

Industrial activity continued to be sluggish, despite a minimal revival in consumer sentiment toward the end of FY09. The Index of Industrial Production (IIP), which has a significant correlation (of 98%) with CV sales, de-grew in the fourth quarter of FY09. CV sales also de-grew during this quarter, but the sequential improvement witnessed over the third quarter was the silver lining.

During FY09, CVs de-grew by 22% and exports declined by 28%. Although all segments were impacted, higher tonnage vehicles were the worst hit. The M&HCV segment de-grew by 33%, as compared to a 7% decline in LCVs in the domestic market. Within the domestic M&HCV segment, a slowdown in construction and mining, and delays in awarding licences and construction projects, adversely affected the sale of tippers and dumpers, which constitute around 30% of total heavy truck sales.

According to classifications, based on the nature of a load, the passenger carrier (bus) segment, which is considered to be non-cyclical, witnessed a 7% y-o-y decline in domestic sales in FY09. In contrast, the goods carrier segment, which constitutes more than 80% of total CV sales, was down 24% y-o-y.

Following the economic downturn and a sharp decline in sales volume, the government initiated measures to help in reviving sales in the CV industry. Its stimulus package comprises two components:

1.	Government grant for buses: Under the Jawaharlal Nehru National Urban Renewal Mission (JNNURM), the government agreed to provide a 50% subsidy on the cost of new buses purchased for urban transportation till 31st December 2009. The total funds allocated for this amounted to INR 42,000 million. It is estimated that around 11,000 buses, amounting to around four months' sales, have already been ordered under the scheme. This is significantly lower than the total grant amount potential, which can cover 60,000 buses, based on the analysis given below. Demand Potential of Buses Amount of grant (INR million) 42,000 Total average cost of a bus (INR million) 1.4 Central government contribution per bus chassis (INR million) 0.7 Potential bus demand (in units) 60,000 Source: Ernst & Young analysis
2.	Government grant for trucks: The government has launched the following initiatives to create a surplus demand for trucks:   ▪  Reducing excise duty on CVs from 10% to 8%.   ▪  Depreciation of 50% on CVs purchased till 30 September 2009.   ▪  Directing public sector banks to increase credit lending to help in reviving the demand for CVs.

 
These initiatives, along with the increased level of industrial activity in the country, have yielded positive results in the CV industry, and FY10 began on a positive note. LCVs have begun to grow from the start of the current fiscal, and have grown by 27% till November 2009, as compared to the same period last year. MHCVs were off to a slow start. This segment de-grew by 30%, as compared to the same period last year, for the first four months till July 2009. It has, however, shown robust sales volumes during the last three months, starting September 2009, and has managed to bridge last year's gap by securing a cumulative volume of 132,357 units by November 2009, as compared to 135,630 units during the same period last year. Driven by lighter tonnage vehicles, the domestic CV industry has been able to show a decent growth of 12% from April to November 2009, as compared to the same period last year.

There has been a sequential increase in the monthly volume of exports. However, as compared to last year, they have only started growing from October 2009, and cumulatively, were down by 22% till November 2009.

Outlook

The first eight months of FY10 have showed an appreciable improvement, as compared to the third quarter of FY09. A robust GDP growth of 7.9% for the second quarter and a 6.5% growth in cumulative IIP till September 2009 confirms that the level of industrial activity has escalated and is being reflected in economic parameters as well. FY10 has seen sales volumes stabilizing, and in view of the strong correlation between CV sales and the level of economic activity, average monthly volumes are expected to rise from here on.

In the short term, the third and fourth quarters are expected to witness high year-on-year growth due to last year's exceptionally low base. Bharat Stage IV, the new vehicle-emission norm, will be enforced from 1st April 2010. To comply with the new regulations, some changes will be required in the technical configuration, which is expected to increase the cost of the vehicle by around 5%. This is likely to prepone some demand in the fourth quarter.

It is evident that there has been a shift in the demand pattern. After the withdrawal of the Golden Pass, transporters have begun optimizing vehicle usage and the hub-and-spoke model of distribution has gained in importance. HCVs are used for long journeys to carry high tonnage cargo. Common points are identified at which loads are transferred to different LCVs to distribute goods to different locations. Players have responded well to this change by launching light vehicles for intra-city movement, e.g., products such as Tata's ACE, Piaggio's APE Truk and Mahindra's GIO. These sub-one tonners, also known as Small Commercial Vehicles (SCVs), have been fairly successful in gaining substantial market share from three-wheelers (goods carriers). The driving comfort, easy maneuverability as well as the prestige of owning a truck, however, small, justifies its relatively higher cost in the eyes of the consumer.

In the long term, there are various drivers in the industry - a growing economy and an expanding road network being the two most important. A sustained level of investment in the country is also expected to increase industrial activities in these sectors, which, in turn, is likely to positively impact the demand for CVs in the next two three years.

Industrial capex (INR billion)	FY09E	FY10P	FY11P	FY12P
Automobiles	209	135	100	75
Cement	79	96	49	26
Fertilizers	10	28	32	85
Steel	205	169	293	365
Textiles	62	45	65	96
Total	565	473	539	647

 
In addition, freight transportation by road is expected to increase due to the enlarged network of highways and inter-state roads. Although the railways are aggressively targeting cargo movement as an enhanced revenue stream, the possibility of any immediate shift in the cargo transport pattern from road to railways is bleak.

Another significant development is the increase in professional third-party transportation and supply chain services (3PL), which will be conducive for the growth of the CV industry.

With the medium-term customer package so full, the industry is gearing up to tap this potential. By collating the various announcements, it is estimated that total capacity will double to 1.5 million units in the medium term. Although it is important to note that the industry's current capacity utilization level is fairly low, producing 0.42 million units on a capacity of 0.85 million, this is not deterring players from adding on extra capacities.

 
It is also significant to note that international players are likely to contribute more than 70% of the incremental capacity. As such, their share in the total industry capacity is projected to increase to 37% in the medium term from the current 10%. To achieve this, these companies are joining hands with local players and collaborating with them as an entry strategy. By doing this, such players seek to gain rapid access to local market intelligence and quickly understand the complexities of dealing with various regulatory and statutory authorities. Apart from leveraging the advantages of an already established distribution network, associating with local players also enables them to achieve instant brand recognition.

Sr. No.	Internatiohnal Player	Indian Partner	Capacity (Units)
1.	Mazda	Swaraj	12,000
2.	MAN AG	Force	24,000
3.	Volvo	Eicher	48,000
4.	Nissan	Ashok Layland	1,00,000E
5.	Navistar	M&M	3,00,000E

Collaborating with overseas partners is beneficial for Indian players as well, since it provides them with easy access to enhanced technology and a wider product range, thereby facilitating their diversification plans. A case in point is Ashok Leyland, the M&HCV major, which has tied up with Nissan Motors to produce LCVs. Similarly M&M, which is the second-largest player in the LCV segment, is partnering Navistar International to venture into the M&HCV segment.

India, which is currently the fourth-largest CV market in the world, is expected to reach the one million annual sales mark by 2020.