Indian Commercial Vehicle Industry: Trends & Outlook

ICRA Rating Feature

Summary

The strong recovery witnessed in the domestic commercial vehicle (CV) sector in the second half of the financial year 2009-10 (FY 2010) has continued in the current fiscal with the April-November 2010 period reporting a growth of 35.2% over the corresponding previous year.

Steady growth in economic activity, pick-up in demand from across end-user segments, adequate availability of financing at competitive rates, and improvement in the overall sentiment are among the key factors that have collectively aided the growth across the segments of the CV industry.

Part of the growth has also been facilitated by pre-buying, a phenomenon witnessed during September 2010, ahead of changes in emission norms from October 1, 2010.

Overall, the growth in the medium and heavy commercial vehicle (M&HCV) segment has been stronger at 47.4% as compared with the light commercial vehicle (LCV) segment, which reported a 25.8% growth during the same period.

Within the M&HCV segment, the tractor-trailer segment was the first to witness recovery with increasing demand for transportation of industrial commodities and pick-up in foreign trade, while the tipper segment, which derives demand from the construction and infrastructure projects, witnessed a more gradual recovery.

Over the past three to four quarters, original equipment manufacturers (OEMs) have effected successive price increases averaging over 10% to recover the increase in input material prices and the cost of making the transition from BS II to BS III emission norms.

While economic activity remains buoyant and freight rates firm, the increase in ownership cost along with rising interest rates and fuel prices is likely to exert some pressure on the viability and cash flows of fleet operators.

With growth in the CV segment during Q2 FY 2011 having been driven partly by pre-buying ahead of BS III, ICRA expects growth in the second half (H2) of FY 2011 to be relatively subdued.

In terms of competition, while in the past, international OEMs were unable to make a major dent in the domestic CV market (characterised by a duopolistic structure), they have now ventured in through joint ventures (JVs), thereby, raising the prospects of increasing competitive intensity.

Some of the JVs are likely to benefit from the in-depth understanding of the domestic market that the local players have, their established vendor base, and their extensive marketing and distribution reach. Nevertheless, the incumbents, in defending their market position, would continue to draw strength from their established brand franchise, extensive service and distribution network, and competitive cost structures.

Industrial upturn and improved financing environment driving growth in CV segment

Barring some blip during the last few months, the key indicator of the underlying demand in the CV industry, the Index of Industrial Production (IIP), has been improving steadily for some time. Much of the growth in the CV segment has been driven by stronger economic activity and improvement in the operating environment for fleet operators, which has benefited from higher freight availability, firm freight rates, and relatively lower financing rates. The upsurge in M&HCV volumes has been supported by replacement demand originating mostly from large fleet operators. Within the M&HCV segment, demand for HCVs, particularly tractor-trailers, has been strong, reflecting improving demand from container applications, and the steel, cement, and construction industries.

During the last four years (i.e. FY 2007-10), the domestic CV industry has grown at a modest CAGR of 4.3% largely reflecting the sharp downturn witnessed in FY 2009. The recovery witnessed in FY 2010 helped the industry report strong growth in FY 2010 benefiting from the low base of FY 2009. The CV industry in India, as is the trend internationally, is cyclical, with periods of volume growth leading to over-investments in fleet capacity and subsequently to periods of correction.

 
Demand likely to remain strong in heavy duty and small commercial vehicles segment

With the country's highway infrastructure improving and the hub-and-spoke model gaining increasing acceptance, the domestic truck industry is witnessing polarisation, with growth in the HCV and Small Commercial Vehicle (SCV) segments outperforming the overall industry growth rate. Within the M&HCV segment, the share of heavy-duty, long-haulage trucks is witnessing a steady increase in proportion to the total M&HCV volumes, while in the LCV segment, SCVs are accounting for most of the volumes. In terms of cyclically, the MCV segment is comparatively less affected by industrial slowdowns as these are primarily used for transportation of agriculture produce, consumer durables, and some bulky commodities (like construction material) compared to HCVs, which cater more to the industrial segment.

In LCVs, the sub-3.5T segment has been able to increase its share consistently from 50% in FY2004 to close to 85% in FY 2010. Some factors that have contributed to the success of the sub-3.5T segment are the adoption of the hub-and-spoke model, increased penetration of modern retail even in rural and tier 2 and 3 cities, and substitution of three-wheelers (3Ws) by SCVs. Collectively, the size of the sub-3.5T LCVs and 3W goods carriers market has expanded from 56,000 units in FY 2002 to over 300,000 units in FY 2010, a CAGR of 23.4%. However, within this, the mix of SCVs and 3W has changed from 25:75 in FY 2002 to 70:30 in FY 2010, underscoring the preference for four-wheeled transportation.

Given the strong performance recorded by the sub-3.5T segment owing to its better performance against cargo three-wheelers, several OEMs such as Bajaj Auto, ALL (through tie-up with Nissan) and General Motors (through tie-up with SAIC) have unveiled plans to produce LCVs in this range. Piaggio, Force Motors and M&M, meanwhile, have already entered the segment. As a result, this segment is likely to get crowded and witness increase in competitive pressures as some of these players would benefit from their existing vendor base, distribution and service network.

CVs continue to be preferred despite cost competitiveness of Railways

The competition posed by the Railways to long-haul HCVs remains formidable, and the share of the railways in the total freight transportation has increased over the last few years. Traditionally, roads have been preferred for the transportation of non-bulk commodities like cement, finished steel, and food grains while the railways have been favoured for moving bulk commodities like coal, iron ore, and fertilizers. For long-haul transportation, the rail option is a less expensive than road transportation. However, even with the high cost differential, road transport has a higher share of the overall traffic. This is mainly because of the advantages of last-mile connectivity, flexibility, and on-time service offered by road transporters, who too have gained (from shorter vehicle turnaround time) from the country's improving highway network.

Some of the long-term drivers for the industry also remain favourable

(a)	The share of roads in total freight transportation has increased over the years following the construction of new highways that have reduced the vehicle turnaround time. CVs continues to offer more convenient service in many routes.
(b)	With substantial investments being made in the power sector, the demand for coal mining is likely to remain strong, facilitating demand for high-end tippers.
(c)	The demand for new trucks is likely to be replacement-led considering the fact that 30% of the total truck fleet, at present, is estimated to be over 12-year old. With the regulatory pressure on banning trucks older than 15 years increasing, replacement demand is likely to pick-up.
(d)	The CV replacement cycle is becoming shorter following the launch of technologically advanced vehicles (that offer higher mileage and reliability).

 
Competitive pressures likely to increase in the CV sector

With the Indian CV industry attaining a meaningful size and showing potential for stronger medium to long-term growth, competitive pressures in the industry are likely to increase, especially given the entry of several international OEMs in the Indian market. While in the past, international OEMs had not been able to make a serious dent in the Indian market, characterised by a duopolistic structure, ICRA expects the competitive pressures in the domestic CV sector to increase over the medium term.

Currently, the international OEMs are following a two-pronged strategy in the emerging markets: (a) adapting premium products for local-markets and (b) entering the low-cost segment through local engineering, sourcing, and production. In India, most of the international players have forged alliances with local partners through JVs so as to gain a deeper understanding of the market here and come up with products that meet local requirements. The JVs are benefiting from the strong product, technology and design capabilities of the foreign partner, and from the in-depth understanding of the local market of the Indian collaborator. However, the established players, in defending their market position, would continue to draw significant strength from their established brand franchise, extensive distribution network, and competitive cost structures.

CV Dealers

▪	The CV market is currently in the transition phase from BS II to BS III system; OEMs are in the process of ramping up production of BS III vehicles; inventory levels in the channel are quite low at present.
▪	Fleet operators are in the "wait-and-watch" mode; apprehensive about the performance of new engines.
▪	Successive price increases effected by OEMs to pass on the increases in raw material prices and the cost of compliance with the new emission norms have increased vehicle ownership costs significantly, thereby impacting operator viability; price increase on account of emission norm changes is around 5-8%.
▪	Overall CV sales are likely to remain low in Q3 FY 2011; expected to pick-up from Q4 FY 2011 onwards.

 
CV Financiers

▪	Interest rates for CV financing have marginally increased (i.e. 25-50 bps) in the recent period on account of implementation of base rates and overall increase in interest rates.
▪	With private sector banks increasing their presence in CV financing, competition is likely to keep a check on rate increases to an extent.
▪	Approach towards lending norms (i.e. LTVs, tenure, customer filtration) however, remains rational.
▪	Disbursal levels are increasing steadily in tune with the underlying growth; delinquency levels have declined sharply.
▪	LTV ratios remain (in favour of customers) above 95%+ for large fleet operators with a credible track record and at 75-80% for the industry as a whole.
▪	Rise in vehicle ownership cost, increase in fuel cost, and possible weakening of freight rates (on account of capacity buildup) remain key concerns.

 
CV Fleet Operators

▪	Large organized fleet operators have been adding capacity, citing strong demand across sectors.
▪	Despite rising interest rates, cost of financing remains quite favourable (below 10%) for some of the large operators with an established track record; LTV ratio close to 100% for these operators.
▪	Trend in freight rates has largely been a mixed one; driven mainly by demand-supply mismatch in market; fluctuation in freight rates and diesel prices are largely passed on to the market.
▪	Absence of quality infrastructure/highways continues to impact viability of high prices sophisticated trucks.

 
Marginal increase in interest rates unlikely to dampen growth rates

Although availability of financing remains one of the key factors influencing growth in the CV industry, given that over 90% of the vehicles are financed, ICRA believes that any marginal increase in interest rates (of say, 50-100 bps) on CV loans may not dampen growth as demand is likely to be influenced more by the underlying economic growth.

 
While heightened risk aversion during the economic slowdown had forced some financiers, particularly private banks, to shy away from CV financing, now, with economic growth picking up and the operating environment improving for fleet operators, most private banks have re-entered the CV financing market. While, competition among banks, non-banking finance companies (NBFCs), and the captive financing arms of the OEMs is on the rise, there has been no significant relaxation in lending norms.

 
Overall, the loan disbursal levels are currently growing at a steady pace in line with the underlying growth in the CV industry. The delinquency levels, which had increased sharply during the downturn, have been declining post Q1, 2009-10, with fleet operators reporting favourable operating cash flows. In fact, for some financiers, the delinquency levels, are almost back to the levels prevailing before the downturn witnessed in H2 FY 2009. In terms of lending norms, the LTV ratios, particularly for large fleet operators with superior creditworthiness, remain high, averaging 90-95% (for M&HCVs, only chassis). In the case of LCVs, given the higher risk perception associated with borrowers belonging to this segment, the LTV ratios remain between 70-80%. While the overall financing environment has improved, the risk associated with the first time users (FTUs) segment remains high, as reflected by a spread of almost 250-350 bps between large fleet operators and FTUs.

Freight rates hold firm in some regions; impact of fuel prices is largely passed on barring some impact of demand-supply mismatch

After a period of tight liquidity during the downturn, the operating environment for fleet operators has been improving since 04, FY2010 on account of several factors, including: (a) overall pick-up in freight demand; (b) increase in freight rates; (c) reduction in interest rates; and (d) some relaxation in lending norms by financiers. Although not substantially, freight rates have moved up by an average of around 8-10% and continue to hold firm. Fuel prices are largely passed on by the truck operators barring some mismatch in demand-supply.

Large fleet operators providing dedicated logistics solution to organised-sector clients tend to insulate themselves from fluctuation in fuel prices through periodic fuel price adjustments.

Road freight evolving into higher value add, to aid in cushioning cyclical downturns and competition from alternate modes of transport

The road freight segment in India is gradually evolving from being a pure transportation business to a complete, service-based, end-to-end logistics solutions industry, which is a positive for the players in the organised road transportation sector. With competition from the unorganised sector getting keener, players in the organised segment have either diversified into higher-margin services such as transportation of sundry goods, over-dimensional cargo or have tied up with large clients, particularly in the automotive, pharmaceutical, and retail sector to provide complete supply chain solutions. Large fleet operators have been looking at providing multi-model logistics solutions via a combination of rail and road network and exploring opportunities in this area through: (a) JVs with container cargo movers; or (b) long-term rake hire contracts with the railways.

Profitability indicators of CV manufacturers likely to remain stable

After deteriorating sharply during the downturn, the profitability indicators and credit profiles of all the OEMs in the domestic CV industry have been on an improving trend, being driven by strong growth in volumes and the benefits accruing from the cost-management measures initiated during H2 FY 2009. The strong underlying demand has allowed the OEMs to regularly pass on the increases in raw material prices to an extent.

Outlook

The medium to long-term outlook for the domestic CV industry remains robust, given the expectations of strong economic activity and infrastructure development, besides the inter-segmental shift. However, the sharp growth in volumes that was witnessed during the last 6-7 quarters may moderate to an extent in the short term. The contributing factors include, among others, partial withdrawal of the stimulus package; expected increase in interest rates; increase in vehicle prices following the successive price revisions (upward) made by the OEMs following the rise in input material costs; and the absence of the pre-buying that happened ahead of implementation of BS III norms. While the long-term growth prospects for the domestic CV industry remain favourable, pricing flexibility for the OEMs is likely to remain constrained mainly because of the entry of new players in the industry and the capacity additions taking place. Besides, the CV industry would also have to cope with the cost pressures arising from the tightening of regulatory norms on safety and emission.

Over the medium term, the growth is likely to be higher in the upper end of the M&HCV segment (that is 16T and above) and in the lower band of the LCV segment (that is less than 3.5T segment). We expect the domestic M&HCV segment to grow in the range of 9.5-11.5% over the next five years and the LCV segment to grow in the range of 10-13% with growth in the (less than 3.5T) estimated to be higher at 13-15% during the same period.