Credit profile of OEMs likely to improve further
With recovery in Indian commercial vehicle sales, the credit profile of CV OEMs is expected to improve in the near to medium term on the back of higher internal cash flow generation and relatively limited capital expenditure requirements.
The credit profile of OEMs in the CV space differs sharply with some of them having sizeable debt, while others maintaining healthy cash balances. For instance, while Tata Motors has sizeable debt (at a standalone entity level), its credit profile continues to derive benefit from its holdings in Jaguar Land Rover (JLR), its strong refinancing capabilities and position within the Tata group. On the other hand, Ashok Leyland too has initiated steps to reduce its debt burden by raising cash from equity dilution, divestment of non-core investments and scaling back capital expenditure plans. The other two OEMs – VECV and SML Isuzu – continue to maintain strong credit profile on the back of staggered investments and healthy cash reserves.
Gradual improvement
In line with pick-up in sales of HCVs, improving realizations and favorable impact of cost-reduction measures, the profitability indicators of CV OEMs have also started improving since the beginning of the current financial year. As per ICRA estimates, the EBITDA margins of CV OEMs have improved by almost 180 bps to 3.6 per cent (in 9m FY 2015) compared to 1.8 per cent (in FY 2014). ICRA believes that with recovery in the M&HCV segment, the margins of CV players are likely to expand further in FY 2016 compared to the previous couple of years. The extent of improvement in margins would also be driven by increasing focus of OEMs to scale up their export volumes, which have grown by 14.7 per cent in 10m FY 2015, vis-à-vis -3.7 per cent in FY 2014.
ICRA believes that the extent of improvement would remain sensitive by continuation of high discounts being offered by OEMs, the likely increase in expenses related to new model launches and the inflationary pressures on account of rising manpower costs. Accordingly, a meaningful recovery in M&HCV sales will be critical for the industry’s earning trajectory to improve going forward.
Interesting times ahead as new OEMs enter LCV segment and others launch refreshed models in HCVs. The competitive intensity in the domestic CV industry has increased over the past five years as new OEMs have entered the market while the existing players have ventured into new segments and expanded their sales-cum-service network. For instance, some of the recent entrants in the M&HCV space like VECV – the JV between Volvo & Eicher – Bharat Benz, the Indian unit of Daimler, and M&M together now account for ~17 per cent of M&HCV segment in India. Accordingly, the market share of Tata Motors has declined by 4.5 per cent over the past four years, while that of Ashok Leyland has remained relatively stable (at 25-26 per cent).
While competition in the M&HCV space has come largely from foreign OEMs, in the LCV space, M&M and Force Motors have been the key players who have gained share on the back of growing acceptability of pick-up trucks and the ‘Traveler’ range of buses, respectively.
While competition from OEMs like VECV and Bharat Benz is likely to be formidable, the strong brand equity of incumbents with fleet operators, well-established product portfolio and widespread servicing network would continue to pose a challenge for new players in gaining meaningful market share, especially in the HCV segment. However, in the LCV segment competitive intensity is likely to increase as two-three new players are expected to enter the segment over the near to medium term. While some of them are established OEMs with deep understanding of the Indian market, others have large-scale globally in the LCV space and experience of operating in markets similar to India.
In addition, it is believed that entry barriers in the LCV space are relatively less stringent in contrast to M&HCV, as having a wide service network is not so much of a compelling requirement as their span of commute is limited to localized area. Secondly, a sizeable proportion of LCV buyers generally tend to be first-time buyers (FTBs), which are easier to tap into vis-à-vis large fleet operators who tend to have higher brand loyalty towards incumbent players.
The Indian CV industry is also witnessing sizeable investments by OEMs towards upgrading their product portfolio, introducing new models and expanding manufacturing capacities. These investments are likely to allow some of the new players in strengthening their positioning in the market.
Double-digit growth in M&HCV segment
In ICRA’s view, the M&HCV (truck) segment is likely to register a growth of 12-14 per cent in FY 2016 driven by continuing trend towards replacement of ageing fleet and expectations of pick-up in demand from infrastructure and industrial sectors in view of reforms being initiated by the Government. Over the medium term, demand for new CVs will also be driven by gradual acceptance of advance trucking platforms, progression to the BS-V emission norms (possibly by 2017 onwards) and introduction of technologies such as anti-lock braking system (ABS), which may lead to some advance purchases by fleet operators.
Unlike M&HCVs, the LCV segment is expected to grow at a modest four-six per cent in FY 2016 as the segment’s prospects continue to be influenced by overcapacity issues and constrained financing environment amidst rising delinquencies. Nevertheless, driven by certain structurally favorable factors, the segment’s growth prospects over the medium-term remain intact. Some of the factors that are likely to support steady demand for LCVs going forward include a further proliferation of “Hub-n-Spoke” logistics model with the implementation of GST, relatively untapped potential in semi-urban and rural areas, and improving urbanization levels. Moreover, the emergence of SCVs has also been a source of attractive employment opportunities for FTBs, which, along with an established financing market, will also support demand for LCVs. Accordingly, we expect demand for LCVs will grow at CAGR (%) 11-13% over the longer-term.
After two years of slowdown, some segments of the domestic CV industry have shown signs of recovery in FY 2015. In the first 10 months of the fiscal, the pace at which domestic CV sales have been declining has reduced to 4.6 per cent compared to a contraction of 20.2 per cent witnessed during FY 2014. Within the CV space, the M&HCV truck segment has in fact posted a positive growth of 19 per cent in 10 months of FY 2015, while the HCV (16T+) segment, which accounts for almost half of the total M&HCV (Truck) sales, has been witnessing strong demand of up 42.6 per cent in the same period of FY 2015, on the back of replacement demand following two years of deferment and capacity addition by organized fleet operators to some extent.
While the M&HCV truck segment seems to have bottomed out, the LCV truck segment is still experiencing a sluggish trend (down 13.8 per cent YoY) as significant capacity addition over the past few years and constrained financing environment amidst rising delinquencies remains a challenge for the segment. The bus segment, which contributes nearly 13 per cent to industry sales, has also started witnessing an improvement from Q3 FY15 onwards after various State Road Transport Undertakings (SRTUs) started placing orders for new buses as part of the JNNURM II programme.
Improved operating environment
From fleet operators’ perspective, the operating environment over the past six-nine months has also stabilized owing to sharp drop in diesel rates and relatively firm freight rates, implying improvement in their cash flows. An analysis of the wide spectrum of fleet operators based in the Northern and Western markets suggests that fleet utilization levels are gradually improving with higher load availability from some of the key freight generating sectors such as automobiles, cement and other general industries. These factors may also aid improvement in the financing environment which has turned challenging, at least for small fleet operators (SFOs) and first-time buyers (FTBs), on the back of sharply rising delinquency levels.
Although asset quality indicators continued to deteriorate till Q3 FY 2015, most of the financiers expect that they are unlikely to deteriorate further.
While the overall environment seems to be improving, there are still pockets of challenges. For instance, demand for tippers is likely to remain subdued in view of delays in pick-up in mining activities in the affected States and sizeable idle capacity. Secondly, the subdued trend in re-sale values of second-hand vehicles, apart from ageing of the existing fleet, suggest that demand recovery is still in the initial stages.