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Sector update: Automobiles - CV tonnage downshift; another area of concern

The CV cycle has shown clear signs of weakness in the last couple of months, with a sharp dip in volumes. As highlighted in our previous notes (refer , , , ), there were apparent contradictions between CV truck sales and underlying freight demand. While the volume decline is visible, we believe another area of concern is the sharp decline in vehicle tonnage (down ~15-20%) over last two months (Oct and Nov). The downshift in volume and tonnage could have an adverse impact on realisations and profitability of companies in this space. We believe Ashok Leyland (AL) will bear a higher impact of this decline compared to other players, as it has a greater share (50%+ marketshare in the 35T+ segment) of high-tonnage vehicles in its portfolio.

Tonnage downshift has been significant: Vehicle tonnage has seen a clear downshift over last two months (Oct and Nov 2018), with average tonnage per truck estimated to have declined 15-20%. More specifically, the share of heavy tractor trailers (35T +) has declined from ~22% in FY18 to 12% of volumes. With overall domestic M&HCV volumes having increased ~2% during this period, the pattern looks skewed. Tractor trailer volumes are down ~40% yoy, while ICV/MCV volumes have risen ~20% yoy.

The trend is likely to persist: We attribute the downshift to 3 key factors: (a) Weakness in haulage freight: As highlighted in our previous notes, haulage freight demand has been weak. Coupled with strong construction-linked demand for tippers, the proportion of tractor trailers in the space has declined. (b) New Axle Norms: New axle norms have led to a downshift towards MAVs from tractor trailers with MAVs/MCVs carrying enhanced load capacities and (c) Liquidity tightening: Financing that has tightened is relatively easily available for tippers, as a sizable portion of the segment demand is driven by tender wins (related to road construction)/fixed contracts.

AL could be impacted disproportionately: The 35T+ tractor trailer segment accounts for a disproportionate proportion of AL’s sales (currently at 21% compared with 12% for the industry). As AL’s market share in this segment of the industry is over 50%, it is likely to be impacted more than its peers. Further, AL’s realisations too seem to be moving in sync with the proportion of the 35T+ segment in its portfolio (down from 40% in FY18 to 21% currently). The sharp downtrend could lead to a decline in AL’s realisations – this in turn could hurt profitability, as negative operating leverage hurts margins.

AL’s production has been consistently higher than sales over last 3 months: In last 3 months (Sept to Nov), AL’s production has been nearly 24% higher than its sales (consecutively), implying an inventory build-up with the company (the last time AL’s production was higher than its sales for more than 3 consecutive months was in the downcycle of FY14. Apart from an increase in AL’s working capital, a consistent rise in the inventory levels could result in greater dealer push. While the extent of build-up is not a concern yet, given the company’s comfortable debt levels (debt:equity at 0.2); it is nonetheless a key monitorable.

We maintain our cautious stance on the CV space and also AL, given the weakness in profitability of freight operators, system wide overcapacity and liquidity tightening. The downshift in tonnage per vehicle could lead to more meaningful downsides to estimates. Given the weak volume growth and potential impact on realisations, we cut our EPS estimates for FY19E/20E by ~10%. We value the stock at Rs95 (8xFY20 EV/EBITDA) and reiterate Neutral. ​