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Sector update: Automobiles - CV conclave: LCVs to face challenges as well

We recently attended a conference on the future of the CV and logistics space in India. From a near-term perspective, the pressure on CV demand will likely persist, with LCVs in particular likely to see cost pressures from the shift to BSVI emission norms. From a longer term view, keeping pace with technological/regulatory changes could be key challenges for the industry. Key takeaways:

LCVs: near-term pressures; BSVI price hike could be a ‘surprise’

• Long-term growth factors in place…: Over the medium to long term, growth prospects for the LCV space are strong. The continuing development of the hub-and-spoke model (post the implementation of GST), pick up in rural demand and specialised usage of LCVs will drive growth. Globally, LCVs for nearly 75% of total CV sales while in India the proportion is close to 62%. Hence, with long-term growth factors in place, LCV volumes could rise from ~6,20,000 to 7,50,000 units over the next 4 year.
• …But, near-term concerns persist: Even though we remain sanguine on the long term picture, near to medium term challenges persist: (a) a change in the ecommerce rules could potentially lead to slower ecommerce sales and consequently, impact demand and (b) Higher interest rates and lower availability of financing (rates up by 100-150bps) continue to impact demand. In particular, first-time user demand has been affected negatively.
• “Surprise” increase in prices as a consequence of BSVI: The increase in LCVs on BSVI norms will likely be meaningfully more than the expected 5-10% for M&HCVs. Consequently, volumes could decline in FY21E (down 20-30%) even though there might be pre-buying in H2FY20. Certain categories (notably sub ton LCVs) could shift to either CNG or eventually electric vehicles. The sharp cost push may force OEMs to take a staggered approach to increasing prices, which could consequently pressure margins.

M&HCVs – current environment sluggish; prepared for BSVI

• Current demand outlook weak: The current demand outlook is sluggish, with operator profitability under stress. A number of factors have impacted vehicle demand, which include weak freight demand (partly owing to upcoming elections) and regulation (axle norms, GST implementation) linked freight capacity hikes. GST implementation (RTOs have been abolished in 40% of the states; average driving range is up by ~10%) has reduced travel time by ~10%. Consequently, operator profitability has been under pressure, particularly since Q2FY19, with freight rates not having kept pace with fuel price hikes. H2 could see a demand pickup on pre-buying before BSVI implementation.
• OEMs focusing on customer service and fleet profitability: In the last few years, there has been a shift from focus on the service to a fleet owner. OEMs and dealers are now focused on ensuring maximum uptime for a vehicle in order to improve profitability – this entails improving service levels and more reliable vehicles (even if the initial purchase cost is higher). It is in this context that telematics would play an increasing important part in logistics management. Telematics penetration (only 10-15% of M&HCVs have telematics) is likely to increase, as it would help improve efficiencies, including lower pilferage/fuel consumption.
• Prepared for a shift to BSVI: The M&HCV segment will largely be prepared for the shift to BSVI norms, even though the jump from BSIV to BSVI is a difficult one. Further, it is for the first time in the world that BSVI will be implemented on vehicles with a cowl making the task even more daunting.

Other takeaways: (a) Next Uber? Private equity and VC funding could flow into the sector, especially with respect to creating a freight aggregation model, ala 'Uber'. Some panelists believed that this could become a meaningful portion of demand in the industry over the next 2-3 years. This would be beneficial for small fleet operators (b) Driver shortage: Driver shortage (pegged at 28%) is a serious issue that has been affecting fleet utilization levels (c) Formalisation of the aftermarket: Implementation of BSVI norms could lead to greater reliability and lower aftermarket revenues for the industry as a whole. However, higher complexity would ensure a shift from the unorganised to the organised sector, leading to higher showroom servicing revenues. (d) Electrification some distance away: While electrification of buses has begun in a modest way (~1,000 electric buses are on the roads), electrification of long-distance trucks could be a while away. However, as battery prices decline (from US$1000kwh in 2010 to US$200 currently) and BSVI increases vehicle costs, electrification of LCVs is likely.

We remain cautious on the M&HCV cycle, despite a pre-buying-induced improvement in demand in H2. This drives our cautious stance on Ashok Leyland (pure play in M&HCVs). Other companies that could be impacted are M&M (LCVs comprise ~45%/25% of automotive/total volumes), TTMT (~16% of consolidated revenues) and Eicher Motors (VECV is ~10% of consolidated profits).