The intense second wave of Covid-19 afflictions and attendant lockdowns will limit growth in the domestic commercial vehicle (CV) sales volume to 23-28% this fiscal, compared with 32-37% expected prior to its onset. Volume growth had hard-braked to a decadal low last fiscal¹.

Credit metrics of CV makers are expected to improve as margins expand on better capacity utilisation and product mix.

The CV market saw two consecutive fiscals of steep volume decline (29% and 21% in 2020 and 2021, respectively), following multiple headwinds such as revised axle norms, BS-VI transition, and the pandemic.

While a sharp recovery from the lows was on the cards this fiscal, it will be constrained by a weak first quarter because of the second wave of the pandemic. In April, freight rates fell ~20% on-month even as diesel prices remained elevated, hurting fleet operators. With lockdowns becoming widespread in May, freight movement, and consequently the profitability of fleet operators, would remain under pressure, weighing on demand at least in the first quarter.

As lockdowns ease from the second quarter, freight demand and rates could normalise, aiding demand for CVs.

Says Hetal Gandhi, Director, Crisil Research, “MHCV volume, which was hurt more in the past two fiscals, should see a strong 35-40% growth this fiscal, driven by the government’s infrastructure thrust² and revival in economic activity. LCVs could grow 15-20% given continued last-mile demand from e-commerce, consumer staples and the replacement market. Demand for buses – the segment hit the hardest because of schools shutting and lack of demand from state transport undertakings and corporates – should grow 67-72%, but will remain at multi-year lows. Overall CV volume would still be ~30% below fiscal 2019 level.” (See details in annexure).

OEMs are unlikely to get a fillip from wholesale push because inventories at dealers were at fairly elevated levels of 35-40 days as of end-March (against normal levels of 25-30 days). Inventories had risen sharply in the second half after near-zero inventory at the beginning of last fiscal due to the BS-VI transition.

However, one key continued positive this year would be faster revenue growth versus volumes. Better product mix due to higher sales of costlier MHCVs compared with LCVs would provide a fillip to average realisations. Raw material cost inflation, particularly in the form of steel prices, is expected to be largely passed on to consumers, similar to last fiscal which saw 10-15% price increases due to both BS-VI and commodity inflation.

Says Naveen Vaidyanathan, Associate Director, Crisil Ratings, “Higher revenue, coupled with improved capacity utilisation (up from ~38% to ~45%) and control on fixed costs, should help CV makers improve operating margin³ this year to ~7%⁴. Last year, players had eked out operating margin of 4.4% despite decadal-low volume due to significant operational improvements and reduction of fixed costs. But notably, margins this year would still be lower than the average 9.5% achieved over fiscal 2016 to 2019.” (See details in annexure).

With improved profitability, capex – cut sharply last year – should more than double this year to normal levels. Nevertheless, higher profitability would drive free cash flow generation and help lower debt. This would support an improvement in credit metrics – interest cover should improve to 3.6x from a low of 1.5x last fiscal.

The forecast is predicated on recovery in demand from the second quarter with easing lockdowns and pace of vaccinations picking up. A third wave of Covid-19 could further dampen sentiment, and will be a key monitorable, too.

¹ Domestic wholesale volumes
² ~10% higher outlay in budget 2021-22 under Ministry of Road Transport and Highways
³ Operating profit before interest, tax, depreciation and amortisation
⁴ This is based on a Crisil study of 3 CV players which account for ~75% of industry revenue