Commercial vehicle manufacturers in India are likely to see a decline in their profitability in coming months due to a resurgence of discount sales in the sector, warned analysts from IIFL Securites.
The analysts were commenting in the context of increasing discounts in CV sales after Tata Motors’ sustained sharp reversals in its market share in the Apr-Jun quarter compared to the preceding three months. India’s largest CV maker Tata Motors had seen its 53% in FY 2022 to 44% in the first quarter of FY 2024.
“Since late 2022, truck makers displayed better pricing discipline by keeping a lid on discounting. This led to better gross margins and EBITDA margins for Tata Motors (CV) and Ashok Leyland. Although volume growth was coming off, pricing discipline and margin expansion drove EPS upgrades and renewed interest in the segment,” noted analysts from IIFL Securities in a note today.
However, now, that discipline is under threat, they said.
“With Tata Motors losing market-share in recent quarters, discount levels are increasing. This may pose a risk to the margin expansion thesis,” they added.
“Overall, we see risk to earnings, from both volume and margin perspectives.”
End of peak cycle?
The Medium and High Commercial Vehicle (MHCV) industry, which typically sees a sales cycle of 5-7 years, had hit its last peak in 2019. After hitting a low in FY20, the industry has been growing fast in FY22 and FY23, both of which saw volume growth of nearly 50% each. However, in the ongoing year, the pace of growth has come down to around 10%.
Typically, investors lose interest in the sector as soon as the high-growth phase is over. But this time, pointed out the analysts, investors continue to show interest in these stocks.
The reason: The industry has resorted to strong pricing discipline in recent quarters, driving improvement in margins. Although volume growth was coming off, pricing discipline and margin expansion drove EPS upgrades and renewed interest in the segment.
Tata Motors' EBIT margins grew 370 bps to 6.5 per cent while profit before tax stood at Rs 900 crore led by improved pricing, superior mix, and stable commodity costs in the April-June quarter.
However, the decision to do away with discounts has cost Tata Motors its dominant market share, and this is unsustainable, said the analysts.
“Beyond a point, protecting market share would become a priority, even at the expense of margins,” noted the analysts.
However, on a positive note, the analysts forecasted industry growth of 10-12% from FY 2024 to FY 2025, indicating that the volume growth will also peak during the period.
“There is a high likelihood of FY26 seeing a down-cycle,” it noted.
Covid Impact
The numbers seem to indicate that the post-COVID up-cycle in commercial vehicles has come to an end.
Prior to COVID, commercial vehicle sales were quite robust, with over 1 million units sold in 2019. This was driven by strong economic growth, increased infrastructure spending by the government, and healthy demand from the manufacturing, construction, and logistics sectors.
However, in 2020, the COVID-19 pandemic resulted in a sharp decline in commercial vehicle sales. Volumes fell by over 20% to around 775,000 units as economic activity came to a standstill during the nationwide lockdown. Demand from cargo operators, builders, miners, and FMCG companies took a hit. Small and medium enterprises, which account for a sizable share of commercial vehicle buying, were severely impacted as well.
The industry saw some recovery in 2021 with volumes growing by 26% to over 975,000 units. The economy began to open up and industrial activity picked up pace. The government also provided some stimulus measures like a vehicle scrappage policy, increased infrastructure spending, and low interest rates, which revived demand.
Growth momentum continued in 2022 with volumes expanding by 16% to over 1.13 million units. Rising infrastructure activity, robust manufacturing sector growth, increasing last-mile connectivity requirements, and growing consumption across rural areas drove sales. Replacement demand also remained high as ageing fleets needed replacement after being used extensively during 2020-2021.
However, high inflation, rising interest rates, and a slowdown in certain industrial sectors have taken a toll on commercial vehicle sales in 2023 so far. Volumes declined by 6% year-over-year to around 550,000 units in the April-August period. Demand from sectors like real estate, FMCG, cement, steel, and mining has moderated.