24 May 2016 20:46 IST

Understanding the commercial vehicle cycle

Investments in road infrastructure, focus on mining and easier borrowing rates bode well for CV sales

If you are a keen follower of the stock market, you may have often come across discussions on whether it is a good time to buy ‘cyclical’ stocks. These are stocks of companies whose sales and earnings go through various ups and downs over a period of time. Essentially, the fortune of these companies depends on the state of the economy. Cyclicality can best be understood by following trends in the auto industry, especially in the sale of commercial vehicles (CV).

Trends in CV sales

In the past, growth in the sale of trucks and buses (known as medium and heavy commercial vehicles or MHCVs) has moved in tandem with growth in the overall economy. Data from the Society of Indian Automobile Manufacturers (SIAM) shows that in 2008-09, corresponding with the global economic slowdown, truck and bus sales dropped by 33 per cent over the previous year.

But in two years that followed, MHCV sales increased by over 30 per cent annually. Following this, in 2011-12, sales growth slowed to around 8 per cent, and 2012-13 and 2013-14 witnessed a 23-25 per cent fall in sales. But there have been signs of recovery in the last two years, with MHCV sales recording a robust 30 per cent growth in 2015-16.

The cyclical pattern in CV sales is due to a few factors. One, commercial vehicles, especially trucks, are used to transport goods and agricultural produce, and for industrial /infrastructure purposes such as mining, and haulage of construction material. Hence, the demand for new CVs directly depends on the state of the economy. Higher consumption triggered by greater disposable income and lower inflation will create more demand for goods movement. Second, considering that purchase of new CVs is always financed, CV sales also depend on the interest rate cycles. The lower the interest rate, the higher the sales.

Besides, lower borrowing rates will give a leg up to industrial growth as well as housing, again triggering greater demand for transport of goods. On the other hand, high interest rates may deter CV fleet owners from replacing their old vehicles with new ones.

Sale of light CVs or LCVs, including mini trucks such as Tata Ace, Piaggio Ape, etc., also follow this cyclicality. These trucks are typically used in last-mile connectivity — to deliver goods from a bigger town or city which acts a hub to nearby smaller towns and villages. They may also be used for carrying lighter loads when demand for freight carriage starts tapering during the beginning of a slowdown. For this reason, LCVs may continue to sell well for a few months more even as MHCV demand begins its descent.

Impact on CV makers and suppliers

This cyclicality impacts both CV manufacturers such as Tata Motors, Ashok Leyland, Volvo-Eicher, etc. as well as companies which supply parts to these manufacturers. Some of the listed component suppliers who focus predominantly on CVs include Wabco India, ZF Steering, Automotive Axels, Jamna Auto and Setco Auto. In line with the upturn in MHCV sales, these companies have seen strong sales and profit growth in the last one to two years.

Consider Ashok Leyland. With CV sales picking up in 2014-15, the company turned around from losses to making profits in the September 2014 quarter — albeit the profit was small, at ₹41 crore. Since then the company has been reporting profits every quarter. For the nine months ended December 2015, the company’s profits grew to ₹653 crore, from ₹31 crore in the nine months ended December 2014.

Similarly, from reporting a ₹3.2-crore loss in 2013-14, Jamna Auto Industries made a profit of ₹29 crore and ₹72 crore respectively in 2014-15 and 2015-16, corresponding with the turnaround in CV sales. The company makes springs, which are part of a vehicle’s suspension system.

The stock market also caught wind of the turning tide, and has rewarded these cyclical stocks handsomely in the last two years. Despite the broader market volatility, many auto stocks have managed to double or even triple. Wabco India, Sundaram Clayton, Eicher Motors, Jamna Auto industries, Ashok Leyland and ZF Steering are a few such stocks.

What to expect

In the months to come, the reform measures taken in sectors such as mining, and the big investments being made by the government in road infrastructure, as also the fact that borrowing rates are getting cheaper, bode well for CV sales.

Besides, higher industrial growth as the economy gains speed and higher agricultural output likely from the good monsoon are expected to keep demand for freight transport strong and, hence, the demand for CVs healthy. With LCV sales also gathering steam, truck sales should fire on all cylinders in the near to medium term.

But after the relentless run, stocks are beginning to look expensive in terms of valuations. A repeat of the handsome gains in the last two years may not be possible, as CV sales are closer to their peak now.

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