Industry Risk Score

CENTURION BANK OF PUNJAB December 2007

Commercial vehicles

Introduction
Industry Risk Score (IRS) reflects the impact of industry variables on the cash flows and debt repayment ability of the companies in the industry over a 3-4 year period. The risk score for an industry is arrived at by aggregating the scores assigned to the relevant parameters for the industry. Industry parameters include variables such as demandsupply outlook, cost structures, competition and financial performance. Parameters are selected based on the extent to which they affect the debt servicing ability of the companies operating in the industry. Scores on these parameters reflect the extent of positive/negative impact on cash flows, and the degree of variability in cash flows of the companies. The industry risk scores have been graded on a ten-point scale, with 1 indicating high risk and 10 indicating low risk.
Risk score 1 2 3 4 5 6 7 8 9 10 Risk factors Extremely negative Extremely negative Negative Marginally negative Neutral Marginally positive Positive Positive Highly positive Highly positive

Contents
Executive summary Background Industry risk parameters Demand-supply Government policies Input-related risk Extent of competition Financial risk Annexure 1 2 3 3 3 4 4 5 6

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Industry Risk Scores Industry Risk Scores (available on 135 industries) capture the influence of industry variables and the extent of positive/negative impact on the cash flows and debt repayment ability of companies in an industry over a 3-4 year horizon. The risk score for an industry is arrived at by aggregating the scores assigned to the relevant parameters like demand supply outlook, cost structures, competition and financial performance.

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Executive summary
Industry The commercial vehicles (CVs) sector is expected to witness moderate competition and moderate growth in the medium term, primarily driven by light commercial vehicles (LCVs). However, we are putting our estimates on demand-supply for the industry on watch, due to concerns over demand cyclicality especially in view of increased interest rates. In 2006-07, the LCV segment grew by around 31 per cent, led by redistribution demand and substitution of large three-wheelers. The medium and heavy vehicles (MHCV) segment grew by around 33 per cent propelled by the positive impact of the Supreme Courts ban on overloading, sustained IIP growth, increased emphasis on construction and mining activities, and increasing port traffic. LCVs are expected to grow by 15-16 per cent in 2007-08, while MHCVs are expected to witness a marginal growth of 1.5-2.0 per cent in 2007-08. The rise in the prices of a few inputs is not of great concern, as manufacturers have been able to pass on the input cost hikes partially to consumers. There is moderate competition in the industry since there are a limited number of players. However, MNCs are gaining an entry or enhancing their presence through collaborations with smaller domestic players. This is likely to increase the intensity of competition. The governments road and highway development initiatives are expected to sustain the share of roads in total freight movement, thereby benefiting the CV industry.
Parameter Automobiles - Commercial vehicles: Industry risk score Industry characteristics Demand-supply gap Government policy Input-related risk Extent of competition Industry financials Operating margin of industry RoCE of industry Source: CRISIL Research 85 35 25 15 25 15 35 65 Weightage Score 6.3 6.2 7.0 5.0 5.0 7.0 6.8 3.3 8.7

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Background
The CV industry accounts for more than 60-65 per cent of the total freight handled in the country. As transportation involves every sector of the economy, the performance of the CV market mirrors the overall performance of the economy. Single truck operators (up to five trucks) dominate the transportation sector. The CV industry is cyclical in nature, as demand is driven by a number of factors such as growth in industrial and agricultural production, growth in freight movement, share of road in freight movement, changes in freight rates and fuel prices, profitability of truck operators and state transport undertakings (STUs), and government policies.

DECEMBER 2007

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Industry risk parameters

Demand-supply Historically, the CV industry has been cyclical, and the sales cycle has broadly followed the industrial growth cycle. After the persistent decline in sales in 2000-01 (12 per cent) and 2001-02 (4 per cent), the demand for CVs recovered substantially, recording a CAGR of over 20 per cent for the past 4 years. Although the industry continues to remain cyclical, the growth in demand is likely to be assisted by partial decoupling of sales from industrial and economic growth, due to an increase in demand of small commercial vehicles, rise in sale of tippers and growth in exports, accompanied by a structural shift (the Supreme Courts ban on overloading). In 2006-07, the LCV segment grew by around 31 per cent, driven by growth in tonnage redistribution demand and substitution of large three-wheelers by the sub-one tonne segment. The MHCV segment grew by around 33 per cent on the back of a lower base (on account of the unavailability of critical components) in the corresponding period of the previous year, propelled by the positive impact of the Supreme Courts order banning overloading of vehicles over the prescribed limit, sustained IIP growth, increased construction and mining activities, and growing foreign trade boosting port traffic. LCV demand is expected to grow by 15-16 per cent in 2007-08 (despite a higher base in 2006-07), while MHCV demand is expected to witness a singledigit growth of 1.5-2.0 per cent in 2007-08, mainly on account of a higher base in 2006-07, due to the one-time demand, following the Supreme Courts order. However, the key monitorable is the rising interest rates, which could slow down economic growth and consumption demand, thereby leading to a slow down in CV sales. Government policies Currently, the excise duty on CVs stands at 16.3 per cent. The reduction in the peak customs duty on imported components to 10 per cent in Union Budget 2007-08 will not have a major impact on the industry, given a very high degree of indigenisation (over 95 per cent). However, it will yield marginal savings in the component costs of buses that use imported engines. The scrapping of vehicles that are over 15 years old in the National Capital Region (NCR) and over 8 years old in Mumbai, and the introduction of compressed natural gas (CNG) buses in certain states have had a favourable impact more so on passenger CV sales in recent months. However, this scheme has not been implemented at the national level; if implemented, there could be a significant impact on CV sales. In a significant judgment on November 9, 2005, the Supreme Court ruled that the issuance of gold cards/tokens under notifications by nine state governments, allowing overloading of trucks in excess of the prescribed weight limit after payment of fixed charges, was in violation of certain acts. A part of this impact has been absorbed by the shift of some specific commodities to rail; the remaining already got translated into a one-time additional demand for CVs in 2006-07. However, the stringency in implementing the weight norms has reportedly reduced in 2007-08, resulting in increased prevalence of overloading.

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DECEMBER 2007

Input-related risk Raw materials and components, which account for 73-75 per cent of the net sales of CV manufacturers, are easily available in India, due to the presence of a developed and highly competitive auto ancillary industry. Almost all players have increased their indigenisation levels to over 95 per cent over the last few years. Thus, import costs do not have a major role in the increase in raw material costs or total costs of the industry. The average annual price of steel rose by 19 per cent (y-o-y) in 2006-07. Also, prices of other inputs such as rubber, plastic and aluminium have gone up. As a result, the proportion of raw materials to sales has increased as compared with the years earlier. In the short-to-medium term, steel prices are likely to remain firm at current levels, resulting in stable input costs. Extent of competition Moderate competition exists in the CV industry, due to the limited number of players. Currently, there are six players in the MHCV segment Tata Motors, Ashok Leyland, Eicher Motors, Swaraj Mazda, Tatra Udyog and Volvo India and eight players in the LCV segment Tata Motors, Ashok Leyland, Swaraj Mazda, Eicher Motors, Mahindra and Mahindra, Hindustan Motors, Piaggio Greaves Vehicles Ltd and Force Motors. Tata Motors and Ashok Leyland account for 75-77 per cent of the industry volume, and this scenario is likely to continue in the near term. However, players such as Bajaj Auto and Hindustan Motors are eyeing the sub-one tonne segment (where Tata Ace, M4 and the recently launched Piaggio Ape are present). Moreover, existing players, in collaboration with a foreign partner such as Force Motors with MAN AG, Mahindra and Mahindra with US ITEC, Volvo with Eicher and Daimler with Hero group are planning to enter the duopolistic MHCV market. In fact, MAN-Force JV has already started selling vehicles in this segment. With more and more such players expected to start commercial production in the short-to-medium term, competition is likely to intensify in the CV industry. However, since their capacities are not expected to be built in the near future, they are unlikely to capture a significant market share in the short term. Global players such as Volvo, Daimler Chrysler and Tatra, who are looking at the domestic market, have restricted themselves to the higher tonnage segment and are unlikely to offer any significant competition to existing players in the medium term.

DECEMBER 2007

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Financial risk
Automobiles - Commercial vehicles: Financial parameters
Select financial parameters Aggregate turnover Operating profit margin Return on capital employed Net profit margin Interest coverage ratio Debt-equity ratio Current ratio Raw materials days WIP holding days Finished goods days Debtors days Creditors days No. of companies Source: CRISIL Research unit Rs million Per cent Per cent Per cent Times Times Times Days Days Days Days Days No 1999-2000 8.5 7.6 1.5 2.0 1.0 1.8 36 9 23 57 75 5 2000-01 5.8 4.2 -3.9 1.2 1.1 1.5 37 9 31 45 96 5 2001-02 8.4 7.5 0.6 2.3 0.9 1.4 35 8 33 41 104 5 2002-03 11.2 16.1 3.8 5.6 0.6 1.2 28 7 29 31 103 5 2003-04 11.9 25.3 5.7 14.2 0.4 1.3 22 6 19 19 95 5 2004-05 10.0 22.1 6.4 21.6 0.7 1.4 23 6 14 16 95 5 2005-06 9.5 20.1 7.4 19.1 0.6 1.5 25 6 17 16 97 5 2006-07 8.6 21.3 6.2 16.7 0.6 1.4 21 5 18 14 80 5 126,721.7 119,966.1 129,275.2 157,948.6 225,387.5 290,877.2 334,361.1 437,103.3

Automobiles - Commercial vehicles: Cost aggregates

Cost structure (% of net sales) Raw material cost Power and fuel cost Other operating costs Employee cost Selling cost No. of companies Source: CRISIL Research Unit Per cent Per cent Per cent Per cent Per cent No 1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 72.5 2.6 3.0 9.7 3.9 5 72.8 2.4 2.7 9.6 5.4 5 67.9 2.2 4.0 9.7 6.4 5 65.7 1.9 3.0 8.5 7.2 5 67.7 1.6 2.8 7.2 5.0 5 72.4 1.3 2.9 6.5 4.7 5 74.5 1.2 2.9 6.3 5.2 5 75.0 1.1 2.8 5.9 5.6 5

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Annexure
Companies used for calculating sector aggregates
Ashok Leyland Ltd Force Motors Ltd Eicher Motors Ltd Swaraj Mazda Ltd Tata Motors Ltd These companies form around 90 per cent of the industry in volume terms, as on March 31, 2007.

DECEMBER 2007

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Automobiles - Commercial vehicles: Business risk evaluation

Risk entity name Business risk Operating efficiency Access to cost-effective technology Capacity utilisation Availability of raw materials Energy cost Raw material usage Management of price volatility Product design and development Adherence to environmental regulation R&D activities FCA/MDA-approved plants Efficiency of beneficiation process Availability of skilled labourers Hygienic processing facility Indigenisation level Integration of operations Multi-locational advantage Selling cost Employee attrition rate Vulnerability to event risk Bargaining power with suppliers Proximity to customers Market position Brand equity Customisation of product Project-management skills Size-related pricing advantages Diversified markets Replacement markets After-sales service Proximity to market Long-term contracts/assured offtake Distribution set-up Financial ability to withstand price competition Access to patents Consistency of quality Product range Deficit region Value addition Consolidation of markets Support service facilities Other promotional ventures Source: CRISIL Research Weightages 100 55 25 30 30 15 45 30 25 25 20 -

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DECEMBER 2007