A 30% decline in sales volume on an already weak base would lead to a nearly six-fold increase in net loss to Rs. 6,000 crore¹ for commercial vehicle (CV) makers this fiscal. That, combined with a stretch in working capital owing to support extended to dealers and suppliers, could result in sizeable negative cash flows and thus ballooning debt. While this may constrain credit metrics in the current fiscal, credit profiles of manufacturers will be supported by strong balance sheets and comfortable cash buffers.

CV makers were already hit by new overloading norms and a slowing economy when the Covid-19 pandemic arrived, and sales volume had fallen 29% in fiscal 2020. In the first quarter of this fiscal, volume plunged another 85% because of the pandemic-driven lockdown. The resultant sharp slowdown in industrial activity has hard-braked sales of medium & heavy commercial vehicles (MHCVs), which account for two-thirds of industry revenue. Sales of light commercial vehicles (LCVs) may fare better with support from the rural economy and private consumption.

Says Manish Gupta, Senior Director, CRISIL Ratings, “Two consecutive years of high de-growth are likely to result in CV volume reaching its lowest point in 10 years. With utilisation down to a third, high fixed costs would dent the profitability of CV makers. Moreover, manufacturers may partly absorb BS VI upgrade costs in their quest to stimulate demand. That could drive down segment operating margins to near-zero from an already low 6% in fiscal 2020, and increase losses.”

Cash flows may stretch further as manufacturers will tend to support key stakeholders to reduce stress across the value chain and help them rebound next fiscal – such as by providing dealers leeway on payment terms and making timely payments to auto-component suppliers. That would temporarily increase the working capital requirements and raise the industry’s debt by almost a third to Rs 40,000 crore this fiscal².

Consequently, credit metrics of the sector would be constrained, but credit profiles will be supported by strong balance sheets and expectation of a bounce-back next fiscal.

Says Naveen Vaidyanathan, Associate Director, CRISIL Ratings, “The pandemic struck when the industry’s gearing was 0.5x – a shade lower than the year before the previous downturn in 2014. Despite the rise, we expect the gearing to be comfortable at 0.7 time by the end of the current fiscal. Manufacturers also have comfortable cash liquidity of nearly 2 times debt servicing needs.”

While rising debt and weak profitability may constrain interest cover to nearly 1.5 times this fiscal from an average 7.1 times in the past 5 years, the number should recover next year with sales volume. The recovery is predicated on an expected pick-up in both, industrial activity and private consumption.

Commercial vehicles are a critical logistical link to the economy and hence sales volume is likely to bounce back next fiscal to reach almost fiscal 2020 level. That would substantially pull up the profitability of manufacturers, reverse the working capital stretch and restore credit metrics. A quick recovery in sales volume is critical; a slower rebound can elongate the pain for manufacturers.

¹ Companies considered include Mahindra and Mahindra, Tata Motors, Ashok Leyland and VE Commercial Vehicles, which comprised about 90% of industry volumes in fiscal 2020. Net losses exclude exceptional items.
² Debt, interest cover and gearing consider company financials