The production cut at Ashok Leyland Ltd, India’s second-biggest maker of commercial vehicles, was inevitable, but its severity suggests things are worse than market anticipations.

Perhaps the sharp drop in October sales was a wake-up call. Domestic sales last month at least halved on a year-on-year basis to 2,976 units, way lower than average monthly sales of 5,388 units in the first half of this fiscal year that began in April. While tight liquidity has impacted commercial vehicle dealers and operators, underlying demand is also lower as economic activity slowed.

For now, Ashok Leyland said it would halve production till December, but if demand remains at October levels, the current inventory will service it for much longer. Even if it raises production early next year, the increase will only be gradual.

Also See Heading South (Graphic)

In what’s looks like an awful sense of timing, Ashok Leyland is expanding capacity from 84,000 units to 134,000 a year in this fiscal year. It had originally planned to increase capacity further to 184,000 units by March 2010, but that would now certainly be seen as unnecessary. As things stand, the current capacity of 7,000 units a month is far ahead of demand.

Analysts say the company has slowed capital expenditure due to the current downturn. Still, the funds it has spent and the additional capacity will eat into profits. This at a time when halving production and sales will lower absorption capacity of fixed costs.

Thankfully, debt levels aren’t high and debt servicing isn’t seen as a risk by the markets. But for operating performance to improve, demand for trucks also needs to improve.

And it’s imprudent to assume demand would bounce back to normal once financing becomes easier. For underlying demand to improve, industrial activity has to pick up. In any case, fleet capacity built up in the past years is likely to be used more optimally before truck operators expand fleets.

The commercial vehicle industry may have well entered its usual long-drawn down cycle.

Graphics by Ahmed Raza Khan / Mint

Write to us at