Overall, the freight market has recovered faster than expected, noted analysts
Fleet owners have been postponing purchases for over 2 years owing to lower fleet profitability
With commercial vehicle sales in the red this year, it has been a bit of a surprise that stocks of firms such as Ashok Leyland Ltd are running on high gear. Heavy truck sales volume is likely to hit a 12-year low in FY2021 due to a contraction in the economy. But Ashok Leyland has already jumped about 10% higher than pre-covid levels. It seems investors are already pricing in an earnings recovery of the next two years.
Of course, some of the good cheer is due to a revival lately. Freight rates are showing signs of accelerating. Capacity utilization of fleet owners seems to be rising. Demand from agriculture, auto, textile and chemicals sectors is on the rise, while analysts note that oil marketing companies are renewing contracts with BS-VI vehicle suppliers.
“Overall, the freight market has recovered faster than expected, and freight rates are now at pre-covid levels," noted analysts at Systematix Shares and Stocks in a client note.
This has led the Street to expect replacement demand to kick in next year. Fleet owners have been postponing purchases for over two years now owing to lower operating profits.
“We expect a sharp recovery in economic activity. Fleet operators have turned profitable as of November, led by an increase in truck utilization rates, partly offset by the sharp increase in fuel prices. At over 70% utilization levels, we expect truck replacement demand to remain buoyant, which augurs well for the domestic truck industry," said analysts at Kotak Institutional Equities.
Financing of trucks is also likely to improve given that interest rates are quite low, which may further spur fleet owners to upgrade. “CV financing demand hit the growth late in July. It has been stronger for small commercial vehicles and light commercial vehicles with some traction also seen in medium-heavy CV financing since October," said analysts at Systematix said in a client note.
However, one factor to watch for in the commercial vehicle revival is the upcoming dedicated freight corridor. This could see some of the road freight traffic shift towards railways. Analysts at Kotak expect road freight growth to be around 3% in the next five years.
Another downside is rising commodity prices such as steel. “Commodity prices could partially offset the recovery in volumes in the coming quarters," said Abhishek Jain, an analyst at Dolat Capital Markets.
Manufacturers may not be able to easily pass on the rising costs as prices of BS-VI vehicles are higher owing to the nascent economic recovery.
But even after factoring the pick-up in volumes in the next financial year, commercial vehicle stock valuations appear quite rich.
Ashok Leyland quotes at a price-earnings multiple of 31 times FY22 earnings, while the Tata Motors Ltd stock is at 15 times.
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