What's behind the continuous Petrol and Diesel price hike?

If someone asks you, how important is money, what shall be your answer? You may say that it is one of the most important things in the world today, right? Even we agree to this. Money is a necessity and more money means power and with that power you can actually buy happiness and do whatever you want. Now, this is at an individual level. Think about those sitting in the government. To manage the economy they need money and more importantly they need our money! Taxes, cess, tariffs etc.

There’s a reason why we are telling you all this. You would surely be knowing that petrol and diesel prices have been rising constantly. Now it’s been 20 days in a row! Yes, that’s right, the prices have been continuously rising since last 20 days. After a tedious lockdown of almost 3 months, now when it has been relinquished to certain extent, constant price rise has hit the common man hard. Now, we’re going to explain why is this happening and what shall be the impact.

What’s the Matter?

In the penultimate week of March this year, lockdown was imposed by the government which put a halt on economic activities. People were staying at homes so, there wasn’t any consumption of fuel (petrol and diesel) as well. At the same time, crude oil prices went down drastically. This was because majority of the oil consuming nations had to impose a lockdown to curtail the pandemic. This is important for you to know because crude oil prices directly affect the prices of fuel in our country.

Let’s also tell you about an interesting fact. Could you guess how much would a litre of petrol cost if the excise duty, VAT and dealer commissions are removed? In this case the cost would be around Rs. 18-20 only! (in Delhi). Out of the aforementioned components, VAT goes to the state government, Excise Duty benefits the central government, and dealer commissions benefit petrol pump/fuel station owners. Surprisingly, the crude oil prices are still down and going down further but, fuel prices are increasing in our country.

The reason is that government is feeling the dearth of revenue and petrol and diesel are most feasible sources for them. Coming back to where we started from, money is important to the government as well. They need money to launch schemes for public and also for various developmental aspects. One way of looking at it is also that, when the elections are near the government will require funds to reduce the rates of fuel etc. and provide subsidies to woo the people and make them vote in their favour.

Concludingly, it can be said that for now the situation is confusing. At a time when the economy is struggling and people need some respite, the fuel prices are giving tough times rather. Government should have intervened but, it itself is involved in this. The fuel prices affect the costs of final goods as well. With all the projections on negative side for the economic growth, this is a big blow to the to economy. Now, let’s see what happens next because we don’t have an option of controlling all this.

Sectorial Talks - Commercial Vehicle Industry (CV Industry)

Already being a part of the automotive industry, Commercial Vehicle Industry is subdivided into two segments namely; Medium & Heavy Commercial Vehicles (MHCV) and Light Commercial Vehicles (LCV). Commercial vehicles form the lifeline of the logistics and supply chain as demand for transportation comes from all sectors of the economy.

MHCVs transports goods to hubs in a hub and spoke model which are further redistributed by LCVs. As these vehicles are used for transportation of industrial and consumer goods, their sales can be correlated to consumption expenditure.

It can be said that the demand for commercial vehicles is closely aligned with economic cycles. Based on usage, CVs can also be classified as passenger vehicles and goods vehicles. The customers of CVs are usually classified into two categories, large fleet operators (LFO) who owns more than 20 vehicles and small fleet operators (SFO) who own lesser.

Generally, LFOs own a mix of MHCV and LCV operating on contract basis for covering larger boundaries whereas SFOs own LCVs and operate mainly within local areas. SFOs are responsible for carrying out last-mile delivery where some are also attached to LFOs.

The industry saw a sharp decline in demand for commercial vehicles in FY20. It observed sales of 7,78,401 commercial vehicles of which 60,713 are exported which is quite less (29% approx.) as compared to FY19. Because of lower demand, many firms reduced production, and being an asset-heavy and capital-intensive industry, it was difficult to cover fixed cost resulting in lower margins.

Due to new axle norms being introduced in 2018, The average weight of vehicles got increased from 16.2 tonnes to 18.5 tonnes thereby increasing the load-carrying capacity by more than 20%. This was good for some operators and bad for others as it led to lower utilization for large fleet operators. This led to a delay in purchase decisions and also contributed to a further reduction in demand which is expected to continue until utilization reaches optimal levels. It is expected to see the lowest sales figure in FY21 as compared to the last 10 years' performance.

By April 2020, it is mandated for all vehicles to comply with BS-VI emission standards. This pressurized many dealers and distributors to empty their stock at lower prices. On the other hand, the cost of production for newly designed vehicles (BS-VI compliant) is going to increase with an estimate of around 10% which will eventually be passed on to customers.

This will further reduce demand affecting the profits. Around 97% of vehicles purchased are externally funded resulting in higher finance penetration in the industry. Banks mainly focus on lending for MHCVs to LFOs whereas NBFCs focus on SFO and FTUs (First Time Users).

Given the rise in NPAs and solvency issues, unavailability of valid documents, and poor financial profile, NBFCs started cautious lending at higher rates eventually affecting sales. Because of these strict credit conditions, the moderating economy, and transitioning to BS-VI compliant vehicles, the recovery of this industry can be expected to be slower.

The industry is of oligopolistic nature and is majorly dominated by 3 Original Equipment Manufacturers (OEMs) accounting for 86% of market share by sales volume. As a segment leader, Tata motors enjoy a ~42% market share followed by Mahindra & Mahindra (28%), Ashok Leyland (16%) in fiscal 2020. There are some factors that will positively affect demand in the industry. In India, there are around one million commercial vehicles running on roads with an age exceeding 15 years.

The introduction of the scrappage policy of removing old polluting fleet will definitely boost demand for new vehicles. Other government initiatives such as fee hikes for registration renewals will also assist in industry recovery. Total sales volume is expected to grow at a CAGR of 6-7% during FY21-25 with exports share rising to 20-25% of total sales from the current level of 9-10%.

In the future, the companies having technological advantage focusing on alternative fuel, hybrid-powered vehicles, and launching new designs as per desired norms will benefit more in a price-sensitive market like India. To pick a stock in the Commercial vehicles industry, we should consider the following financial aspects:

• D/E Ratio: To check the financial health of such a capital-intensive industry, the D/E ratio should be less than 1.36

• ROE: The Return on Equity should be at least 19% (3Yr-Average)

The better the stock fits in the aforementioned criterion, the better option it would be for investment. It’s quite simple, first, the criterion needs to be right to select the right stock. The data regarding the company’s revenue, expenses, and financial ratios are available on ticker.finology.in