Ind-Ra: Persistent Rise in Fuel Prices to Impact SRTOs' Performance & CV Loan Collections

India Ratings and Research (Ind-Ra) believes that a gradual recovery in freight volumes and fleet utilisation levels will enable fleet operators to pass on a portion of the recent rise in fuel prices, albeit with some lag. The pass-through in fuel prices will vary across states, depending upon the available system capacity and freight demand. However, the lag in pass-through could create near-term margin pressures, subsequently affecting the commercial vehicle (CV) loan performance and the debt serviceability especially for small road transport operators (SRTOs). Additionally, Ind-Ra expects higher tonnage market contract operators will be better placed than lower tonnage market load operators.

Likely Near-term Pressure on Operating Margins: The average diesel prices across Mumbai, Delhi, Chennai and Kolkata have risen over 20% yoy since May 2017. Fuel cost accounts for 60%-75% of the operating expenses for a fleet operator; hence, the margins could come under pressure in the near term, since the pass through in freight rates would be gradual. A continued rise in fuel price could put further pressure on the margins.

The short-term disruptions emanating out of the GST-led changes (such as e-way bills) are also likely to affect the operating cash flows of SRTOs over the near to medium term. Assuming a 7.5% increase in average diesel prices (average of INR66.44/litre) in FY19 (FY18: INR60.34/litre), the aggregate debt service coverage ratio (DSCR) of truck operators is likely to reduce 35%-40% yoy considering around 90% of the increase in diesel prices is passed on to end-users in over three months. Similarly, assuming a 15% increase in average diesel prices (average of INR69.37/litre) and a similar pass through, the DSCR is likely to reduce over 50%. Ind-Ra's base case macro-economic forecast is based on the average Brent crude oil price of USD70/bbl in FY19. (Oil Headwinds to Widen FY19 Current Account Deficit by USD22 billion-31 billion).

Impact to Vary Across Regions: Ind-Ra opines that fleet operators' ability to pass on higher diesel prices will be determined by the current level of system capacity and the overall demand for freight. Players operating in states with a high demand and low capacity are likely to pass on the increases promptly compared to those operating in states with high capacity and low demand. Though capacity in each state will be partially fungible, it provides us a clear estimate of the probable movement in freight rates across key states. While demand is typically not localised, regional demand-supply dynamics have a significant bearing on the performance of freight rates. The impact of regional dynamics, thus, is more pronounced for SRTOs - especially in the low tonnage segments. Freight rates within the higher tonnage segments are relatively harmonised across the country. Nonetheless, the localised factors continue to affect the near-to-medium term movement in freight rates and therefore fleet operators' ability to pass on changes in fuel costs.

Consequently, Ind-Ra expects players in states such as Andhra Pradesh and Karnataka to be positioned better while players in Gujarat, Maharashtra and Tamil Nadu are likely to face challenges in passing on the increased diesel prices to the end user.

Near-Term Increase in Delinquencies Likely: SRTOs are already reeling under the challenges accompanied by the implementation of E-way bills. The likely stress on operating cash flows - arising out of the increase in diesel prices - is likely to put further pressure on SRTOs' credit profile. Consequently, delinquencies in the CV and SRTO loan portfolios could remain elevated in the near term. Ind-Ra opines that an increase in the lag with which higher fuel costs are reflected in freight rates could result in slippages across delinquency buckets and could even result in an increase in the quantum of delinquencies in the harder buckets.

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