Vijay Kumar Gaba: February 2023

Tuesday, February 28, 2023

Is the tide turning for E-commerce stocks?

The recent move in prices of some popular e-commerce stocks listed in India has caught the eye of the market participants. These stocks have sharply outperformed the benchmark Nifty50, Nifty IT and even NASDAQ in the past one month. Notably, these stocks have been sharply underperforming the markets for the past one year particularly. Most of these stocks have lost about two third of value from their respective all time high stock price levels. Many investors who had bought these stocks in the 2021-2022 frenzy have seen material erosion in their investment value. It is therefore pertinent to examine, from the individual investors’ viewpoint, whether the tide is turning for these companies; to assess whether they should stay invested, buy more or consider using the latest price rally to exit their positions.

Use your own parameters

One grave mistake small investors usually make while investing in the stock of a company, is to use the valuation matrices followed by specialized investors like private equity, venture capitalists, angel investors etc. or professional investors who invest on behalf of other investors.

Specialized investors evaluate a business idea in terms of potential for wider acceptability, scalability and eventual profitability. They mostly invest in early stages of business development and are usually not concerned with conventional valuation ratios like price to earnings etc. Failure of a business idea is as routine matter for them as the death of a patient for an oncologist. In fact, in their case a 25% success rate is considered a great performance. They do not fall in love with any business and are always on lookout for an exit, regardless of profit or loss.

Professional investors are mostly concerned with the relative performance of their portfolio in relation to the benchmark indices. For example, a fund manager would be considered very successful if his fund loses 10% in a year when the benchmark index has lost 15%. There is no opportunity cost of the money assigned to them for management.

In my view, small investors should use their own parameters to evaluate the businesses they want to invest in. Losing money should not be an option in their investment strategy. They should aim to earn at least more than the risk free return they can get in bank deposits and government securities.

Individual investors can earn from their stock portfolios in three ways:

1. Dividends or any other form of regular cash flows.

It is important that the company makes sufficient profits; is able to convert these profits into cash (good working capital management) and maintains reasonable free cash flows.

2. Stock prices rise in tandem with earnings growth.

Assess if the earnings growth is sustainable (not cyclical) and healthy (good ROCE).

3. Stock prices rise due to acceptability of higher valuation benchmarks like price to earnings ratio (PE or EV/EBIDTA); price to book ratio (PB); price to earnings growth ratio (PEG) etc.

Remember, higher multiple to the benchmark valuation criteria should be supported by fundamental change in the operations and balance sheet; and not just by the broader market movement or irrational exuberance.

Assessing the latest move in ecommerce stocks

For making an investment decision, investors need to assess whether the recent move in ecommerce stocks is a broader market wide move or a response to company specific developments. In case of the latter, it needs to be evaluated whether it is sustainable in medium term or just a temporary phenomenon.

For example, post 3QFY23 result, One 97 Communication (PayTM) has seen multiple upgrades from various brokerages. Analysts seem to be excited about improvement in lending volumes, operational efficiency, prospects of substantial improvement in revenue growth in forthcoming quarters and profitability at ‘adjusted EBIDTA’ level in the current quarters. The analysts are projecting marginally positive EBIDTA in FY25; but no one is projecting positive PAT or free cash flows in the foreseeable future.

As per some recent media reports, telecom major Bharti Airtel, has proposed to merge its payment bank with the PayTM payment bank in a share swap deal; though the company has apparently denied any such proposal. PayTM had also announced a share buyback program in December. Ant group of China, one of the promoter entities, has decided to materially pare its stake in the company, offering a big revenue opportunity for brokers. It is to be evaluated whether these events have excited the analysts or they have holistically changed their outlook on the stock.

In the case of Zomato, the company has announced re-launch of its membership program (Zomato Gold), termination of services in a few cities and some other operational corrections. The analysts are not too excited about these changes and have not tweaked their estimates materially. Similar is the case with FSN E-Commerce.

Conclusion

In my view, the recent rise in ecommerce stocks could be more in the nature of a technical or generic move that may not necessarily be sustainable. The current valuations or the projected performance matrix of these companies provides little comfort from the individual investors’ viewpoint.

Besides, the regulatory environment for ecommerce business is still at a nascent stage and could have material implications for these businesses, similar to what we saw in the case of telecom and private mining during the past two decades. Investors need to factor in this risk also while deciding to invest in these businesses.

By nature, all these businesses are strong and highly scalable. If these companies sustain for 4-5years and deliver 30-40% revenue growth, these may become profitable and generate enough cash flows to fit in the conventional valuation matrices, without using manipulative terminologies like ‘Adjusted EBIDTA’, etc.

The investors will get ample opportunities to invest in these businesses in future, once they mature and the regulatory environment stabilizes. Till then leave it to the professional investors and focus on already matured businesses.

Friday, February 24, 2023

Some notable research snippets of the week

FY24 Economic Outlook (India Ratings)

India Ratings and Research (Ind-Ra) expects GDP to grow 5.9% yoy in FY24. Although National Statistical Organisation’s (NSO) first advanced estimate (AE) of FY23 GDP is 7.0%, it does not expect the growth momentum witnessed in 1HFY23 to sustain in 2HFY23. NSO estimates GDP growth to drop to 4.5% in 2HFY23 from 9.7% in 1HFY23. The pent-up demand which had provided thrust to the growth is normalising, exports which had been buoyant are facing headwinds from the global growth slowdown and credit growth is facing tighter financial conditions. The International Monetary Fund expects the global GDP growth to fall to 2.9% in 2023 from an estimated 3.4% in 2022.

Ind-Ra expects PFCE to grow 6.7% yoy in FY24 (FY23: 7.7%). Yet, it may not lead to a broad-based consumption demand recovery, because the current consumption demand is highly skewed in favour of the goods and services consumed largely by the households belonging to the upper income bracket. The goods and services of mass consumption have yet not shown a sustained pick-up. This to some extent is reflected in the way the recovery in consumer durables and non-durables in terms of Index of Industrial Production has so far panned out in FY23. While consumer durables grew 3.4% yoy during 9MFY23, non-durables contracted 1.2% yoy.

After PFCE, GFCF is the second-largest component (FY23AE: 29.4%) of GDP from the demand side. Ind-Ra expects GFCF to grow 9.6% yoy in FY24 (FY23:11.5%), due to the sustained government capex. Expenditure on the capital account and grants-in-aid for the creation of capital assets together in the union budget FY24 have been pegged at INR13.71 trillion. This is INR3.17 trillion higher than FY23 revised estimate (RE), an increase of 30.1%. This will push the government capex (including grants-in-aid for creation of capital assets)/GDP to 4.54% (FY23RE: 3.86%). GFCE had been providing the much-needed support to the economy for a while, averaging 7.9% growth during FY16- FY20. However, due to the government’s focus shifting towards capex, the size of the revenue expenditure in the union budget FY24 has been kept at INR35.02 trillion, only INR0.43 trillion higher than the FY23RE of INR34.59 trillion. Ind-Ra therefore expects GFCE to grow at 2.5% yoy in FY24 (FY23: 3.1%).

The fourth demand-side driver - net exports (exports minus imports) - has been negative over the years and thereby not contributing positively to the aggregate demand. Thus, a reduction in the size of negative net exports would be a positive for aggregate demand. However, with merchandise exports losing steam due to the global growth slowdown and merchandise imports not moderating proportionately, Ind-Ra expects the share of net exports to GDP to increase to negative 9.2% in FY24 from negative 7.1% in FY23.

On the supply side, the agricultural sector has been doing well, and Ind-Ra expects it to grow 3.1% yoy in FY24 (FY23: 3.5% yoy) on the assumption of a normal monsoon in 2023. However, industrial growth is expected to remain tepid because of the ‘K-shaped’ recovery, which is neither allowing the consumption demand to become broad based nor helping the wage growth especially of the population belonging to the lower half of the income pyramid. Ind-Ra therefore expects the industrial sector to grow 3.9% yoy in FY24 (FY23: 4.1%). Services, the largest component of GVA, is estimated to grow 7.3% yoy in FY24 (FY23: 9.1%). Services sector may face some headwinds from the tightening financial conditions, but some upside may come from the roll-out of 5G which is expected to increase the reach of online commerce, education and telemedicine to remote regions, and create new-age business and associated employment.

Ind-Ra expects the current account deficit to narrow down to 2.5% of GDP in FY24 (FY23: 3.3%) in response to the evolving domestic and global demand conditions. Due to the uncertain external demand, merchandise exports are expected to grow just 0.5% yoy in FY24 (FY23: 1.8%).

Insolvency Cases Rise by 25% in Q3, but Recoveries Still on Downtrend (CARE Ratings)

After slowing in the pandemic period of FY21 and FY22, the number of insolvency cases increased by 25% y-o-y in Q3FY23. However, despite the increase, the number of cases admitted to the insolvency process continued to be lower compared to earlier quarters in FY19/20. The distribution of cases across sectors continues to remain broadly similar, compared to earlier periods given the extended resolution timelines.

The overall recovery rate till Q3FY23 was 30.4% implying a haircut of approximately 70%. The cumulative recovery rate has been on a downtrend, decreasing from 43% in Q1FY20 and 32.9% in Q4FY22 as larger resolutions have already been executed and a significant number of liquidated cases were either BIFR cases and/or defunct with high resolution time, coupled with lower recoverable values.

The status of the cases has largely remained constant compared with the previous period. Of the total 6,199 cases admitted into CIRP at the end of December 2022:

· Only 10% have ended in approval of resolution plans, while 32% remain in the resolution process vs. 35% as of the end of March 2022.

· 1,901 have ended in liquidation (31% of the total cases admitted). Meanwhile, 76% of such cases were either BIFR cases and/or defunct. These cases had assets which had been valued at less than 8% of the outstanding debt.

· Around 14% (894 CIRPs) have been closed on appeal /review /settled, while 13% have been withdrawn under Section 12A. A significant number of withdrawn cases (around 54%) were less than Rs.1 crore, while the primary reason for withdrawal has been either the full settlement with the applicant (306 cases) or other settlement with creditors (210 cases).

3QFY23: New quarter, old challenges (BoB Capital)

Q3FY23 was a tepid quarter which saw Nifty 50 earnings rise 11% YoY led by the BFSI sector. Investment-led sectors such as capital goods and cement posted a healthy topline while consumption-driven sectors such as FMCG and durables found their pricing abilities put to the test. BFSI had a good quarter with margin expansion and improved asset quality. Exports were steady in both services and manufacturing sectors led by tier-I IT and electronics manufacturing services (EMS) players, though the pharma sector saw continued generics price erosion in the US.

Capital goods and cement spring topline surprises: We note clear outperformance among investment-driven sectors, such as capital goods which posted strong numbers and robust order inflows. The recent capex-heavy budget lends a further fillip to these sectors. Cement saw 18% YoY topline growth but muted margins and profits.

Consumption sector slows: Staples and durables players had a dull quarter as inflationary pressures weighed on demand. Rural consumption remained sluggish though commentary points to some respite in Q4, a view echoed by auto majors.

Exports shine: Tier-I IT companies posted 1-5% CC growth despite a seasonally weak quarter due to furloughs and also reversed their underperformance vis-à-vis tier-II players (seen over the past 4+ quarters).

Agriculture – Sugar spread strength (ING Bank)

There are reports that the Indian government has decided not to allow further sugar exports this season beyond the already approved 6mt. There have been growing concerns for several weeks now that the government would not allow further exports, given worries over the domestic crop. The government will once again evaluate the domestic balance in March, at a time when cane crushing nears its end before deciding on exports. The move does raise concerns over tightness in the global market, which is reflected not only in the strength in the flat price, but also the March/May spread, which is trading in deep backwardation of more than USc1.60/lb. Worries over tightness should ease once the CS Brazil harvest gets underway in the second quarter.

Indian Pharma (IIFL Securities)

Although pharma companies and the government are focusing on NCDs mainly cardiac, diabetes and respiratory through new launches as well as price caps through NLEM, volume growth in the domestic pharma market is not picking up meaningfully given the limited coverage of quality healthcare infrastructure for the diagnosis of these diseases and subpar availability of doctors in several rural markets. While the India Pharma Market (IPM) has grown consistently at 10-11%, volume growth currently drives only 2-3% of market growth vs 6-7% growth 10 years ago.

The doctors in India have been prescribing a higher no. of products in supporting therapies (such as vitamins, nutraceuticals, etc.) vs 10-15 years ago. This, along with price hikes, is driving a meaningful portion of the overall market growth, thereby masking weak volume growth in many of the underlying core diseases.

While lower prices can supposedly drive higher volume growth, NLEM-led price caps have not aided IPM’s volume growth meaningfully, given that there have been very limited initiatives by pharma companies and government to expand the accessibility of essential medicines across all pharmacies and hospital formularies.

However, the government and pharma companies have been focusing on driving penetration beyond Metro/Tier-1 towns, where the availability of qualified doctors seems to be an issue. A strong OTC policy could make the most commonly used medicines widely available in such smaller markets and towns. Additionally, innovative portable, digital point-of-care diagnostic testing devices can help accelerate the detection of NCDs and diagnose early conditions of NCDs (such as pre-diabetes). These two initiatives, along with focus on patient awareness and counselling, can aid accelerating volume growth in the IPM.

Banking sector (JM Financial)

Given the substantial rate hikes since May’22, it is imperative to look at the benefits that have accrued and incremental gains left from NIMs perspective. For large banks (ICICIBC, AXSB, HDFCB, SBIN, KMB, BOB, CBK, IIB), the average increase in loan yields has been 109 bps (vs RBI’s repo rate hike of 250 bps – and time weighted repo rate hike of 119bps between Apr22-Dec22). Avg NIM expansion for the above set has been 37 bps with CoF increasing by 63bps.

Avg floating rate portfolio of above banks is 69% (~38% Repo/EBLR-linked and ~31% MCLR-linked). As a result, ~3/4^th of yield increase on the portfolio can potentially be attributed to repo/MCLR changes. While repo/EBLR linked loans reprice almost immediately, avg 1-yr MCLR hike for large banks was 123bps (as of Dec22) which implies that a sizeable upward repricing of MCLR-linked loans is likely to come through incrementally as well, thereby supporting NIMs. This implies continued tailwinds on yields aiding NIMs (or ability to attract deposits by offering higher rates). We note that PSU banks’ share of floating rate portfolio is reasonably higher than private banks (~80% vs ~62% for pvt banks). As a result, we expect most large banks to sustain health NIMs – though it is desirable that incremental yield gains should be passed to drive deposit growth.

With regards to NBFCs, the NIM performance has been relatively healthy (avg NIMs +34bps ex-NBFC-MFIs), contrary to expectations of meaningful negative impact of the rate hikes on NBFC margins. Avg yield expansion for NBFCs in our coverage has been 111bps (though 68bps excluding NBFC-MFIs wherein yield increases have been quite sharp at 240bps). Of these, HFCs and diversified lenders have seen yield increase of 94 bps and 120bps resp., while vehicle financiers have seen lower hike of 46bps given higher share of fixed rate portfolio. Cost of funds increase has been 53bps over this period. Incrementally, as banks re-price their MCLR-linked loans higher, the pass through to NBFCs should see stabilization of NBFCs NIMs – which would still be a healthy outcome in light of the sharp rate upswings.

Asset Quality Improvement Continues in December 2022 (CARE Ratings)

Gross Non-Performing Assets (GNPAs) of Scheduled Commercial Banks (SCBs) reduced by 19.7% y-o-y to Rs.6.1 lakh crore as of December 31, 2022, due to lower slippages, steady recoveries & upgrades, write-offs, and transferred to Asset Reconstruction Companies (ARCs). SCBs GNPA ratio reduced to 4.5% as of December 31, 2022, from 6.6% over a year ago and is likely to reach the pre-Asset Quality Review (AQR) levels. Robust growth in advances by 18.5% y-o-y is also supporting this reduction.

Net Non-Performing Assets (NNPAs) of SCBs reduced by 32.5% y-o-y to Rs.1.5 lakh crore as of December 31, 2022. The NNPA ratio of SCBs reduced to 1.1% from 2.0% in Q3FY22 which is significantly better than pre-AQR levels of 2.1% (FY14).

SCBs credit cost stood at 0.7% in Q3FY23. Besides, it has been ranging 0.7-0.9% over the last six quarters with improvement in overall credit quality and level of economic activities.

Overall, the SCBs stress level has reduced as their outstanding SMAs and restructuring book have reduced significantly in Q3FY23, indicative of improving asset quality. This comes after covid pandemic and associated business disruptions have led to an increase in restructured standard assets over the past two years.

Liquidity: Can it be a devil in disguise? (BoB Capital)

Liquidity has been quite a pertinent issue of late when financial conditions remained stringent on account of tightening policy response to higher inflation. In this context, we look at how banking system liquidity is going to evolve in the coming year. In India’s context, relatively well placed macro fundamentals and pent up demand contributed to faster pace of credit growth, which outpaced deposit growth where transmission to rates have been relatively slower as the new rates apply to fresh or renewed deposits while the existing ones remain unaffected. This has widened deficit significantly in context of liquidity in the current fiscal.

Even in the coming year, with anticipation of moderation in pace of nominal growth, we expect a considerable gap between demand and supply of funds to the banking system. Further, significant quantum of LTROs/TLTROs are maturing in FY23 and FY24, which will put additional strain on liquidity.

This can be corrected through conduct of RBI’s long term variable rate repo operations, with the frequency being increased. Or there could be OMOs to induce liquidity in the system on a permanent basis if required. Also, since Banks’ net profit have improved significantly they are well placed in terms of capital. Thus, to continue with the higher pace of lending, they could consider digging into their own capital or reserves and surplus going forward.

Thursday, February 23, 2023

What Modi is doing right!

Continuing from yesterday (The great Indian carnival)

With the presentation of the union budget earlier this month, the incumbent government has entered the final phase of preparations for the 2024 general elections. The preparations would be tested in several state assembly elections to be held prior to the general elections. Amongst these Karnataka, Madhya Pradesh and Rajasthan shall be keen contests.

As per most of the recent surveys, the ruling National Democratic Alliance (NDA) led by Prime Minister Narendra Modi, is likely to return to power for a third successive term in 2024. The alliance is mostly riding on the popularity of PM Modi for its electoral success. Of course the lack of a strong national alternative is also working in favour of the incumbent government, to some extent. It is therefore pertinent to examine what PM Modi has done right to maintain its popularity for the past nine years.

I would not like to delve into the role of the political strategy of BJP in sustaining the popularity of PM Modi, as it could involve dealing with several controversial issues. Besides, the political strategy is too obvious for everyone to see. I would therefore focus on the economic strategy of the PM Modi led government.

Continuing the good work of previous governments

The first thing that PM Modi has ensured is that the key growth drivers of the Indian economy that have evolved over the past two decades are not only sustained but also provided additional impetus. His government has continued and even accelerated the infrastructure development program, especially connectivity & logistics (roads, ports, airports and telecom), self-reliance in defence and development and commercialization of space programs, initiated under the Vajpayee led NDA-1 government and sustained under UPA governments (2004-2014).

The incumbent government has materially enhanced the program to digitize the economy with Aadhar and UPI developed by NPCI at the core. The financial inclusion program started in early 2010s has gathered significant pace with wider acceptance of Aadhar and UPI, and evolution of digital payment technologies.

In a recent presentation Nandan Nilekani, succinctly summarized the key drivers of the economic development and growth of India in the next ten year. Speaking to a group of investors in Bengaluru, Mr. Nilekani said, he believes “the Digital Public Goods (DPG) used in India today will form the basis for India’s economic development because the three cornerstones of the modern economy are no longer roti, kapda, aur makaan; they are identification, financial inclusion, and mobile + internet connectivity. The creation of the ‘India stack’ – Aadhaar (universal identification), Jan Dhan (bank accounts for all), Unified Payments Interface (UPI: online transactions using mobile phones), and Open Network for Digital Commerce (ONDC: seamless & democratized eCommerce) – is helping India get closer to delivering on this critical trinity. These initiatives will impact three key sectors – credit, logistics, and eCommerce – which in turn could have positive spillover effects thus propelling India towards becoming a $10 trillion economy”.

The government adequately supported DRDO and ISRO to continue with their missile and space development programs; and added significant impetus to domestic defence production by opening some key areas to the private sector.

Supporting the bottom of the pyramid through food and social security

Like the previous governments, the incumbent government has also maintained a socialist character and continued to support the bottom of the pyramid through social security programs like MNREGA and National Food Security Act. It has in fact further enhanced the social security programs through introduction of basic universal income and health insurance for select segments of the society.

Widening the global trade

The incumbent government has not only continued the policy of deepening the trade ties with the traditional trade partners, but materially widened the global trade of India, by engaging with new trade partners and introducing many new lines of goods and services in India’s trade basket. The policy of bilateral free trade agreements has been continued and assigned high priority. This widening of trade engagements helped India in enhancing its strategic relevance to some extent.

Energy security with focus on green energy

A key area of achievement of the incumbent government is enhanced focus on energy security with high focus on green energy. Significant capacity has been added (is being added) in the areas of solar energy, wind energy and biofuel production. The green hydrogen mission has been initiated. Though it is still early days, the strategy is likely to yield material benefits in socio-economic terms in the coming years.

Fiscal discipline

Fiscal discipline has been a hallmark of the economic policy of the incumbent government. Despite several social and political challenges the government has successfully reigned fuel subsidy; and managed the food and fertilizer subsidies reasonably well to keep the overall fiscal deficit within the acceptable parameters.

These features of the economic policy have ensured that the Indian economy has weathered the pandemic & consequent global slowdown; and monetary tightening with minimum damage. Though the growth trajectory has stagnated at suboptimal level; employment generation has been poor, and performance in some key areas like disinvestment, farm sector reforms etc., has not been good, the popular sentiment continues to be in favor of PM Modi.

Wednesday, February 22, 2023

The great Indian carnival

Festivals are quintessential to the idea of India. No one can imagine India excluding the hundreds of festivals we celebrate. There is hardly any day on the calendar that is not marked with a religious observance or a social celebration. As a community we are so addicted to festivities that we even celebrate sporting events as festivals. Not surprising, political events like elections, local level political appointments, conventions of political parties, etc. are also celebrated as major festivals in India.

The largest festival in the world, Indian general election, is scheduled to be held in about one year from now. All political parties, like the troops participating in the annual carnival in Brazil, have already started preparing for the quinquennial event. The potential 950million voters are also looking forward to it; though one third of them may actually not bother to exercise their franchise.

In most major democracies in the world, the incumbent leadership and/or party seeks reelection on the basis of its performance in the current term and proposed agenda for the prospective term. However, in India the elections are mostly about persons rather than policies and programs. The caste and religion of the candidate is assigned more importance than their views on socio-economic policies; commitment to political ideology; or past performance.

There are many examples of one person contesting and winning as candidate of political parties subscribing to completely opposite socio-political ideologies. There is no limit on the number of times a person can represent a constituency (or different constituencies) in the parliament. There are numerous examples of candidates repeatedly winning from the same constituency despite dismal past performance and inadequate agenda for the future. In fact, many notorious candidates facing serious criminal charges like murder, rape, dacoity, kidnapping etc. not only get repeated nomination; they get elected with overwhelming majority.

In my recent trips to the hinterlands and various large cities, I discussed the current political scenario with people from various sections of the society. There appears to be unanimity on the point of the quality of politicians. Everyone appears convinced that the quality of politicians in India has deteriorated over the past 3 decades. Senior citizens recall that politicians in the 1950s, 1960s and 1970s were highly educated and held impeccable character. The quality started deteriorating in the late 1980s and the rate of decline accelerated sharply from the 1990s.

Surprisingly, the decline in the quality of Indian politics and politicians coincided with the structural improvement in the Indian economy. The socio-economic parameters like growth rate, occupational structure, urbanization, globalization, literacy rate, access and connectivity (roads, media, telephony, TV, internet etc.), higher education, gender equality, etc., have indubitably improved materially in the past three decades. The worst part is that the primary driver of popular mandate is no longer socio-economic upliftment; but the regressive agenda of aggressive social divide.

The points to ponder therefore are: (i) Why the empowered, enabled and enriched citizens are not aspiring for a cleaner, ethical and progressive political system; and (ii) Does socio-economic growth and development in India have any correlation with the political set up in India?

….to continue

Tuesday, February 21, 2023

Summers could be hotter this year

The Reserve Bank of India has increased the policy repo rate six times in the current financial year (FY23). It has continued to withdraw excess liquidity from the financial system through various means and has mostly maintained a hawkish demeanor, insofar as the policy outlook is concerned.

In spite of (i) aggressive rate hikes; (ii) withdrawal of excess liquidity from the system; (iii) sharp correction in global commodity prices (especially energy); (iv) restoration of supply chains that had got damaged during pandemic resulting in severe supply shortage of key raw materials and inputs; (vi) three consecutive normal monsoon seasons yielding bumper crops; and (vi) slow growth – CPI inflation has persisted above the RBI tolerance range of 4 to 6% and credit growth has accelerated and remained strong. Obviously there is a disconnect somewhere. Even one third of the members of the Monetary Policy Committee of the RBI do not agree with the policy stance of the RBI and have voted against rate hikes.

Personal loans and working capital demand driving credit growth

In a recent report rating agency CARE Ratings highlighted that “Credit growth has generally been trending upward throughout FY23 and remained robust in recent months even amid the significant rise in interest rates.” The report pointed that “Retail and NBFCs have been the key growth drivers for FY23. Besides, demand for capex too is expected to drive industry credit growth.” As per the agency, “Incremental credit growth has risen by 12.2% so far in FY23. In absolute terms, credit expanded by Rs.14.5 lakh crore from March 2022. The growth has been driven by continued and sustained retail credit demand, strong growth in NBFCs and inflation-induced working capital requirement”.

Personal loans, driven by housing and vehicle loans, continue to be one of the fastest growing segments of credit growth. Even in December 2022, “Personal loans grew by 20.2 per cent (y-o-y) in December 2022 from 14.9 per cent a year ago, largely driven by housing and vehicle loans.”

Banking system liquidity turns negative from a large surplus

The banking system liquidity has been quickly evaporating in FY23. From a large surplus a year ago, the banking system liquidity has turned negative in recent weeks. As of January 27, 2023, the banking system liquidity deficit stood at Rs.18,916 crore as against a surplus of Rs.6.4 lakh crore at the beginning of FY23.

Credit growth outpacing deposits

For the fortnight ended January 27, 2023, deposits with scheduled commercial banks (SCBs) stood at Rs177.2trn. The current deposit base is higher by Rs12.5trn as compared to the beginning of FY23. Bank deposits growth continues to lag the credit growth resulting in gradual rise in credit to deposit ratio.

Conclusion

From a plain reading of the above mentioned data points and corroborating evidence, I am drawing the following conclusions:

· The economic growth continues to be highly skewed (K shaped)

The top decile of the population seems to have emerged economically stronger from the pandemic. Record high spend on foreign travel; record sales of high end cars; 9yr high sales of premium homes; are just a few indicators of this trend.

On the other hand, the middle classes have struggled to sustain their pre-pandemic lifestyle. Their savings are depleting; credit card outstanding and rolling credit is rising; and high inflation is hitting their consumption.

The reliance of poor people for essentials like food, shelter, healthcare, education on government is intensifying. Over 800million people are now availing free food.

· Rates could rise further

Persistent inflation, neutral to negative liquidity, high current account deficit (INR under pressure), slowing household savings rate, and credit demand outpacing the deposits imply that the overall environment for rates remains bullish. We may see deposit and lending rates rising further; while the policy rates stay elevated. A pause by RBI may not result in lowering of rates in the short term.

· Growth to remain suboptimal, private capex may remain in slow lane

There is evidence that high real rates may have started to constrict economic growth in India. The real GDP growth in FY24 is forecasted to be 5.8% to 6% by most economists and analysts, though RBI has projected an optimistic 6.4% in its latest monetary policy statement. Private capex may thus remain in the slow lane despite optimistic projections.

· Banks’ margins may take a hit

In the past one year Indian banks have enjoyed strong margins as loans were repriced in tandem with the policy rates. The deposit rates usually get repriced with a lag. We shall see deposit rates rising in the next few quarters impacting the margins of the banks.

· Economic inequalities may rise further

With inflation, high rates, slower economic growth (poor employment generation) continuing to hit the middle classes and poor hard, we shall see the economic inequality continuing to rise further. The consumption of the premium segment may sustain and grow faster as compared to staples and essentials.

Friday, February 17, 2023

Some notable research snippets of the week

Assumptions Have Consequences (John Mauldin)

Remember National Lampoon’s Vacation? It was a 1983 comedy film in which suburban dad Clark Griswold (Chevy Chase) takes his family on a cross-country road trip to the fabled Walley World amusement park.

Clark made one critical mistake, though. He assumed Walley World would be open and waiting for them. This was to be the family’s reward for a long, stressful journey. His assumption was...incorrect.

Many have noted the word’s first three letters hint at how assumption can make an ass out of u and me. Yet we must assume some things or life becomes impossible.

Assumptions can be wise or unwise. They can be unduly optimistic or excessively pessimistic. Slightly different assumptions can produce giant changes in predicted outcomes. Assumptions are necessary but we shouldn’t make them lightly, nor forget we are making them.

This is important because assumptions abound in our assessments of the economy and markets. They tend to sort of fade into the background while we explore everything else.

January CPI Inflation surprises on the upside (Kotak Securities)

January CPI inflation increased by 6.52% (December: 5.72%), led mainly by a sequential rise in prices of cereals (2.6% mom compared to 1.1% in December) and eggs (2.3% mom compared to 4.9% mom). On the other hand, vegetable prices contracted, but the contraction was shallower than in December ((-)3.8% mom % versus (-)12.7% mom in December).

Rural and urban inflation rose sharply by 6.85% and 6%, respectively (December: 6.05% and 5.39%, respectively). January core inflation (CPI excluding food, fuel, pan, and tobacco) remained elevated and sticky at around 6.41% while increasing sequentially by 0.53% (December: 0.31% mom). Gold and silver prices, yet again, caused an increase in the personal care and effects category. Further, rural core inflation continues to outpace urban core inflation.

Likely data anomaly in cereals’ index There appears to be some data anomaly in the cereals index for January. Our calculated series for the cereals category based on its twenty sub-categories suggests a 0.8% mom increase in the index compared to 2.6% mom increase in the official data release. Historically, the gap between our calculated series and the official series has been negligible. The January print shows a marked deviation of 1.8 ppt. If this data print was to undergo revisions, the cereal index’s sequential momentum would be around 0.8%, leading to food and beverage inflation at 5.75% (compared to 6.19% as per the official release). Consequently, the headline CPI print would stand corrected at 6.29% (23 bps lower than the official release).

Strategy: World is not secular – India continues to shine 9Elara Capital)

India’s relative outperformance in CY22 was driven by strength in earnings revision and performance, especially as its North Asian neighbors saw a sharp downward revision. CY23 would continue to offer comfort on inflation growth dynamics, and India is expected to remain the fastest-growing large economy, which clubbed with strength in India Inc’s balance sheet, is likely to provide tailwinds to earnings growth despite global challenges. This means India will continue to command a valuation premium compared to peers.

However, on an absolute basis, India equities saw time correction, with ~20% correction in 12-month forward P/E of the Nifty to ~18x from peak of ~23x. While markets may time correct for the next couple of quarters (as clarity on global rate cycles emerges), we expect earnings growth and India’s relative strength to be key drivers of Index returns, and our models based on earnings expectations and valuation (forward P/E, What’s in the price model and aggregation of bottom-up expectations) imply a Nifty trading in the range of 17000-20000, with back-ended returns in the Index. This implies ~14% upside to the Nifty from current levels.

Industries Slow Down in December (Centrum Research)

Industrial production for the month of December displayed a healthy performance, thereby registering a print of 4.3% YoY as against the 7.4% YoY growth rate a month ago. The expansion in the industrial output was a bit slower than expansion in eight core sector growth of 7.4% in December-22. Rise in the industrial output has been broad based across sectors as well as in the used based category and mainly that has kept industrial activities in a positive territory. Within the use based classification, consumer durables output entered in the contractionary territory and registered a negative print of 10.4% YoY in December against a contraction of 1.9% a year ago, thereby reflecting the existence of prevalent lacklustre demand amongst the urban households.

For December 2022, the production in the eight core industries expanded 7.4% compared to a growth of 5.7% for the month of November. It was the highest recorded number in the last three months. The December print was weighed up by a large expansion in mining, infrastructure, infrastructure and primary goods. From a consumption perspective, the results were a mixed bag as consumer durables and non-durables recorded contraction and expansion respectively.

Steel: Prices consolidate, spreads contract (ICICI Securities)

HRC prices in traders’ market consolidated after seven successive weeks of hikes. However, rebars continue to fare better with rebar-HRC premium still at Rs2,800/te. Regional HRC price stayed unchanged; however, Indian HRC export price was up US$25/te at US$715/te on higher realisation by exporting to Europe. Of late, Indian producers are concentrating on better-remunerative Europe and Middle East markets. Secondary rebar price, however, declined by Rs500/te WoW as pellet price was down US$8/te, tracking global iron ore price.

We would await more clarity on stimulus and policy in China as key debt and money supply indicators do not show any sign of a pick-up, as yet.

Technology: Moderation in Cloud growth intensifies near-term uncertainty (MOFSL)

The Cloud business growth of key Hyperscalers (Amazon, Microsoft, Google, etc.) ebbed for the fourth straight quarter. More importantly, the managements of key Hyperscalers indicated a further slowdown and a shift in focus towards cost optimization projects from enterprises due to high macro uncertainty. While our view of the near-term divergence between Hyperscalers and IT services growth continues to play out, the pace of deceleration has been steep and might impact the follow-on IT services work adversely with a lag. Given the low industry visibility, this adds to demand uncertainty despite having a substantial Cloud migration opportunity globally.

· The Cloud growth across Hyperscalers continues to taper off from its peak seen in 4QCY21. The slowdown in demand is a function of reprioritizing enterprise spends towards core operations amid the challenging macro environment.

· The deal pipeline remains healthy and robust with a few customers planning to go slow with the migration and have committed to stay for a long-term horizon.

· We believe the Cloud migration activities have taken a temporary pause before it starts to accelerate further going ahead.

· Despite the four consecutive quarters of slowdown, the IT services companies have not witnessed any material weakness in delivering Q3 performance.

Robust Credit Growth Persists in Jan, Credit Deposit Ratio Rises Further (CARE Ratings)

Credit offtake rose by 16.3% year on year (y-o-y) for the fortnight ended January 27, 2023. Incremental credit growth has risen by 12.2% so far in FY23. In absolute terms, credit expanded by Rs.14.5 lakh crore from March 2022. The growth has been driven by continued and sustained retail credit demand, strong growth in NBFCs and inflation-induced working capital requirement from sectors such as “petroleum, coal products & nuclear fuels”, and chemicals and chemical products.

With a higher base, deposits witnessed a slower growth at 10.5% y-o-y compared to credit growth for the fortnight ended January 27, 2023. The short-term Weighted Average Call Rate (WACR) has increased to 6.44% as of January 27, 2023, from 3.72% as of January 28, 2022, and from 6.09% as of January 13, 2023. Deposit rates have already risen and are expected to go up even further due to rising policy rates, intense competition between banks for raising deposits to meet strong credit demand, a widening gap between credit & deposit growth, and lower liquidity in the market. The deposit rates rise with a lag effect and are expected to increase the cost of borrowings for the banks.

RBI increased the repo rate by 25 bps to 6.5% in its last monetary policy held on February 08, 2022. This is the sixth hike by RBI in FY23 due to elevated core inflation. The RBI has continued its stance of withdrawal of accommodation and has maintained a hawkish tone.

RE at 121 GW; generation growth peaks (Elara Capital)

As per Power System Operation Corporation (POSOCO) data, power generation surged 18.4% YoY in January 2023 to 137.0BU from 115.8BU in January 2022. Robust power consumption growth in January primarily indicates sustained momentum of economic activities. We believe power demand as well as consumption will increase and continue to grow in mid-teens on increased demand as we move towards the summer season though demand in North India would be stable, led by ongoing winters and further improvement in economic activity on account of the end of the Rabi season.

India seeks to raise its installed RE generation plant capacity to 500GW by CY30E from the current 121GW. We are positive on the companies focused on RE capacity with strong balance sheets.

As per the Ministry of Power’s PRAAPTI portal, DISCOM owed INR 1,195.8bn in July 2022 versus INR 765.2bn in January 2023 to power generation companies. Outstanding dues (>45 days) of power producers from distribution companies slipped 76% YoY to INR 235.7bn in January 2023 versus INR 1,051.8bn in July 2022.

In January 2023, 14 new RE tenders with cumulative capacity of 7,966MW were issued. In December 2022, 17 new RE tenders with cumulative capacity of 6,578MW were issued. In December 2022, 1,370MW (419.6MW in December) of solar and wind capacity was added, taking the cumulative RE capacity to 120.9GW. From January 2022 until December 2022, 13,956MW solar capacity and 1,847MW of wind capacity were added in India. This is ~17.5% and 26.6% higher than in 2021, respectively. Rajasthan added the maximum utility scale solar capacity of 675MW in India followed by Chhattisgarh (138MW) and Tamil Nadu (77MW) in December 2022.

Chemical price trends (Sunidhi Securities)

Brent Crude oil has been hovering around $85/barrel mark for the last few months led by sluggish economic performance across Europe, Asia and the U.S., along with lower demand from China amid Covid new wave. Somewhat stable crude oil prices coupled with weak demand kept most of the chemical prices under pressure. However, anticipation of a bounce back in crude oil prices remains firm globally as analysts are betting high on reopening of Chinese market to spike global demand while Russia’s production cut announcement to lend support. Some early green shoots are visible in some of the chemical products but broad base recovery will take time to reflect in the prices.

Chemical prices of products like MIBK (up 52%), Ethanol (up 25%), MTBE (up 24%), Styrene (up 18%), EDC (up 16%), Caprolactam (up 16%), Butadiene (up 15%), Benzene (up 14%) and Toluene (up 14%) have gained on MoM in the domestic market. On the weaker side sharp correction was witnessed in chemicals like Chloroform (down 27%), DMF (down 17%), Caustic soda lye (down 16%) and Anhydrous HF (down 13%) on MoM basis. Soda ash remained stable on MoM basis.

Domestic demand has been fairly good in the last couple of quarters while export demand has been impacted due to ongoing geopolitical issues. We believe the global demand recovery and improvement in production activities to soon take shape with relatively steady crude oil prices, fading our higher inventory channel scenario and reopening in China. Moreover, with cooling off energy cost and lower raw material prices, margin profile for chemical manufacturers to look better in the coming quarters.

High services inflation remains a worry for central banks (Danske Bank)

Inflation drivers continue to paint a mixed picture but inflation is likely to head lower through 2023 in US and the euro area. Price pressures from food and freight rates have clearly eased as has energy and electricity prices in Europe. Labour markets remain tight, but wage pressures have showed tentative signs of easing. Core inflation pressures remained elevated in January both in the euro area and the US, and we expect the ECB and the Fed to react by continuing to hike interest rates in the spring meetings.

Inflation expectations: Both US and euro area consumer inflation expectations have remained elevated, but off the peak levels. Some short-term US indicators rose modestly, but market-based long-term inflation expectations remain broadly stable.

Logistics sector: Bumpy ride; shimmer of hope for a few (ICICI Securities)

Q3FY23 was a challenging quarter for logistics companies under our coverage. Key highlights: 1) Festive season was bleaker than expected with lower than expected e-commerce volume; 2) lower EXIM volumes owing to adverse global macros impacted earnings of container companies; 3) margins got impacted due to higher cost; 4) consensus estimates and target price post earnings have been slashed for all the companies; and 5) management commentary was cautious for Q4FY23 for most companies with upcoming price hikes and cost efficiencies in middle-mile, the key focus area. Going ahead, we believe margin improvement is likely for surface express players such as TCI Express and Gati; however, CONCOR’s margin is likely to remain tepid owing to higher decline in EXIM volumes.

Metals – Aluminium smelters in Europe still facing challenges (ING Bank)

Despite the recent drop in energy prices, aluminium smelters in Europe still face challenges, Norsk Hydro has said. The company’s CFO said a further 600,000 tonnes of aluminium capacity is still at risk if we see another spike in energy prices.

Mitsui Mining & Smelting Co., Japan’s largest zinc smelter, will raise premiums for Asian ex-Japan buyers for the second year in a row by more than 10% over LME prices for 2023. The company expects zinc supply to remain tight and sees a supply deficit of 150kt in 2023, the third annual deficit in a row. It expects zinc prices to range between $3,000 and $3,400/t in the first half of the year.

Trade: Deficit narrows owing to sharp import dip (Yes Bank)

India’s Trade Deficit narrowed sharply to USD 17.8 bn in January 2023 from USD 22.1 bn in December 2022 led by 15.8% MoM decline in imports. However, exports dropped by 13.5% MoM.

Moderation in imports is seen across oil, gold, and core imports. Drop in core imports probably reflects lower domestic demand but needs to be tracked for confirmation.

Despite fears of global slowdown, India’s services exports show strong momentum.

FY24 CAD revised to 1.8% of GDP (USD 66 bn) amid improved outlook for services exports and lower goods imports.

Thursday, February 16, 2023

No bear market likely in 2023 as well

It was spring of the year 2022. The news flow was worsening every day. The Russia-Ukraine conflict was dominating the global media headlines. NATO-Russia acrimony was at its worst since the cold war era. China committed to a zero Covid policy and implemented strict mobility restrictions, further impacting the global supply chains. Inflation was beginning to spike and most central bankers were ready to embark on an accelerated tightening cycle.

Back home, the enthusiasm created by a path breaking budget had not survived even for a whole week. Issues like macroeconomics (growth, inflation, current account, yields, INR), geopolitics (Russia-Ukraine), politics (state elections) and persistent selling by foreign portfolio investors (FPIs) was dominating the market narrative. The trends in corporate earnings also were not helpful to the cause of market participants.

By early March 2022, the benchmark indices had fallen substantially from their highest levels recorded till then, between October 2021 and January 2022. The Nifty50 was down ~11%; the second most popular benchmark Nifty Bank was down ~16%, the Nifty Midcap 100 was down ~14% and the Nifty Smallcap 100 was down ~17%. Though technically, the market was still in ‘correction’ mode, sentimentally it did feel like a ‘bear’ market.

Amidst all the gloomy headlines and bearish forecasts, I felt that we are most likely to witness a boring market rather than a bear market in India during 2022 with breadth narrowing. (see here). Since then benchmark Nifty is higher; but it has mostly moved in a range occasionally violating the range on both the sides.

Since the beginning of 2022, Nifty50 (+1%) is almost unchanged and midcap (-3%) have performed mostly in line. Nifty Bank (+10%) has been major outperformers; while Smallcap (-20%) have underperformed massively. The market breadth has accordingly been mostly negative.

Nothing much has changed in the past one year - the geopolitical situation remains fragile; the war continues; inflation remains a worry; economic growth is decelerating; earnings growth is slower than anticipated; rates are higher and expected to remain elevated for long; monsoon is expected to be below normal; and FPI outflows continue. To add to this we are entering an intense election season that should culminate with general elections in March-May 2024.

However, the narrative now is not negative. At worst it is neutral. The war is now on the 13^th page of the newspaper. It is neither mentioned in the prime time news headlines nor does it trend on social media. Central bankers have successfully anchored inflationary expectations and the popular discussion is around peaking of rates & inflation rather. The US and European recessions are not a consensus now. India growth is also estimated to be bottoming above 6%.

Given these fragile macroeconomic & geopolitical conditions; declining optimism over earnings growth; higher debt returns and optimistic equity positioning, it is important to assess what could be the market behaviour in the next one year?

In my view, we may not see a decisive direction move in Nifty50 in 2023. It may move in a larger range of 16200-20600 in 2023, averaging above 17600. We may therefore not witness a bear market in 2023. Smallcap stocks which have been underperforming for quite some time now may end up outperforming the benchmark Nifty50 for 2023; though gains could be back ended.

Wednesday, February 15, 2023

Russia, China and El Nino

In the past one year, inflation has been one of the primary concerns for most countries across the globe. Rising prices of food and energy in particular have materially impacted the lives of common people on all continents. The central bankers of most major economies have hiked policy rates in the past one year to control inflation. In the current year 2023 so far, 13 major central bankers have taken policy action(s) and all of these actions have been hike in policy rates.

However, in recent weeks inflation has shown some tendency of cooling down. It is difficult to assess how much of this cooling down is due to tighter monetary conditions; and how much could be attributed to other factors like restoration of supply chains that were broken during the pandemic and warmer winters resulting in lower energy demand in the northern hemisphere, etc. Nonetheless, some central bankers have adjusted the pace of tightening to smaller hikes. Most of them, though remain circumspect about the persistence of inflation. While the debate continues over the trajectory of price hikes in the next few quarters; an overwhelming majority of experts believe that prices may remain high for much longer.

The global growth forecasts have witnessed some downgrades in the past six months as tighter monetary conditions and higher prices are seen hurting demand for consumption and investment. As per the latest assessment of the World Bank, in 2023 “the world economy is set to grow at the third weakest pace in nearly three decades, overshadowed only by the recessions caused by the pandemic and the global financial crisis….Major economies are undergoing a period of pronounced weakness, and the resulting spill-overs are exacerbating other headwinds faced by emerging market and developing economies (EMDEs).”

With this background, three key issues that could influence the future trajectory of global prices and therefore interest rates are geopolitical situation; impact of China ending Covid restrictions and the impact of the emergence of El Nino on global food production.

Geopolitical conflict in Eastern Europe (Russia-Ukraine) has materially influenced the prices of energy and food in the past one year. Any worsening or this conflict or expansion to Western Europe could make things worse. Some events in the recent weeks have indicated that Sino-US relations may not improve anytime soon. NATO countries hardening their stand on Russia; Russia retaliating with a cut in energy output; and some key OPEC members openly expressing disagreements with US oil pricing has materially increased the uncertainty in the energy market.

China has been gradually relaxing the covid restrictions for the past many months. This has eased the logistic logjam across the world. The supply chains that were broken due to congestion at major ports, shortage of containers, short supply of key raw materials, and poor take-off have mostly been repaired. The freight rates that had become prohibitively high have eased to pre Covid (2019) levels. The debatable question however is whether China reopening will be inflationary (higher demand) or deflationary (complete supply chain restoration and consequent destocking; improved mobility of workers etc.).

As per the latest forecast of various weather agencies (see here), the probability of El Nino conditions developing in the coming summer could impact the agriculture production in major countries like India, this year. If these forecasts come true, we may see food prices remaining at elevated levels.

A variety of views prevail on these three issues and their outcome. In my view, China reopening will indubitably be deflationary for the global economy, especially metals and other raw materials).

I am however not sure about the geopolitical conditions. I would therefore continue to expect elevated crude oil prices through 2023. By the way, the RBI in its latest statement has assumed the price of Indian basket of crude oil to be US$90/bbl for FY24, against the current price of US$84.19/bbl (see here).

It is little early to talk about weather conditions in the forthcoming summer and its eventual impact on global food prices. For now, the Rabi crop in India appears to be good; and there is enough food in the Indian granaries. Thus availability of food should not be a problem for sure even if we had a poor monsoon year after three normal/excess monsoons.