Economic momentum further gained; Inflation and IIP at 4% (Phillips Capital)
CPI eased to a 25-month low: CPI for May slowed to 4.25% (PC/Consensus estimate: 4.26%/4.31%) vs. 4.7% in the previous month and 7% a year ago. Sequentially, CPI registered 51bps increase as in the last month. Core CPI stable at 5.2% yoy as in the last month with sequential pace lower at 40bps vs. 60bps in the last month. Food inflation (heavy-weight) up by 62 bps mom vs. 51bps hike in the last month led by higher price for vegetables (3%), condiments (2%) and egg (2%). Fuel prices up by 0.6% mom vs. -0.1% deflation in the last two months. Clothing inflation pace stable at 0.3% mom as in the last month while pan/tobacco and housing price increase pace slowed to 0.2%/0.2%. Services inflation pace eased to 0.3% vs. 0.5% in the last month with highest increase in price for personal care (0.6%), medical care (0.4%), education (0.3%), recreation (0.3%), household requisites (0.3%) and transport & communication (0.2%).
IIP well above expectation: April IIP saw 4.2% yoy growth (PC/Consensus estimate: 1.5%/1.4%) vs. 1.7% in the last month (revised up from 1.1%) and 7% a year ago. Mining/Manufacturing registered 5%/5% yoy growth; electricity fell by -1% vs. 8%/6%/12% growth in April’22. Among the use-based segments, 5/6 were stronger yoy. Infrastructure (13%) saw the strongest growth followed by consumer non-durables (11%), capital goods (6%), primary goods (2%) and intermediate goods (1%). Consumer durables (-4%) contracted yoy.
Sector wise: 12/23 sectors progressed yoy. Growth was noted in pharmaceuticals (25%), other transport equipment (12%), machinery (11%), basic metals (10%), electrical equipment (10%), motor vehicles (4%), chemicals (3%), food products (2%) and fabricated metals (1%). Production declined among tobacco products (-21%), computer & electronics (-11%), beverages (-10%), paper products (-8%) and textiles (-6%).
China data disappoints (CNBC)
China’s youth unemployment rose to a record in May, while major data missed expectations, according to data released Thursday by the National Bureau of Statistics.
The unemployment rate for young people ages 16 to 24 rose to 20.8% in May, a record and above the high set in April. The jobless rate for people of all ages in cities was 5.2% in May.
Retail sales for May rose by 12.7% in May from a year ago, below expectations for 13.6% growth forecast by a Reuters poll.
Industrial production rose by 3.5% in May from a year ago, slower than the 3.6% expected by the Reuters poll.
Fed pauses, no pivot yet (CNBC)
After a two-day meeting, the Federal Reserve decided to leave interest rates unchanged.
“Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy,” the central bank’s post-meeting statement said.
The surprising aspect of the decision came with the “dot plot” in which the individual members of the FOMC indicate their expectations for rates further out. The dots moved decidedly upward, pushing the median expectation to a funds rate of 5.6% by the end of 2023.
Equity Strategy: OWT Banks vs UWT IT — Still more room (Jefferies Equity Research)
The financials & IT sectors together account for c. 50% of Nifty & are key for any India portfolio. Past ~14 year data shows that both move in the opposite direction 70%+ of the time. We believe that there's still a lot of room in the OWT banks / UWT IT call, given the fundamental trends & relative valuation. Also, empirically, this type of trend usually lasts for 3 quarters. We are just half-way into it currently. We would be sellers into the recent IT rally.
IT and banks perform in an opposite direction usually. Put together, financials & IT account for c.40% of MSCI India and 50% of Nifty. Our analysis of performance of Nifty IT and Nifty Banks since 2010 shows that the two indices tend to generally perform in opposite directions. As compared to the Nifty, on a trailing 3m or 6m basis, the relative performance of IT index and Banks index has been in the opposite direction 76% & 70% of the time, respectively. Even if we consider longer periods say 1/2 yrs; the opposite performance sustains for >60% of the time. The fundamental reason is that the banks tend to OPF during the times of favourable macro like stable / strong INR, falling yields, strong growth etc. While IT tends to OPF during weaker macro, rising yields/inflation and weakening INR.
We view the banking sector positively. The banking sector has seen strong performance in FY23 as system wide loan growth at 16% was at a multi-year-high. Moreover, asset quality is benign and fast transmission of rate hikes has helped to widen NIMs. The outlook for the sector is strong with 12-14% sector loan growth (higher for pvt sector at 18-20%) likely in FY24 partly, as India starts seeing a new private capex cycle (both housing and private corporate capex in upturn).
Strong macro also suggests OWT Banks. India's 4QFY23 GDP data beat on higher capex and RBI with construction activity showing early signs of the cyclical upturn; GDP forecasts are being upgraded; with RBI projecting 6.5% for FY24. Inflation has also declined to 2-3 year lows with WPI -ve and CPI below 5%. The RBI has also brought its rate hike campaign to a pause. INR is seeing support from improving CAD; with the same trending near breakeven. Despite new highs, valuations are still reasonable for the banks. Our model portfolio is OWT lending financials by 2ppt; while IT is the largest UWT 4ppt.
Negative view on the IT services sector. IT outsourcing demand has weakened substantially in 2023 with several tech majors reporting flat to declining revenues in 4QFY23. The outlook is weak as well with mid-single digit growth guidance and no increase in employee headcounts planned in FY24. Despite weak outlook, IT cos valuations are still above the historical averages. March quarter was the first quarter with some disappointments for IT majors. We believe that more disappointments are likely, especially in the mid-caps. For large caps our EPS estimates are 1-6% lower than consensus.
Other technical factors. The average instance of Banks or IT OPFing the Nifty lasts for a duration of 12 months and generates an OPF of 24ppt vs. the Nifty. The current period of Banks OPF started Feb23 and at 4mths /16ppt OPF &, in our view, still has a way to go.
India consumer: Disruption of valuation models too (Kotak Securities)
In our view, investors may need to reevaluate the extant valuation framework for consumer companies, given increasing risks to growth, the bulwark of current valuation models. Traditional valuation models essentially assume steady growth at high profitability for extended periods of time. This may not hold given rising disruption risks, which may alter the growth and profitability profile of most consumer sectors and companies.
Traditional valuation framework may no longer be reliable: We believe the extant valuation framework for consumer stocks based on (1) historical P/E multiples and/or (2) long-term DCF models, which simply extrapolate recent history of growth and profitability may be redundant given swift changes to business models of companies and sectors. The conventional framework of according high valuations for ‘assured’ high growth and profitability for an extended period of time (in effect, some variant of GAAP—growth at any price) may no longer work given declining visibility on both growth and profitability in an increasingly disrupted future.
A different framework for a new era: Investors may want to reassess the four traditional pillars of ‘assured’ growth and profitability of consumer companies in order to appreciate the resilience of their business models—(1) brand power, which accords superior profitability and returns, (2) distribution strength, which reinforces brand, (3) market structure, which determines the extent of competition and profitability; brand and distribution feed into this key variable and (4) product relevance, which determines the period and rate of growth.
Business models will be tested: As argued in several reports over the past five years, we see disruption across all categories of the consumer sector. The traditional moats of consumer companies will likely get eroded and even breached over time. (1) Brands will likely become less important, (2) traditional general (B2C) distribution channels may lose salience, being gradually substituted by other distribution channels, (3) markets will become more competitive with the entry of new players using different routes and technologies and (4) products (some of them) will lose relevance given changing consumer lifestyles and preferences.
High valuations of companies would suggest no concerns around disruption: The high valuations of most consumer companies would suggest that investors expect (1) a ‘business-as-usual’ outlook for companies for an extended period of time or (2) the companies to successfully navigate the ‘uncertain’ future without any negative impact or to even benefit from the emerging environment. In our view, it would be imprudent to dismiss disruption risks and impractical to assume that all or most incumbents will manage disruption well.
Paper Industry: Set to See Margins Moderate in FY24 (CARE Ratings)
The paper industry, including paper, newsprint, and paper products, witnessed a significant improvement in operating margins of 926 basis points (bps) in FY23 compared to the previous year for the top 10 listed companies based on market capitalisation. This improvement was primarily driven by revenue growth of 45%. The industry experienced higher volumes and a notable surge of nearly 40% in net realization, which contributed to the sharp improvement in operating margins. In the first three quarters of FY23, the paper industry demonstrated robust financial performance, fueled by pent-up demand and price hikes implemented by market players to capitalize on the surge in demand. However, during Q4FY23, the industry began showing signs of stabilization after achieving double-digit growth for eight consecutive quarters until Q3FY23. Factors such as China’s ban on paper waste and supply disruptions resulting from the Russia-Ukraine war led to a significant increase in Net Price Realizations (NPR) worldwide, soaring from Rs. 70,000 per tonne to Rs. 100,000 per tonne. Looking ahead to FY24, CareEdge Ratings anticipates moderation in both topline and operating margins by 200 to 300 bps. This expectation is based on the stabilisation of demand and the cooling down of raw material prices, which is likely to result in a corresponding moderation of net price realisations.
Textile Sector: On the cusp of an upcycle (Sharekhan)
The Indian textiles sector is strategically consolidating its position in key export markets such as home textiles and readymade garments, capitalising on opportunities arising from the US-China trade war. India has witnessed a notable increase in its share of exports in these segments to the US. After challenging and subdued FY2023 affected by muted demand, higher retailer inventory, supply constraints, and rising cotton prices, the textile companies believe the worst is over and anticipate a demand revival by Q3FY2024 with reducing inventories on global retailers’ shelves.
Further, factors such as the “China + 1” strategy, geopolitical uncertainties in competitor countries, and potential free-trade agreements (FTAs) with the UK and Europe offer promising prospects for consistent earnings growth and improved cash flows. With material capex already completed, textile players are poised to leverage their expanded capacities. Moreover, falling cotton and crude prices are expected to bolster margins and enhance India’s competitiveness in export markets. The Indian textile sector is well positioned to overcome challenges and looks forward to ride the next upcycle.
Near-term drivers: Likely recovery in demand for home-textile products and improved demand for garment products in key export markets from H2FY2024.
· India continues to gain market share in key export markets such as the US and Europe (with share gains in the past five years).
· Improvement in the capacity utilisation with higher capacities would boost volumes.
· A fall in cotton prices from its highs of Rs. 1,00,000+ per candy to ~Rs. 60,000 per candy will drive margins and will also provide competitive advantage in export markets.
Medium to long-term drivers
· Rising labour costs and geopolitical tensions have the potential to shift the focus of exports from China towards other countries.
· Some big global brands are reducing their exposure to China over time and continuing to develop alternate suppliers in other regions.
· The FTA with UK/Europe will be beneficial to Indian apparel exports.
· Government incentives and support from state governments for low-cost locations; PLI schemes to increase investments in man-made fibres and technical textile and FTAS with other countries.
…increase in Cotton MSP (Phillips Capital)
Indian Government has increased MSP for Cotton by c. 9% for medium staple from Rs 60.80 per kg to Rs 66.20 per kg and by c.10% from Rs 63.80 per kg to Rs 70.20 per kg for season 2023-24.
We believe cotton Minimum Support Price (MSP) increase is aggressive step to support cotton farmers to compensate for an increase in cultivation cost. India need to work on cotton yield improvement urgently to maintain cotton textile value chain globally competitive. The Government has continuously increased MSP without improvement in cotton yield, in fact Cotton yield has shown declining trend in past few years. We have highlighted this as serious issue and need to be addressed on priority basis.
Cotton prices has seen sharp correction from Peak of Rs 100,000 per candy in 2021-22 to Rs 57,500 per candy now which is close to MSP of 2022-23. MSP increase by c.10% will now structurally increase cotton price going ahead to c. Rs 63,500 per candy.
Steel: Healthy Domestic Demand; Sustainability to Take Centre-Stage (CARE Ratings)
During FY23, the domestic finished steel consumption grew by 13.3% y-o-y led by healthy demand from infrastructure, real estate and automobile industries.
• Steel exports declined sharply by 50.2% y-o-y due to the imposition of export duty on steel products from May-November 2022 coupled with weak global demand due to continued geopolitical tensions and inflationary trends.
• As the domestic industry looks to double the steel capacity and production by FY31 from current levels to cater to healthy domestic demand and export opportunities, sustainable availability of key raw materials – iron ore and coking coal, and enhancing export competitiveness will be critical.
• Further, the industry is becoming increasingly conscious of the Environmental, Social and Governance (ESG) aspects and significant investments are expected towards reducing carbon emissions and developing of cleaner production technologies going forward.
The domestic steel consumption is expected to grow at 8-10% in FY24 led primarily by infrastructure push in the pre-election year. The demand uptick from China has been slower than expected which is expected to have a bearing on steel prices in the near term. As Indian players prepare to cater to future demand, accelerating domestic iron ore production and identifying sustainable and cost-effective sources of import-dependent coking coal will be the key. While the transition to cleaner technologies such as green steel is desirable, these technologies require high capital investment and their adoption will depend on the support provided by the government and industry participants.
Auto: Steady Growth on Low Base; UVs are Clear Winner (Reliance Securities)
Domestic auto sales volume (excluding CVs) grew ~18% YoY (up 9% MoM) to 18,08,686 units in May’23. Notably, all segments of the automobile industry witnessed a decent performance in domestic market, supported by healthy urban sales and steady recovery in rural, supported by healthy agri output at higher MSPs. However, exports continue to remain laggards. Industry witnessed strong YoY as well as MoM growth across segments. Marriage season helped industry’s retail performance to some extent, while low base led to YoY growth. In PV segment semiconductor supply impacted production to some extent.
On the other hand, 3W segments recorded healthy double-digit growth of >70% YoY. UV segment remained clear winner with highest growth of 33.5% YoY, contributing 54% to industry’s PV volume.
Despite improvement, overall demand level remained below pre Covid level for 2Ws during the month. The wholesale volume was broadly in line with the retail. We expect volume improvement to continue gradually as nearly normal monsoon and higher water reservoir would support Kharif cropping and rural recovery in coming months. Recent IMD forecasting of normal monsoon further improves rural sentiment and likely better rural economy ahead. Industry would witness steady improvement in FY24 with decent agri output and cool off in inflation, turning customer sentiment positive coupled with stable pricing environment. EV penetration should improve further in 2023.
However, near term challenges due to monsoon delay and heat wave may spoil the show and may put some challenge for automobile industry. Therefore, we would monitor the situation closely to gauge the FY24 performance for various segments of the automobile industry, which would depend on timing and distribution of 2023 monsoon.
Chemicals: The biggest fear – Is there a downcycle in global ag-chem? (Axis Capital)
Indian specialty chemical players are highly skewed to the global agri space, supplying intermediates to global innovators, who in turn sell branded/ patented products. Given elevated global channel inventory (for generics’ agri inputs), softening crop prices, and slower export growth in last few months, there are investor concerns of a possible downcycle in global ag-chem. In this note, we look at key global indicators like crop prices, inventory data etc. and try to connect the dots with industry feedback. Prima facie, we see near-term earnings risk to domestic ag-chem companies. However, risks to specialty chemical revenue growth appear limited given client commitments, contribution from new product launches etc.
Crop prices softening in sync with a decline in input prices...
After a sharp rally in CY22, crop prices have softened over the last few months across corn, wheat, soya etc. – down 15-25% from the peak, though still up ~60% vs. pre-Covid. We note that the earlier price rally as well as the current price decline is largely led by the price trend of key agri-inputs/ fertilizers, which in turn were driven by global gas prices (sharp rally earlier, decline now). Fertilizer prices have declined 50% from the peak (+20-40% vs. pre-Covid), while key raw materials for fertilizers have declined 40-70% from the peak (+15-30% vs. pre-Covid). Weather concerns have also kept crop prices elevated.
...but rising alternate usage, exports to China restrict price decline
Globally, land under acreage is on a steady decline, while improving crop productivity has been able to largely maintain the demand-supply balance overall. However, with an increased use of crops for alternatives like ethanol blending/ biodiesel etc. and a rise in agri exports to China, crop demand has accelerated, keeping agri commodities inflationary. This is also visible in rebasing for the FAO index globally – led by cereals and vegetable oils. India has also raised its ethanol blending target to ~20% by CY25 vs. 5% earlier. Such alternate uses may keep agri-commodity prices more in tandem with global oil prices structurally.
Generic agri input inventory elevated globally; India relatively better off
Commentary from global ag-chem majors suggests (a) high global channel inventory in LATAM on drought-led impact in South America and resultant slower demand, and (b) sharp decline in RM and intermediate prices in China, driving lower prices of end-products, putting pressure on distributor margin (high-cost inventory). While agri majors expect normalization in 1-2 quarters, higher probability of El Nino (70%, as per Australia's Bureau of Meteorology) may delay global demand recovery
· India is facing higher inventory as well, especially in insecticides, but empirical data suggests absolute agri input sales declined only once in El Nino over the last 2 decades - possibly on improving irrigation and higher MSPs.
· Global majors expect good demand from new product launches, but demand revival for existing products may be backended in CY23. There is weak outlook from Adama, FMC, but strong commentary from Bayer, Sumitomo, Corteva.
Indian players continue to eye market share gains – confident on growth
Being pull products, branded/ patented agri inputs may not see much demand pressure, unlike generics. Despite slower exports in initial months, most Indian specialty chemical players (supplies agri-intermediates to global innovators) remain confident of 18-20% revenue growth guidance given discussion/ commitments with global majors, with no delays or cut in capex as they aim to gain market share globally (China +1/ Europe +1).
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