Vijay Kumar Gaba

Soft underbelly of India’s robust economic outlook (AXIS Capital)

Is private consumption growth weak due to job distress or weak real income growth? Official labor surveys show that jobs are not a problem in urban India. Participation rates are stronger and unemployment rates are lower than 2019 levels. Both jobs and real incomes were improving over the past few quarters. But the latest bout of high food inflation is a setback for real income and hence broad-basing in consumption.

India’s macro position is being hailed due to its relatively robust GDP growth and well-contained risk parameters like core inflation (within the headline target band) and current account deficit (<2.5% of GDP). However, the soft underbelly of India’s otherwise robust economic outlook is weak private consumption, with growth in real terms near 3% YoY as of the Mar’23 quarter.

There is reason to be hopeful of stronger private consumption over the medium term, since the current growth is primarily led by investments and exports – meaning, stronger activity in these parts of the economy will eventually spill over to a pronounced consumption growth down the line. However, in the near term, we are still confronted with the question: what is ailing private consumption – weak real income or lack of jobs?

The official labor market survey does not indicate post-Covid stress except in a few regions. Over the medium term, labor market conditions should continue to improve as India gains export market share and businesses invest to prepare for a larger domestic economy. Meanwhile, as per a private labor survey, there is job distress among women post-Covid, especially in urban India.

The reason for urban women quitting the labor force could be due to a lack of sufficient job opportunities. On the bright side, the expansion of service exports and the jobs they are generating should improve the pace of urbanization and create opportunities for self-employed women and wage workers.

Plotting changes in urban labor force participation by states against electricity

demand and vehicle registration show a modest positive relationship between the official labor market survey results and hard economic data. This means a sustained improvement in labor force participation should tighten the labor markets, improve wage growth, and broaden the consumption recovery.

Over the next few quarters though, high food inflation trends will likely suppress the pace of broad-basing in private consumption.

India Strategy – Headwinds ahead (Prabhudas Liladhar)

NIFTY has given more than 14% return in FY24 YTD as India attracted more than USD16.5bn of net FII flows. India seems well poised for growth in longer term, however coming months will be a real test for the economy and markets given 1) EL Nino impact on crops and Inflation as food inflation has spiked to more than 7.4% and rainfall outlook remains subdued and 2) dim possibility of further cut in interest rates with some possibility of an increase in 2H. We expect markets to start factoring in political risks as election related activity picks -up with state elections in November and Lok Sabha elections in April 2024. Economy is getting a big push from Union Govt induced capex even as rural India is showing faint signs of recovery and urban discretionary demand remains tepid. Expected interest rate hike in US and its impact on INR/USD with impending political and inflation risk can impact capital flows. We believe high inflation can be a political hot potato in an election year, forcing govt to slow down capex. We remain positive on Auto, Banks, Capital Goods and Healthcare. We cut NIFTY target to 20,735 given cut in earnings (impact of floods and late Diwali in 2Q) and expect markets to consolidate ahead of 2024 elections. We advise stock specific approach and avoiding sectors / companies with weak fundamentals and lack of business moats.

NIFTY EEPS has seen a cut of 1/2.8% for FY24/25 with 14.7% EPS CAGR over FY23-25 with FY24/25 EPS of Rs1013/1138 (1024/1171 earlier). PL EPSE are 3.9% and 6.1% lower than Bloomberg consensus EPS estimates.

NIFTY is currently trading at 18.3x 1-year forward EPS, which is at 11.6% discount to 10-year average of 20.7x.

Base Case: we value NIFTY at 12% discount to 10-year average PE (20.7x) with March25 EPS of 1138 and arrive at 12-month target of 20735 (21430 based on 18.3x March 25 EPS of Rs1171 earlier).

Bull Case: we value NIFTY at 10-year average (20.7x) and arrive at bull case target of 23563 (24353 at LPA PE).

Bear Case: Bear case Nifty can trade at 25% discount to LPA (25% earlier) with a target of 17672 (18264 earlier).

Microfinance Industry Beats Covid Blues, Likely to Grow by 28% in FY24 (CARE Ratings)

The Microfinance industry (MFI) experienced a growth spurt in FY23, expanding at a rate of 37% Y-o-Y due to a favourable macroeconomic climate and renewed demand, which has led to a surge in disbursements over the past few quarters. Consequently, NBFC-MFIs have surpassed banks in the overall microfinancing landscape, constituting approximately 40% of the total outstanding microfinance loans as of March 31, 2023, compared to 34% for banks.

CareEdge Ratings anticipates growth momentum to continue, with the portfolio of NBFC-MFIs expected to grow at a rate of 28% y-o-y in FY 2024. However, increasing customer indebtedness, rising average ticket size and a gradual shift from the Joint Liability Group (JLG) model to individual loans pose the risk of overleveraging for the industry. Also, considering the inherent nature of its asset class, NBFC MFIs are highly prone to event-based risks, such as political, geographical uncertainty and susceptibility to natural calamities. Moreover, the evolving global macroeconomic environment and the continuation of support from impact funds and PE investors at the same pace will also be critical and needs to be closely monitored.

The removal of the lending rate cap by the Reserve Bank of India (RBI) has enabled MFIs to engage in risk-based pricing, which has boosted net interest margins (NIMs) and, in turn, increased returns on total assets (RoTA).

Credit costs have declined from their peak in FY 2021 but remain higher than pre-Covid levels, with a portion of the restructured book slipping into NPA. CareEdge Ratings expect NIMs to continue improving, resulting in RoTA rising to approximately 3.8% for FY 2024, aided by controlled credit costs of approximately 2.5% for the same year.

Asset quality, although on an improving trend, still remains moderate as compared to the pre-Covid level owing to additional slippages arising from the restructured portfolio. The MFI sector has taken the cumulative impact on the credit cost of around 19% of the portfolio, as on March 31, 2020, from FY21 to FY23 due to Covid-19. However, with an improving collection efficiency trend, GNPA is expected to improve to 2.0% in FY24 from a peak of 6.26% for FY22.

 

India’s Carbon Credit Revolution – Stepping Ahead Of The World (CARE Ratings)

Carbon credits serve as a potent market-driven incentive, effectively catalyzing the reduction of greenhouse gas (GHG) emissions. These credits operate within the framework of international agreements such as the Kyoto Protocol and the Paris Agreement, thriving within carbon markets where projects designed to curtail emissions yield tradeable credits. These credits, in turn, can be purchased by entities seeking to offset their own emissions, thereby showcasing their unwavering commitment to fostering sustainability. The proportion of global annual greenhouse gas emissions covered by carbon credits has risen from 5% in 2005 to 22% in 2022.

However, the attainment of carbon credits is a formidable achievement, as projects undergo rigorous evaluation by impartial auditors to ensure strict adherence to established standards. Upon successful verification, these credits are introduced into various markets, effectively directing investments toward emission reduction initiatives and sustainable undertakings, particularly within developing nations.

Beyond their symbolic significance, these credits carry tangible benefits, acting as a catalyst in propelling the global transition towards a low-carbon future. By attaching quantifiable value to emission reductions, they serve to invigorate international collaboration in the ongoing battle against climate change. The adoption and incorporation of carbon credits into our practices signify an inspiring journey towards safeguarding our planet and embracing an eco-friendly, sustainable tomorrow.

The popularity of the credits could be estimated by the fact that India alone has a market share of 17% globally with 35.94 million USD currently (the global market stands at 2 billion). By some estimates, the global carbon credits market would reach 100 billion USD by the end of 2030 as per Confederation of Indian Industry. It has also been estimated by MarketsAndMarkets that global market size would reach 1,602 billion $.

The Indian Context Of Carbon Credits In India, the carbon credit system operates primarily under the Clean Development Mechanism (CDM) of the United Nations Framework Convention on Climate Change (UNFCCC). The process of carbon credit generation and trading follows a structured flow, adhering to guidelines set by relevant regulatory bodies. The journey begins with Project Identification and Development, where projects contributing to GHG emission reduction are selected. These encompass renewable energy projects, energy efficiency improvements, and waste management schemes, aligning with CDM and regulatory criteria.

The Project Design Document (PDD) is pivotal, outlining the project's objectives, methodologies, baseline emissions, additionality assessment, and emissions reductions. Validation and Verification are critical turning points, with designated Operational Entities (DOEs) conducting independent assessments and rewarding projects that meet criteria with validation reports. Implementation and Monitoring are essential, with robust systems ensuring accurate emission reduction reporting. Verification and Certification culminate in Certified Emission Reductions (CERs) issuance based on verified emission reductions.

Carbon Credit Trading showcases CERs' value, drawing entities to offset emissions or meet regulatory commitments. Retirement or Surrender of CERs concludes the journey, ensuring the integrity of emissions accounting. The effectiveness of the system is amplified by the Types of Projects Allowed Under the Carbon Credits Scheme, including Renewable Energy Projects, Energy Efficiency Projects, Waste Management Projects, and Afforestation Projects.

The Current Regulation & Way Forward The Carbon Credit Trading Scheme (CCTS), outlined in the draft by the Ministry of Power, stands as a pivotal force shaping India's regulatory framework concerning carbon credits. A significant stride in this direction was taken through the introduction of the Energy Conservation (Amendment) Bill in 2022, which established the groundwork for the forthcoming Indian carbon credit market. The draft blueprint envisions the establishment of the India Carbon Market Governing Board (ICMGB) as the central entity responsible for the oversight and regulation of the carbon credit market.

This board boasts representation from critical ministries including Environment, Forest, and Climate Change; Power; Finance; New and Renewable Energy; Steel; and Coal. The multifaceted responsibilities of the ICMGB encompass policy formulation, regulatory framework establishment, and trading criteria definition for carbon credit certificates.

 

India IT Services (Goldman Sachs)

We see key investor debates in India IT Services to be around growth trajectory and the impact of Generative AI, where our demand trackers suggest that while revenue growth is likely to stay muted near-term on the back of macro concerns (4% YoY revenue growth in FY24E for our coverage), the market could be underappreciating the recovery and upside from FY25. We forecast a 9-10% annual revenue growth for our India IT coverage from FY25, which is a c.2x multiplier of the 5% revenue growth for GS covered global companies in CY24 (a sharp pick-up vs 1% growth in CY23).

In our view, this growth will be aided by the pent-up demand (order book has remained robust), initial tailwinds from Generative AI (our differentiated analysis suggests IT Services companies playing a meaningful role in enterprise integration), and continued shift to cloud and managed services (cloud penetration is only c.30%.

Indian IT Services companies have doubled their market share in the last 10 years (to 6.2% of the global IT spending in CY22), and given the structural advantages of a large, skilled and low-cost workforce, coupled with a diversified geographical footprint, we expect Indian IT firms to continue gaining share.

We expect operating profit growth, at 12-15% over FY25-26E, to be faster than revenue growth, as we see presence of multiple margin levers and forecast an expansion in margins for all the companies within our coverage. While India IT is trading at premium valuations vs its last 10Y average (in line with last 5Y), we argue that higher multiples are warranted as we view growth in IT/Tech spends as an industry perennial with a lower susceptibility to disruptions, and shareholder payouts having meaningfully improved over the decade.

In our view, what is different this time vs previous downturns is that order book for most IT Services companies have remained strong, as enterprises hold back on actual spend (which translates into IT revenues) until more clarity emerges on the macro.

Our economists’ recently lowered the probability of the US economy entering a recession in the next 12 months to 20%, with the team’s analysis of recent data suggesting that bringing inflation down to an acceptable level would not result in a recession; the US geography makes up c.60% of India IT Services revenues, and improving economic outlook in the region should help drive higher technology spends in our view.

In addition, aggregate data from global GS covered companies, which has a high correlation with IT revenue growth (c.2x historical multiplier), shows revenue growth of global enterprises picking up to 5%/6% in CY24/CY25, after a 1% growth in CY23.

We expect this acceleration in enterprise revenue growth to translate into c.10% annual revenue growth for our India IT Services coverage in FY25/FY26, after a 4% YoY growth in FY24.

However, we expect weakness in the communication vertical to persist for longer given pressures on telco opex/capex; we note that TechM has the highest exposure to this vertical at 38% based on 1QFY24 revenues.

Our global analyst teams expect enterprise clients to increase cloud computing spends in CY24, further aided by deployment of Generative AI (link). Adoption of cloud, and the ensuing multitude of applications created for the cloud, has a positive revenue implication for IT services companies. We forecast a 9%-10% annual revenue growth for India IT beyond FY24, and share of IT/technology in enterprises’ budgets continuing to rise.

Consumer durables - Hopes pinned on 2HFY24 (JM Financials)

Electrical Consumer Durable (ECD) companies’ revenue grew by 16% YoY (+13% 4-year CAGR) in 1QFY24, largely on the back of healthy growth in the B2B segment (particularly cables) while demand environment in the B2C segment remained subdued due to soft summer/unseasonal rains and consumption slowdown in general. Although gross margin improved on the back of a benign RM envionrment, that improvement was not reflected in operating margin due to a) high competitive intensity, and b) sustained spend on long-term strategic initiatives (A&P, GTM, etc). We continue to be positive on the space from the medium- to long-term perspective given macro tailwinds (low penetration in some categories) and category expansion opportunities. Our top picks - Bajaj Electricals, and Havells.

B2B drives revenue while B2C remains subdued in 1QFY24: ECD companies’ aggregate revenue witnessed healthy growth of 16% YoY (+13% 4-year CAGR; -4% QoQ). This was largely on the back of healthy growth in the B2B segment while demand environment in the B2C segment remained subdued due to consumption slowdown and soft summer. ECD segment saw another quarter of modest revenue growth while wires & cables continued to outperform, growing in double digits aided by strong volume growth.

Unseasonal rains and consumption slowdown impacted demand in ECD segment: ECD segment saw another quarter of modest revenue growth of 3% YoY (+8% 4-year CAGR) impacted by a) weak demand environment, and b) soft summer due to unseasonal rains. Moreover, fans segment continued to witness volatility because of BEE energy rating transition. Revenue grew 8%-16% YoY (excluding Havells/Symphony, which saw 13%/17% decline). Low volume, high competitive intensity, high discounting on non-rated fans inventory and liquidation of high-cost inventory kept margins under pressure.

Cables & wires revenue outperformance led by volume: Cables & wires segment revenue grew 30% YoY (+18% on 4-year CAGR); copper prices fell 5% YoY, implying strong volume growth in cables and wires. Within this, we believe industrial cables is growing at significantly faster pace compared to consumer wires. Healthy demand from government as well as infrastructure side aided volume growth. With most of the high-cost inventory liquidated, EBIT margin improved across companies

RM prices soften in 1QFY24: In 1QFY24, prices of key commodities fell by 5-36% over 1QFY23 but remained high compared to pre-Covid levels. However, amidst a weak demand environment, brands in an attempt to stimulate demand offered schemes/discounts leading to heightened competitive intensity, which put pressure on margins.

Maintain positive outlook from medium-term perspective: Notwithstanding near-term pain (weak consumer demand; fans energy rating transition) the industry remains optimistic of demand recovery given a) expectation of strong H2, b) recovery in rural markets, and c) stability in the input cost environment. We remain positive from the medium- to long-term perspective given macro tailwinds, low penetration for some of the categories, and category expansion opportunities for companies.

Farm Inputs & Chemicals - 2Q to be largely similar to 1Q (IIFL Securities)

1QFY24 turned out to be a shakeout quarter for Indian Chemical manufacturers, both for bulk chemicals and specialty basket. Agrochemical companies had a slow start in 1Q, owing to delayed onset of monsoon and uneven rainfall that impacted sowing pattern. Export growth got impacted as well. The common trend across companies was a steep product-price decline due to excess channel inventory — leading to demand slowdown. The management across companies commented on the customers postponing purchases because of extreme volatility in prices and continue to be in a wait-and-watch mode.

Downgrades by global agchem majors: Global crop protection majors have downgraded their revenue for CY23 and expect 2H’23 to remain muted. Recovery is expected from CY24. In 1Q, domestic crop protection revenues for PI, UPL, BASF and Rallis were under pressure. With rainfall improving, sowing has picked up in 2Q and should trigger agrochemical liquidation/consumption.

Washout quarter for Chemicals: In 1QFY24, bulk chemicals reported weak performance, on the back of steep decline in key product prices. Soda ash was an exemption as global prices stayed firm, while domestic prices were under pressure. Domestic prices of soda ash, caustic soda, refrigerants and PVC continued to be under pressure, with Chemplast Sanmar reporting Ebitda loss.

New capex announcements take a pause: Barring Deepak Fertilisers that announced Rs19.5bn capex for setting up weak nitric acid & concentrated nitric acid plant, the new capex announcements by chemical companies were muted during 1Q. However, the companies remained committed on their ongoing capex and were optimistic about recovery during 2H’24.

Resurgence of malls (Kotak Securities)

Immense scope for retail growth in India; occupancy levels at 94% India has a per capita retail space of <1 sq. ft, much lower than developed economies such as the US (23.1 sq. ft) and Canada (16.4 sq. ft), as well as some of the developing economies/cities such as Beijing (5.2 sq. ft), Jakarta (4 sq. ft) and Hanoi (3.5 sq. ft). The undersupply, coupled with rising income levels, offer a long runway of growth for retail spaces in India. The Indian retail sector has seen healthy leasing momentum after Covid, with 4.2, 5 and 2.8 mn sq. ft of (grade-A) gross leasing in CY2021, CY2022 and 1HCY23, respectively. The momentum has partly been aided by the churn of existing tenants. The demand for smaller spaces (<2,000 sq. ft) constituted 59% of overall demand, followed by 2,000-5,000 sq. ft spaces (28% share). With limited new supply additions of 4.4 mn sq. ft in the last 2.5 years, occupancy levels have risen to 94% as of 1HCY23 from 87-88% in CY2020.

Tier-1 cities lead the way, tier-2 cities catching up Of the 51 mn sq. ft of Grade-A stock in tier-1 cities in India, NCR has a 22% share, followed by Mumbai (21%) and Bengaluru (19%). There is an additional 25 mn sq. ft of under-construction retail assets, expected to be completed by 2027—North and West India should lead the new mall supply in the next few years. Key malls in tier-1 cities have seen a 12% yoy uptick in rentals in 2QCY23, which has been aided by an 18% yoy consumption increase. Among the tier-2 cities, top-5 cities (Lucknow, Ahmedabad, Chandigarh, Indore and Kochi) account for 57% of the total tier-2 stock, with another 5 mn sq. ft supply coming up in 4-5 years. These top cities have seen a rental increase of 13-17% in 4QCY22.

Healthy demand outlook to aid rental appreciation With rising income levels and spending power, the demand for luxury retail is expected to remain strong across tier-1/2 cities in India. Anarock expects a 17% CAGR in sales volumes, reaching US$136 bn by 2028, and 10-20% annual rental appreciation for key malls in India. The adoption of technology will enhance the customer experience, while collaboration in the retail space will help in fortifying the business, and also allow entry into newer markets, thereby increasing customer outreach. Institutional investments in the retail space should rise going forward, following US$1.5 bn of investments in 2019-22.