Vijay Kumar Gaba

Banking system liquidity deficit worsens (Miscellaneous)

As per the latest RBI data, liquidity deficit as measured by fund injections by the Reserve Bank of India (RBI) into the banking system was INR1.47trn as of September 18, the highest since April 2019.

The Reserve Bank of India (RBI) injected Rs 1.47 trillion on Monday and Rs 1.46 trillion on Tuesday. Market participants believed that the disbursement of Rs 25,000 crore as the second tranche of incremental cash reserve ratio (I-CRR) will not be enough, and the liquidity might tighten further to Rs 2 trillion in short term due to tax outflows and arrival of the festival season.

“For now it looks like going into the festival season there would be more outflow and cash leakage from the system. It will lead to higher deficit for the banking system,” said Naveen Singh, head of trading and EVP at ICICI Securities Primary Dealership. “There are other factors at play. We are not seeing much dollar flows coming into the system and the RBI has been continuously defending from the other side. We are not seeing any inflow from the Fx (foreign exchange) side, and the RBI is not in the mood to add durable liquidity in the system. Gradually, the liquidity deficit might go up to Rs 3 trillion, but not in the immediate future,” Singh said. (Business Standard)

Advance tax payments took place last week, while outflows towards Goods and Services tax will be completed by Wednesday, with bankers estimating aggregate outflows of up to 2.50 trillion rupees. The impact has magnified as the twin outflows have occurred in the same reporting fortnight, at a time when a chunk of the money is not available for use as it is blocked in the incremental cash reserve ratio (I-CRR). Moreover, "another drain on rupee liquidity could be from RBI's (Reserve Bank of India) FX intervention if depreciation pressures on the rupee persist," said Gaura Sen Gupta, an economist with IDFC First Bank. (Zawya.com)

The RBI had decided on September 8 to discontinue the I-CRR by October 7 in a phased manner. Out of the total I-CRR maintained, 25% was disbursed on September 19, another 25% on September 23, and the remaining 50% will be released on October 7.

Growth and inflation upgrade (MOSL)

For the past nine months, the fears of slowdown have been totally unfounded. India’s real GDP growth was better than expected (at 6.1% YoY) in 4QFY23 and then improved in line with expectations (at 7.8% YoY) in 1QFY24. Not only India, the US economy too has been much more resilient than our predictions at the beginning of the year.

In view of this, we upgrade India’s real GDP growth projection to 6.0% YoY for FY24 from 5.6% YoY anticipated in Jun’23 (and vs. 5.2% YoY in Mar’23). We, however, keep it broadly unchanged at 5.4% for FY25E (projected at 5.5% in Jun’23). Further, nominal GDP growth forecast is also kept unchanged at 7.8% for FY24, since higher real growth is entirely offset by a cut in GDP deflator forecast. It is likely to improve ~10% for FY25, slightly lower than earlier projection.

After lower-than-expected retail inflation in Apr-May’23, CPI inflation has been much higher in 2QFY24 led by vegetables, pulses and spices. Accordingly, we raise our CPI inflation projection to 5.6% for FY24 (from 4.3% earlier) with a slight upward revision in FY25 (to 5.3% from 5.0% earlier). Accordingly, due to downward revision in GDP deflator, the nominal GDP growth forecast is kept unchanged at 7.8% for FY24, and ~10% (from 10.5%) for FY25.

Rising crude adds to upside risk to external imbalances (JM Financial)

India’s merchandise trade deficit widened to USD 24.2bn in Aug’23 (USD 20.7bn prior). Although August marked a moderation in decelerating trend in trade activity during last four months, however it is too early to call it bottoming out of the weakness in overall trade.

Manufacturing PMI indicated improved export demand, which we believe will reflect in India’s exports data in the forthcoming months. Services exports declined for the first time, this is in-line with the weak guidance given by the Indian IT companies. As crude oil prices are expected to remain elevated in the near term, it adds to the upside risk to India’s external imbalances. We re-iterate our expectation of CAD at 1.4% of GDP for FY24.

Trade imbalance widens further: The sharp deceleration in trade activity during the past four months, moderated in Aug’23. However the decline in exports (-6.9% YoY) was sharper than in imports (-5.2% YoY). Strong sequential gains in imports (10.8% MoM) vs in imports (6.9% MoM) widened the trade deficit further to USD 24.2bn in Aug’23 vs USD 20.7bn in the previous month. On a FYTD basis (Apr-Aug), trade deficit of USD 101bn in FYTD24 is lower than the levels seen in FYTD23 (USD 113bn).

Flat core exports; First decline in services exports: At USD 34.5bn, India’s exports continued to decelerate with strong sequential gains (-6.9% YoY, 6.9% MoM). Non-oil exports remained flat (0.2% YoY) however the fall in oil exports was sharp (-31% YoY). India accounted for 40% of global rice trade in 2022, the ban on exports of parboiled and broken rice was supplemented with exports duty (20%) which reflected in the sharp decline (-10% YoY, -4% MoM) in rice exports. As per the findings of the manufacturing PMI, export orders have been robust even in Aug’23. Firms reported incremental orders from Bangladesh, China, Malaysia, Singapore, Taiwan and US which we believe should reflect in the trade data of forthcoming months.

While on the services front, exports (prelim) declined (-0.4% YoY) for the first time in Aug’23 (Ex 5) after showing signs of moderation since Apr’23. Since software forms major portion of our services exports, this fall can be attributed to the reduced demand for software exports, as reflected in the moderating deal wins by Indian IT companies.

Continued deceleration in imports: The deceleration in imports continued for eight months in a row, however recorded a consistent growth of 10% on a 4yr CAGR. Sequential uptick in Aug’23 (10.8% MoM) is unlikely to sustain. Close to one fourth of India’s imports consists of oil imports; the sequential gain in oil import (12% MoM) is on the back of an uptick in crude oil prices. We expect that the crude oil prices to remain elevated in the near term which will exert pressure through rising oil imports. Coal imports (-43.5% YoY, -6% MoM) are at its lowest in last two years (USD 2.6bn), which is reflecting the downtrend in coal prices after it peaked in May’22. At USD 4.99bn, Gold imports (38.8% YoY) were the highest in last fifteen months. Imports of machinery and electronic goods have been consistently growing with 4yr CAGR of 7% and 10.3% respectively. But with the ban on imports of laptops and PCs w.e.f 1^st November, it is highly likely that imports of electronic goods will moderate.

Crude oil prices expected to remain elevated; CAD expected at 1.4% of GDP: Rising crude oil price is capable of impacting India’s external balance, India crude oil basket has risen sharply by 8% to USD 86.4/bl in Aug’23. Brent crude prices breached the USD 94/bl mark after OPEC’s prediction of supply constraints in the oil market, estimating an oil deficit of 3.3mn barrels (mbpd) while IEA estimated a moderate 1.1 mbpd deficit during Q3FY24. We expect these prices to remain elevated in the near term as this spike is not demand-led but it is engineered through curtailing supply by oil producing countries. On the demand side, we expect China’s demand to come online in a gradual manner. Hence any expectation of pull back in prices will only be on the back of increased supply. Our expectation of CAD at 1.4% of GDP in FY24 would be at risk if monthly run rate of trade deficit breaches USD 20bn mark (Currently at USD 20.2bn).

India NBFCs: Funding cost likely to peak out by 3QFY24 (Nomura Securities)

We take a deep dive into the liability profiles of India NBFCs in light of regulator (RBI) caution on NBFCs’ elevated reliance on bank funding (link ) and further increase in yields across different constituencies by ~10-15bp since 1Q24. Our analysis of rates and liability mix of NBFCs shows that cost of funds (CoF) should peak out by 3Q24, after rising ~30-40bp from 1Q24 levels. This quantum of increase is higher than guidance given by most of the NBFCs. Further, the benefit of policy rate cuts, if any in 1HFY25, on cost of funds for NBFCs should be visible only in 2HFY25.

NBFCs’ reliance on bank funding remains at elevated levels: As of FY23, bank funding to NBFC/HFCs constituted ~57%/44% of their total borrowings. Further, bank loans to NBFCs/HFCs have almost tripled to ~INR13.7tn in Jul’23 at a CAGR of 21% vs 12% for overall bank credit, with PSU banks having 65% market share in it. Bank funding to NBFCs/HFCs reached ~64% of their net worth in 1Q24 (PSU banks: 102%) vs 35% in FY17. We expect NBFCs’ reliance on bank funding to come down in coming quarters, driven by a pickup in alternate sources of funding (e.g., bond market/securitization).

Increase in CoF for NBFCs has been lower than broader increase in interest rates: During 4Q22-1Q24, when repo / 1Y T-bill /1 Y Corp AAA yield inched up by 250bp/242bp/248bp, most of the NBFCs/HFCs barring CIFC and SBI Cards saw a <100bp increase in funding cost vs a >100bp increase for large banks. Compared to CoF of 3QFY19, when the policy rate was at similar level of 6.5%, cost of funds for NBFCs are still lower by up to ~200bp.

Hence, we believe it is quite evident that repricing of NBFC liabilities is still underway, as it happens with a lag both in the upward and downward rate cycles.

Cost of funds could rise another ~30-40bp from 1Q24, and likely peak out in 3Q24: We expect CoF for NBFCs could rise another ~30-40bp from 1Q24 before peaking out in 3Q24. This increase would be driven by 1) another ~10-15bp increase in yields across buckets since 1Q24; 2) a further increase in cost of NCDs, as coupon rates for maturing NCDs in remaining FY24/25 (~25%-50% of 1Q24 outstanding NCDs) are ~100-200bp lower than current yield; and 3) MCLR-linked bank loans are still getting repriced upwards due to a lag. This CoF increase of ~30-40bp during 1Q24-3Q24 is higher than the guidance given by most of the NBFCs and the average 20bp increase built into our current estimates. Hence, there could be ~1-5% risk to our FY24F EPS coming from pressure on CoF.

Benefits of potential policy rate cut in 1HFY25 to accrue only in 2HFY25: We expect benefit of any policy rate cut in 1HFY25 on funding cost of NBFCs to accrue only in 2HFY25. Bank funding forms >50% for NBFC liability side. While repo/T-bill linked bank borrowings will get repriced downward immediately, it will take time for MCLR-linked bank borrowings to reprice downward as well. Further, we estimate that ~60% of a repo rate change gets transmitted into MCLR. On the bond side, NCDs maturing even in FY25 has lower coupon rate compared to current yield which is already factoring in repo cuts.

SBI Cards/Five Star/CREDAG to benefit the most purely from CoF/spread perspective: Only from funding cost and spread perspective keeping other things constant, SBI Cards (SBICARD IN, Reduce), Five Star (FIVESTAR IN, Buy) and CREDAG (CREDAG IN, Buy) should benefit the most in a declining rate cycle as only ~23%/27%/40% of their borrowings are fixed, while the entire loan book is fixed in nature. We expect LIC HF (LICHF IN, Buy) should be negatively impacted the most, as ~43%/99% its borrowings/loans are floating in nature. Having said that, cost of funds is only one of many factors we look at to arrive at our rating on various stocks. 

Defense stocks: No defense against any potential negatives (Kotak Securities)

A reverse valuation exercise of the major listed defense stocks implies that they will capture the bulk of defense capex in the future, which is contrary to historical trends. Indian defense stocks have witnessed an explosive rally in their stock prices over the past few months on expectations of strong spending by the government and indigenization. We concur with the growth part, but are less sure about the implied profitability assumptions.

Indian defense sector is showing signs of exuberance

The Indian defense sector has witnessed a sharp rerating and delivered massive returns over the past 3-6 months on (1) expectations of large spending by the government for an extended period of time and (2) steady increase in indigenization. Large deal wins of companies boosted investor sentiment. In our view, the stocks largely factor in the aforementioned positives, but not potential risks of (1) delays in ordering and (2) lower profitability.

Listed defense companies will need to execute Rs1.3 tn of defense orders PA

Our reverse valuation analysis based on the current market capitalization of a basket of major defense stocks suggests that these companies will need to execute around Rs1.4 tn of defense orders annually to justify their current stock prices.

For context, these companies combined revenues of Rs625 bn in FY2023. Our assumptions bake in the average margin profile for these stocks (see Exhibit 5). We would note that we have not considered a number of private companies (difficulty in segregating market cap. pertaining to the defense segment alone) and government organizations (unlisted) in this exercise.

Defense capex for domestic procurement at Rs1.6 tn in FY2026E

India’s total defense capex increased at a CAGR of 9% over FY2017-23, resulting in a steady decline in its share of overall government capex. We note that India’s defense imports were around Rs400 bn in FY2019-20. We estimate a market opportunity of Rs1.6 tn for domestic procurement by FY2026 based on our assumptions of (1) strong growth in overall defense capex and (2) low growth in imports due to indigenization.

As such, the basket of defense stocks will need to capture a significantly larger share of India’s domestic defense budget compared with history, even as more private companies are entering the sector.

Profitability may be bigger challenge for companies and investors

We are not sure about the future profitability of the defense companies, as (1) their current profitability seems to be on the higher side, (2) the defense industry could become more competitive with the entry of private sector players and (3) government may tighten procurement terms (monopsony buyer), as domestic production capabilities scale up over time. We would note that lower profitability assumptions will imply much higher implied revenues, which may not be feasible in the context of the market opportunity.

Oil & Gas - Fall of the last bastion? (Prabhudas Lilladher)

We remain cautious on PNGRB’s decision to implement common carrier for product pipelines due to the challenge it poses for OMCs. OMCs own ~90% of marketing infrastructure including pipelines, marketing terminals and depots. While pipelines constructed under bidding process already have provisions for common carrier, older pipelines are still lacking behind.

Overall utilization of product pipelines at 68% in FY23 does present an opportunity to other interested parties including private players. Pipelines provide the cheapest method of transportation, as next best coastal is ~46% costlier while roadways are even twice as costly. In addition to the cost of creating new infrastructure, uncertainty of obtaining right of using land for laying pipelines remains a key challenge limiting expansion of private players in product retailing. However, post implementation of unified tariff of natural gas pipelines, we expect PNGRB to open petroleum product pipelines, a step that may sound like fall of the last bastion for OMCs.

Although HPCL/BPCL/IOCL are trading at 0.9/1.2/0.8x FY24 PBV, a look at their long term valuation charts suggests that they could still correct from here. More importantly, the common carrier access of product pipelines may result in sustained de-rating of these stocks even lower.

Almost all marketing infrastructure owned by OMCs: India has total ~22,500km of product pipelines and ~5,000km of LPG pipelines, almost all owned by OMCs. There are 310 marketing terminals/depots, 91% of which are owned by OMCs. Out of 283 aviation fuel stations, 89% are owned by OMCs and 90% of 87,458 retail outlets are also owned by OMCs.

Pipelines are the most critical part of the supply-chain as their construction takes long time. Just to share a perspective, Kochi-Bangalore gas pipeline has still not been completed even after a decade of commissioning the Kochi LNG terminal.

Common carrier access could break the oligopoly: Private players have largely remained at bay (6-7% market share in sale of petrol/diesel in FY23) given 1) pricing interventions in petrol and diesel resulting in non-competitive environment, and 2) high cost plus time involved in laying marketing infrastructure alongside risk associated with it. However, at times OMCs have bled in terms of losses in marketing segment due to inability to pass on high cost to consumers, over a longer period of time; they have shown resilient profits.

The common carrier access in product pipelines, could thus, lower the entry barrier for private players, thereby challenging dominance of OMCs over a period of time.

Marketing margins losses continue: Average HPCL and BPCL returns have under-performed Nifty by 15/7/6% in past 3/6/12month, while IOCL’s performance has given 8% underperformance against Nifty in 3 months (overperformed 3/16% in 6/12m) due to inability of raising retail prices amidst rising crude oil prices. As per our calculation, the gross marketing margin on petrol and diesel stand at Rs5.5lit and loss of 3.8/lit respectively in Sep’23 compared to Rs10.6lit/10.2/lit in 1QFY24 and Rs8.4/2.7/lit in 2QFY24YTD. 

The latest FOMC decision may be influenced by the recent evidence showing that the hikes already implemented are beginning to impact inflation, despite strong economic outcomes. Notwithstanding, its latest decision to pause, 12 out of 19 FOMC members felt that one more rate hike would be needed in 2023 before the current rate hike cycle ends, as inflation is still running above the Fed’s 2% target. The persistent strength in the economy requires caution as inflation might bounce back again.

In particular, FOMC members sounded cautious about the tight labor market, as wage growth has so far accounted for the bulk of price pressures in the service sector,

Higher for longer

Speaking at the post-meeting press conference, Fed Chairman Jerome Powell, cautioned that "Holding the rate doesn't mean we have reached the stance we seek”. The committee projects the median Federal Funds rate at 5.1% in 2024, higher than its June estimate of 4.6%, suggesting that rates will remain higher for longer than earlier projections.

The FOMC members now see a couple of rate cuts in 2024, against four rate cuts projected previously. For 2025, interest rates are expected to drop to 3.9%, well above the 3.4% previously projected, and fall further to 2.9% in 2026.

Economic growth forecast upgrade

Taking cognizance of the persistent strength in the economy, FOMC upgraded its economic growth forecast for 2023 to 2.1% from the previous 1% rate projected in the June 2023 meeting. The growth forecast for 2024 was also raised to 1.5% from the previous 2.1%.

Yields spike, curve inverted

Post the announcement of the FOMC decision, the US bond yields rose to cycle highs. The benchmark 10-year G-Sec yields ended at 4.395%, while the more sensitive 2yr yields were at 5.17%. The US treasury bond yield curve is now sharply inverted, indicating market expectations of much slower growth, if not full-blown recession in the offing.

Equities correct led by big Tech

The US Equities corrected over 1% from their intraday highs, post the FOMC decision. The fall was led by the growth sectors, especially the big technology companies like Alphabet (-3%), and Meta Platforms (-1%) and Apple (-1%).

Mad (-cap.) dash (Kotak Securities)

We see limited point in trying to find fundamental reasons behind the steep increase in stock prices of several mid-cap. and small-cap. stocks. There is no meaningful change in the fundamentals of most companies; in fact, they have worsened in many cases. The primary driver of the rally appears to be irrational exuberance among investors, with high return expectations (and purchase decisions) being driven by the high returns of the past few months.

Varying degrees of exuberance in the mid-and-small-cap space

We do not see many fundamental reasons for the meteoric rise in the stock prices of many mid-cap. and small-cap. stocks in the past few months. The fundamentals of most sectors have not changed much. However, market sentiment is quite exuberant, based on

(1) steep increase in the prices of many mid-cap. and small-cap. stocks;

(2) large inflows into mid-cap. and small-cap. mutual funds; and

(3) huge number of new retail participants in the mid-cap. and small-cap. funds. The strong performance of the mid-cap. and small-cap. indices has possibly pushed up return expectations among retail investors.

Stocks with great history (but potentially less favorable future)

Most of the traditional favorite mid-cap. stocks of institutional investors in the broader ‘consumption’ sector have been large laggards in the ongoing mid-cap rally, given weak consumption demand in general. However, the valuations of these companies have stayed high or gone to historical-high levels due to earnings cuts. We see risks of (1) lower profitability and (2) lower valuation multiples due to weakening business models (erosion of business moats of brand, distribution market structure and product).

Stocks with great purported future (but mediocre history)

Many of the new favorite mid-and-small-cap. stocks of institutional and retail investors are in the broader ‘investment’ sector (capital goods, defense, EMS, railways, real estate, renewables). These stocks have delivered eye-popping returns in the past 3-6 months, led by the broader ‘investment’ narrative.

We expect a decent investment cycle, but we are not sure about the quality of many of the stocks given their historical weak execution and governance track-records. In addition, many of these sectors fall in the B2G (business-to-government) or B2B categories, which raises issues around execution and profitability both. We believe that market expectations for both revenues and profitability may be too optimistic across these sectors.

Stocks with no history or possibly future (but why not?)

The last lot of the new favorite mid-and-small-cap. stocks fall in the dubious category of ‘turnaround’ stories. Many of these companies have been through serious operational and financial challenges (including bankruptcy) in the recent past, but the market has high hopes of these companies doing well in the future. We are not sure of the basis of the market’s confidence.

Strategy - Nifty Weight Analysis (Phillips Capital)

A snapshot

·         Index leader – banks – near its peak weight in August 2023 (18.4%/25.4% in N-500/N-50 adjusted for HDFC Ltd).

·         Highest weight increased in investment-oriented sectors, driven by industrials and metals. Basically, our favourite infra plays – industrials, metals and cement – have moved up strongly, but are slightly lower than peaks seen in 2010-15.

·         IT is currently below pre-covid levels.

·         Staples lost 200-250bps from its peak in 2020, but gained c.150bps since 2022.

·         Discretionary (ex-auto) is nearing its highs of 2020.

·         Automobiles’ weight up from covid lows, but still quite low vs. pre-covid levels.

·         Pharmaceuticals gained weight in 2019-21; currently stagnant at 2022 levels.

·         Oil & gas down c.200bps from its 2022 peak.

Financials – gains due to financial penetration

In N-50, financials have been leaders with banks being major contributors, gaining c.7% in the last 10 years (between March 2013 and 2023), plus c.4% in FYTD24 (due to the HDFC merger). Since 2014, in N-500, the sector’s weight increased by 5% to touch 22.4%.

Banks: The sector’s weight increased steadily in the past decade, especially in the N-50, to 31% from 20%; excluding HDFC Ltd’s merger impact, to 25.4%, up c.5%. Banks’ weight decreased during the onset of covid in 2020, while it has risen in the N-50 but is now stagnating at around 26%.

NBFCs: The sector has remained in focus in the last decade, gaining due to greater financial penetration and expanding economy, up almost 3-4% in terms of Nifty weight. Its weight increased consistently till 2021 from 2016, and declined gradually after that, seeing the highest drop in July 2023 due to the HDFC merger, excluding which, the segment’s weight is near all-time highs.

Investment-oriented sectors – highest gainers post covid

The weight of investment-oriented stocks in N-50 and N-500 was declining since 2014, but increased gradually yoy post covid. Their weight in the N-500 grew to 13% in FY23 from 9% in FY20 while in N-50, it increased to 10% from 7.5%, with a major rise coming from the industrials and metals & mining sectors.

Industrials: Its N-500 weight almost halved by 2020 (from 2014) to 3.6%, but doubled to 6.0% from FY20; it increased substantially post FY22 due to capex, infrastructure, and economic expansion. In the N-50, the sector saw its weight falling to 2.7% in FY21 from 7.7% in FY11 (led by change in constituents – then, BHEL, Suzlon, ABB, Siemens were a part of N-50 while at present it is only L&T). Weights rebounded by 110bps to 3.8% in FYTD24 from FY21, with major increase taking place after FY22.

Metals & Mining: Just like industrials, its N-500 weight declined to 2.3% in FY20 from 4.9% in FY14; then, spiked to 4.4% in FY22 due to a significant rise in demand after covid and sharp surge in prices. As prices corrected, so did the sector’s performance in FY23, losing weight by 40-100bps. In the last few months, it has picked up (in line with our expectations). In N-50, the trend and weight have remained almost same. In FYTD 24, the sector’s weight almost doubled to 4.3% in FYTD24 from a low of 2.2% in 2020.

Cement: Its N-500 and N-50 weights have been stable, at 2-3% since 2014 (after a slight dip in 2018-20). In the last two years, the weight has been stable near 2%, and we see an upside.

Consumption oriented – higher discretionary spend driving share

The weight of consumption-oriented stocks in the N-50 / N-500 was in the 15-21% /18-23% range since 2015. The sector gained momentum during the onset of covid, slowed over the next two years, but weights have increased lately, in 2023. Consumption’s weight in the N-50 / N-500 fell to 15% / 18% in FY22 from 21%/ 22% in FY14, but increased to 19% / 21% in FYTD24 due to staples and auto & ancillary.

Staples: The sector saw mixed sentiment in different periods, resulting in many swings in the last decade. Overall, its weight in the N-500 / N-50 declined to 6.4% / 7.2% in 2022 from 9.6% / 10.6% in 2014. It increased FTYD24 by 140/210bps for N-500 / N-50 from 2022 levels, led by price hikes amid softening commodity prices, downsizing product packets, and slight demand recovery – driven by increasing disposable income and emerging channels such as modern trade and e-commerce.

Discretionary: In the past decade, the sector attracted investor attention, resulting in an increase in weight by c.300 (also led by new listings) in N-500 and 100bps in N-50 during 2014-20. During the onset of the pandemic, it remained in focus, but after April 2020, its weight stayed mostly flat. The weight has increased in N-500/ N-50 to 6.2%/ 3.2% in FYTD24 from 3.4%/ 2.0% in 2014.

Autos & Ancillary: The sector’s weight has reduced from 2017 to 2022, halving since 2017. N-500 / N-50 weights reduced to 5.2% / 4.8% in 2022 from 9.9%/11.0% in 2017. However, recently (in the past 8 months), its weight increased by almost 100bps due to the rising standard of living and disposable income, robust demand for PVs/ CVs/EVs, government PLIs, and increasing government focus on infrastructure development.

IT and other services – global economy dragging the sector

Nifty weight of ‘IT and Other Services’ grew drastically from 2017 to 2022, gaining 450bps in N-500/N-50. During the same period, while the IT sector gained, Telecom and Services sector remained flat.

IT: The sector saw enormous growth in index weight during 2017-22; N-500/N-50 at 14.7%/18.2% from 9.8%/13.0%. A strong bounce in IT came after covid, as more businesses rushed to adopt digitization, enhancing demand for IT software and solutions. However, weight started falling in the second half of 2022 due to the global economic slowdown.

Telecom & Media: The sectors’ weight consistently declined since 2015, but increased slightly during the onset of the pandemic in 2020. It has been inching marginally higher since FY22.

Services: The sector’s weight remained flat for N-500 / N-50 at c.2%/1% since 2017.

Pharma & Chemicals – a mixed bag

The Pharma & Chemicals’ N-500 / N-50 weight was flat at c.7% / 3% between FY18-19. In N-500, its weight increased mostly after the pandemic until 2022, and stagnated thereafter. However, within this, the pharma sector’s weight grew majorly in 2020, while the chemicals sector’s weight grew majorly in 2021 and 2022. Currently, both sectors’ weights are below their all-time highs.

Pharma and Healthcare: The pharma sector’s N-500 weight remained flat at c.4.7% in FY18 and FY19. During the pandemic, in N-500, it increased by 90bps in 2020 from 2019 levels, while N-50 weight increased by 160bps in 2022 from 2019 levels. Currently, the sector’s weight in both indices is near its highest since covid, as it gained momentum recently due to improvement in business and earnings.

Chemicals and fertilizers: The sector’s weight in the index was stagnant during 2018-20, before rising in FY21. Its N-500 weight remained flat at 2% from FY17 to FY20. But in 2021, a sharp increase in global demand for speciality chemicals and a rise in prices propelled its weight. Currently, the sector’s weight in both indices is down (from 2022 highs) due to weak domestic demand, subdued global economies, and declining commodity prices.

Energy sector – almost flat!!

The energy sector’s weight has remained almost flat since 2017 with a sharp increase in 2022 due to high demand and low production. In the N-500, its weight increased slightly to 13.5% in FY22 from 11%.5 in FY17 and is currently at 10.8% in FYTD24, while in the N-50 its weight increased slightly to 14.9% in FY22 from 13.7% in FY17 and is currently at 12.9% in FYTD24.

Oil & Gas: The sector saw a slight increase in index weight majorly in FY16 and FY17. Its N-500 weight increased to 8.6% in FY17 from 6.8% in FY15, while in the N-50 it increased to 10.8% from 8.2% in the same period. Current weight is 8.2% and 10.7% in N-500 and N-50 respectively.

Power: The sector has seen a consistent decline in weight from FY17 to FY21, with negligible growth in recent months. Current weight is 2.7% and 2.2% in N-500 and N-50 respectively.

Corporate profit cycle enters value-creation zone (ICICI Securities)

RoE of NIFTY50 index is rising above the 15% mark after a decade and we expect it to expand to ~17% by FY25E, thereby clearly entering the value-creation zone, driven by improving demand environment for capital-intensive and cyclical stocks. P/B ratio of NIFTY50 index is at the long-term average mark of ~3x and a rising RoE is likely to boost it driven by the aforementioned stocks. A similar trajectory was observed between 2002-07 when cyclical recovery in the economy driven by the capex cycle boosted RoE to >25% and P/B >5x. Currently, as capacity utilisation is moving above the 76% mark, we believe the benefits of operating leverage have started to creep in, although corporate re-leveraging cycle is yet to begin. High-frequency indicators corroborate rising utilisation levels.

NIFTY50 index enters value-creation zone after a decade

Stocks that are likely to improve their RoEs over FY23 to FY25E and transition into value-creation zone include capital intensive and cyclical sectors such as auto, capital goods & infrastructure, utilities, telecom, commodities and financials. The RoE trajectory provides a sense of ‘déjà vu’ of what happened in the pre-GFC era between 2003-2007 when stocks within capital-intensive and cyclical sectors like L&T, BHEL, Bharti, NTPC, Hindalco, M&M,ACC, Reliance and DLF transitioned from sub-14% level RoE to value-creation zone of RoE >15%. Most of the aforementioned stocks further touched the high quality zone of RoE >25% at the peak of the investment and credit cycle.

Expansion in RoE could boost P/B ratio which is around long-term average

As capital intensive and cyclical sectors expanded their RoEs above the 20% range in pre-GFC era, their P/B ratio was also boosted and by the peak of the profit cycle, P/B ratio expanded well above 5x. A similar behaviour cannot be ruled out going ahead. Relatively less capital-intensive sectors such as FMCG, IT, pharma etc. are largely in value-creation zone (RoE >15- 20%) and do not provide any major driver of boosting RoE from current levels.

High frequency data indicates demand is robust and being largely driven by rising ‘investment rate’

Capacity utilisation improved to ~76% in the economy, as per RBI’s OBICUS survey, and high frequency indicators like PMI, GST collections, infra orders, and real estate construction indicate demand overall remains robust driven by the investment side of the economy.

Agri output and IT hiring slowdown are key risks to consumption demand

However, severe weather conditions pose risk to agriculture output and income growth for rural economy with ~46% of the working population involved in agriculture. Also, within the formal segment, IT hiring has been slow along with a weak outlook. Its enormous share of ~42% to the private corporate sector wage bill remains a key risk.

Refining Margin of Indian Players to Stay at $9-10/bbl (CARE Ratings)

After a period of almost nine months, Brent crude again breached the $90/bbl mark at the start of September 2023. With this, the gap between international benchmark Brent crude prices vis-à-vis Urals, the flagship Russian crude, has widened for Indian refiners as Russian crude can be sourced within the G-7 price cap of $60/bbl.

The Urals had mostly traded below the G-7 imposed price cap of $60/bbl but have breached the cap in recent weeks whereby it is trading at around $69/bbl. Upon the rise in prices of the Urals, the share of Russian crude in India’s total crude oil sourcing basket declined to 34% in August 2023 from nearly 40% since the outbreak of the Russia-Ukraine war.

With Saudi Arabia and Russia deciding to reduce their daily crude oil production by 10 lakh barrels till December 2023, any major softening in crude prices is unlikely in the near term on the back of stable demand prospects.

In this backdrop, Indian refiners which are the key beneficiaries of cheaper Russian crude should still be able to clock Gross Refining Margins (GRMs) of around $9-10/bbl in FY24 as the likely decline in their margins on processing Brent crude is expected to be offset by the significant expansion in margins on processing Russian crude which can even balance out the potential decline in supply of Russian crude in the near term. Also, with the onset of winter in Western countries, cracks for refined products are expected to improve from the existing levels, further helping the GRMs of Indian refiners.

FMCG: A crude spike and an uneven monsoon could spoil margin gains (Anand Rathi)

Spotty monsoon could drive food inflation higher, drag rural demand. August saw a sharp monsoon deficit after a flurry of rain in July. At present, the all-India monsoon (till 6th Sep) is 11% deficient with uneven rainfall distribution across the country. While sowing area rose 0.4% over the last year, less area sown in pulses, cotton, jute, etc was seen till 1st Sep. This could drive food prices up as was seen with select vegetable prices shooting up recently.

Palm oil, soda ash, packaging prices soft. Barring prices of milk, wheat and sugar prices of most other commodities have been down. Palm oil prices fell ~40% in FY23 and fallen another ~11% so far in FY24. The steep fall in palm oil prices benefits soap (~60% of input cost), snack (~30%) and biscuit (10-20%) manufacturers.

We expect the drop in palm oil prices to be favourable to HUL (~25% soaps portfolio) and GCP (~25%). Further, prices of many crude-linked inputs have fallen (soda ash down 14% y/y in the last six months,p olyethylene down 12% y/y). Soda ash accounts for about 20-25% of the input cost in the manufacture of detergents. Packaging costs constitute 15-30% of FMCG companies’ input costs. HUL (~25% of the portfolio) and Jyothy Labs (~30% of the portfolio) are expected to benefit from lower soda ash prices.

Gross-margin gains could shrink on crude-oil price spikes. The recent spike in crude oil (~17% over 3m) could mar gross-margin gains for FMCG manufacturers. In Q1 FY24, lower input costs (primarily crude-linked derivatives) for them had led to 100-800bp gross-margin gains. However, the spike in crude-oil prices drove prices of packaging, soda ash, LAB, titanium dioxide higher, which could shrink gross-margin gains.