Strategy: Are companies and investors both being ‘short-termish’? (Kotak Securities)
We are quite puzzled by (1) consumer companies’ excessive focus on near-term profitability and (2) investors’ endorsement of the same. Companies seem willing to compromise on market share and volumes to improve profitability. However, this strategy may create fertile ground for more competition from regional players in the short term and from new entrants in the short to medium term. Their high profitability and returns are unlikely to sustain anyway, given weakening business moats and models.
Consumer companies focusing on near-term profitability, despite weak demand
The sharp improvement in profitability of consumer companies in the past four quarters, despite sluggish demand would suggest that they are prioritizing profitability over volumes. In fact, the profitability of automobile companies has risen dramatically in FY2023, despite a sharp increase in RM prices over FY2022-23 and collapse in volumes over the past few years (see Exhibit 6). The companies’ strategy of profitability-maximization through constant price increases may have also impacted volumes negatively through lower affordability.
Preparing against competitors or preparing competition
We are not sure about the logic of the profitability-maximization strategy of the incumbents. They may be keen to maximize profitability/profits in preparation for forthcoming competition. However, they may also be arming competition inadvertently. (1) Consumer staple companies are seeing market share loss to regional players, who have been faster to cut prices and pass on the benefits of declining RM prices to consumers. (2) Incumbent companies could see a major dent in profitability as and when entrants achieve scale. The entrants may be content with lower profitability and still earn reasonably high returns (higher than cost of capital). The high profitability/returns of incumbents has already attracted deep-pocketed competition in several consumer categories.
Investors also focusing too much on near-term profitability
The sharp rerating in multiples of 2W and paint companies over the past 2-3 quarters would suggest that investors are (1) endorsing the short-term profitability-maximization strategy of companies and (2) ignoring the medium-term risks of this strategy. These sectors will see tremendous increase in competition in the next 1-3 years. As articulated in our earlier reports “Disruption of valuation models too, disruption is a matter of ‘when’ and not ‘if’ in several sectors”.
Investors may be dancing to ‘flows’
We are unclear about the rationale behind the endorsement given by investors to the profitability-maximization strategy of companies, given near-term weak volumes and medium-term risks to business models. Strong FPI and DII ‘flows’ (see Exhibits 9-10) may have brought the near-term positives of improvement in profitability to the forefront and pushed short-term issues of weak demand and medium-term concerns of a likely sharp profitability cut to the background.
Strategy: What happens when household spending slows down? (MOFSL)
We believe that personal consumption and/or household investments will slow down this year, which has the potential to disrupt the retail lending boom that India has witnessed over several years. The primary assumption behind this thought process is that net financial savings (NFS) of the household sector is likely to pick up in FY24, after falling to a three-decade lowest level in FY23. In this note, we discuss whether history supports our thesis.
Based on data for almost the past quarter of a century (FY00-FY23E), the following two questions arise:
1. How strong is the synchronization between personal consumption and household investments (or physical savings)? and
2. How correlated are the movements in household spending (consumption +investments) vis-à-vis household debt?
Our analyses confirm that consumption and investments of the household sector have moved in similar directions in two-thirds of the period between FY00 and FY23E. In 16 years of the 24-year period, both personal consumption and household investments have either grown at a faster pace or decelerated (or contracted) together. Of the remaining eight years, they moved in different/opposite directions, i.e., when consumption grew faster, investments grew slowly (or declined) and vice-versa.
During the past 24 years, the growth in household spending and debt has synchronized 13 times, of which it happened eight times since 2010. Of the remaining 11 episodes, spending growth had weakened in six years, while debt rose at a faster pace (only twice since FY
`10). In other words, of the 14 years in which household spending growth weakened (including FY21 when it declined), household debt growth also decelerated in eight episodes – about three-fifths of the time. Further, we find that the relationship between household spending and their debt has improved in the post-2010 period, more so with banks’ exposure to the household sector.
Overall, the historical analysis does not give us any reason to change our thesis. We continue to believe that due to weak income growth and an assumed pick-up in NFS, personal consumption and/or residential investments growth would grow slowly in FY24, which could disrupt the retail lending boom this year.
Alternatively, NFS could drop further this year, supporting household spending and debt growth at the cost of higher investments.
Wages recover in FY23, IT and rural jobs are key near-term concerns (ICICI Sec)
In FY23, the aggregate wage bill of the listed private corporate space expanded by a robust 17% to reach Rs11.5trn driven by NBFC, private bank, IT, consumer discretionary, industrial and auto sectors. Aggregate wage bill, or ‘compensation of employees’ (CoE), of the entire private corporate space in the economy grew by a sturdy 21% YoY in FY22 to reach Rs30trn. This overtook the public sector wage bill (~Rs28trn) for the first time as per the National Accounts Statistics (charts 1&2).
The rising trajectory of private corporate wage bill appears structural having grown from ~9% of GDP in FY12 to ~13% in FY22 as the formalisation effect takes effect. This has resulted in a 10-year CAGR of 14% as against nominal GDP growth of 10% (chart 1). A developed economy like the US has a private sector ‘compensation of employees’ to GDP ratio of ~45% vs ~13% for India – thus indicating significant runway ahead.
Private corporate wage bill growth over the past decade was driven by the twin effect of robust wage growth for existing employees (8-10% as per salary surveys) and new additions to the formal workforce. Rapid expansion of the formal workforce is corroborated by EPFO data (14mn net additions over the past 12 months) and rising personal income tax collections.
Key near-term risk to private corporate wage bill expansion lies in the significant
weight of IT services in private corporate sector wage bill in India (~42% for the listed space) in an environment of slowing IT and tech start-up hiring, as well as slow wage increase in the near term. However, in terms of the number of employees, the IT/BPO sector accounts for just 12% of the organised sector workforce, or ~1% of the overall workforce (chart 8).
Growth in aggregate wage bill of the informal segment holds the key for aggregate
income growth as it accounts for the lion’s share of non-agri working population (~72% of the non-agri workforce – chart 9). It can be assumed that the agri-related workforce, which makes up ~46% of the overall workforce, is largely informal thereby taking the overall informal workforce north of 85%. As per the Economic Survey 2022, the informal sector constituted ~89% of the workforce in FY20.
Informal job demand in urban India appears strong due to the cyclical recovery in investment rate, real estate, construction, leisure, hospitality, etc., which can potentially generate more informal jobs. Annual PLFS study indicates that, for a casual labourer in urban India, the daily wages increased from Rs385/day in Q2FY21 to Rs464/day in Q1FY23. Also, the monthly average income of a salaried person in urban India grew from Rs20,030/month in Q2FY21 to Rs21,647/month in Q1FY23. Private surveys indicate strong demand for ‘blue collar’ jobs (link to media reports on blue collar jobs demand).
On the flip side, average income of a salaried person in rural India has stagnated at ~Rs14,700/month for the 18-month period ending Q1FY23 as per the annual PLFS study. However, daily wages of rural casual labourers have increased from Rs302/day in Q2FY21 to Rs368/day in Q1FY23.
Key near term risk to rural income is the uncertainty around agricultural output in FY24 due to severe weather conditions.
Monsoon and Sowing: Positive changes seen (Bank of Baroda)
India’s South-West monsoon has gathered momentum with higher rainfall at 5% (above LPA) till 23 Jul 2023. With this pickup, overall kharif sowing is also higher by 1.2% with rice acreage in green though pulses continue to register lower sowing compared with last year. Region wise, North West and Central Region have recorded higher rainfall, while Southern peninsula and Eastern region rainfall are in the deficient zone. A total of 8 subdivisions and 6 states, have received lower rainfall during this period (1 Jun-21 Jul 2023). Distribution of rainfall needs careful monitoring along with sowing of Kharif crops. Any shortage or excess might play a significant role on prospects of agriculture growth.
Where does Kharif sowing stand? The overall kharif sown area has increased by 1.2% as of 21 Jul 2023, (-2% in the previous week) compared with last year. Acreage of rice picked up pace (2.7%) and is in surplus for the first time in this season. Led by improvement in sown area of Bajra (11.3%) and steady pick up in Jowar and maize, the overall sown area of coarse cereals (4.8%) has improved compared with last year. Steady improvement was also registered in the sown area of sugarcane and oilseeds. However, pulses sowing has declined by 9.8% led by Arhar (-18.4%) and Urad (-9.7%). Even cotton and Jute & Mesta has registered lower sowing this year.
Utilities: Smart metering – a game changer? (IIFL Securities)
The state-owned discoms forego Rs1.4-1.5tn revenue p.a. due to billing inefficiencies. To plug such revenue losses Govt is fast-tracking installation of 250mn smart meters by FY26 which can read, store data, and bill power consumption remotely (GPS/radio frequency, etc). Several players (NTPC-PWGR JV, TPWR, Genus, etc) are eyeing this opportunity (EPC/system integration).
Seamless execution can fetch these players ~15% RoE. Smart meters with pre-paid feature can significantly alter the sectoral landscape; this however remains politically sensitive. As such we maintain a positive stance on the sector.
Smart meters can alter the sectoral landscape: As per CEA, due to billing inefficiencies (due to human intervention, etc) the state-owned discoms are estimated to forego revenues of Rs1.4-1.5tn p.a. Installation of smart meters can potentially plug such revenue losses through real time automatic remote reading. The Govt is persuading discoms to install 250mn smart meters by FY26, for which a grant of Rs233bn is set aside (~25% of the cost); as such if executed well, it can significantly alter landscape of the Indian power sector.
Vendor base can earn ~15% RoE: As of now only 6.6mn smart meters are operational; given the policy push, several states may expedite the installations; however instead of incurring capex on their own, discoms will likely opt for the TOTEX mode (vendor incurs capex, undertakes O&M and earns monthly rental), which avoids upfront investment and yet improves billing efficiency. Several players such as EESL (PWGR-NTPC JV), TPWR, Genus Power, HPL Electric, etc. are eyeing this business opportunity from pick up in smart metering activities. Such activity can earn 12-15% RoE if executed well; meter manufacturing will also see a ramp up, where however barriers to entry are relatively low.
Not the ultimate solution: Installation of smart meters is the first step towards improving billing efficiency; it needs to be followed with improvement in collections, which is equally challenging; hence installation of pre-paid meters combined with smart meters can bring desired results. Pre-paid smart meters, while logical and efficient, may not go down well politically, particularly in an election heavy year.
How do smart meters differ from traditional ones? The billing activity in a discom is conducted by physical inspection of meters at the customer premise; this is either done by employees of discoms or a contractor to whom the activity is outsourced. Given human involvement, such a process often leads to inefficiencies in billing data and lower collections for the discom.
As per CEA India’s average billing efficiency was ~85% (i.e. of every 100 units sold, only 85 units are billed); that means, nearly 227-230BU were not billed to consumers by utilities across the states, leading to a revenue loss of Rs1.4-1.5tn; if this is contained the revenues of discoms can potentially increase by 10-15%, and they may not need constant financial support from various financial institutions including PFC/REC. As such there is a need to cut down human intervention, enhance automation, data storage, etc, which can potentially be done by the installation of smart meters.
In case of smart meters, the power consumption data is shared through wired/wireless means to the service provider on a real-time basis; there is no human intervention for reading, reconciliation, etc. Smart meters keep records of power consumption by the customer, encrypt the data, and transmit it using communication protocols to a meter data management system at the utility centre, basis which the consumers are billed at the end of the month.
India Chemical: No respite yet from cheaper imports (IIFL Securities)
Import volumes across DAP, complex fertilizers, Bromine and Phenol rose sharply QoQ while that of PVC, Soda Ash and Ammonium Nitrite declined. Though imports of some chemicals have declined sequentially, they remain at elevated levels creating headwinds for domestic import substitution products. Benign freight costs have only aggravated the pain.
DAP and NPK imports on the rise: Imports of NPKs rose ~41% YoY in 1QFY24, while it rose 31% sequentially. The growth in volumes was primarily driven by higher imports from Russia which rose 43% YoY. DAP import volumes rose ~2.9x YoY to 2.3 mn MT as availability improved. This was also due to government of India’s push to have sufficient inventory ahead of kharif season. China accounted for ~49% in DAP imports as against ~20% in FY23.
Imports decline sequentially, but remain elevated: India became net importer of Caustic soda as imports rose sharply from Iran. Even though PVC volumes declined sequentially, imports remained at elevated levels. Phenol imports saw spike of 18% YoY while Bromine and Ammonia rose 19% and 20% YoY respectively. Imports of Fluorspar and Acetic Acid remained flattish.
Soda ash imports remain elevated: Imports of Soda Ash rose 61% YoY to ~185,000 MT. Though imports from US were down from abnormally high levels witnessed during 4QFY23, it still remained at elevated levels. Turkey’s share of imports increased from 26% in FY23 to 30% in 1Q. The higher imports have compelled domestic players like Tata Chemicals to take cumulative price cut of ~13-14% during 1QFY24 with the company taking price cut in Apr, May and June 2023.
Infrastructure: Road activity slows down in June 2023
Total road awards by the NHAI and MoRTH combined stood at 229km in Jun-23 (268km in May-23 and 473km in Jun-22). After blockbuster awarding in Mar-23, the NHAI had halted project awards—no LoAs were issued in April and May. However, they awarded three projects spanning ~87km in Jun-23. The NHAI and MoRTH together constructed 785km of roads in Jun-23 (942km in May-23 and 659km in Jun-22).
Project awards and construction decelerate The total road awards (NHAI + MoRTH) stood at 229km in Jun-23 (268km in May-23, 473km in Jun-22). All the projects awarded in April and May 2023 were by MoRTH as the NHAI did not award any new road project. However, after a two-month pause, the NHAI awarded three projects aggregating ~87km in Jun-23.
Combined awarding in FY23 stood at 12,375km (12,731km in FY22), of which the NHAI awarded ~6,310km (6,306km in FY22). Road construction in Jun-23 stood at 785km (NHAI + MoRTH) versus 942km in May-23 and 659km in Jun-22. Of this, the NHAI constructed 262km (413km in May-23 and 326km in Jun-22). In FY23, road construction stood at 10,993km in total, of which the NHAI constructed 4,500–4,600km of roads. According to a media article, the ministry is looking to increase its road construction target to ~14,000km from 12,500km, implying a pace of 38km/day in FY24E.
Outlook: A mix of hope and caution While NHAI awarding was disappointing in FY23, higher budgetary outlay for roads provides hope for better awarding going ahead. While commodity prices have softened, high competition remains an issue (with knock-on effect on margins going ahead). The pause in interest rate hikes by the RBI, government’s thrust on roads and improved credit availability from banks are notable encouraging factors.
Given this backdrop, we argue road developers must work on segmental diversification since their ability to win adequate road orders at desired margins is now under question. We prefer road companies with robust balance sheets.
