Vijay Kumar Gaba

(a)   Mother Nature helping a bountiful crop (especially vegetables);

(b)   Current rise in inflation being transitory in nature; but MPC is ready to preempt the second-round impact;

(c)   Capex (both public and private) sustaining despite positive real rates and diminishing liquidity and continuing to remain broad-based;

(d)   Growth in the Indian economy staying resilient enough to withstand the external challenges; and

(e)   Government taking adequate steps to mitigate supply-side shocks, while maintaining fiscal discipline, trade balance, and growth stimulus.

Evidently, RBI has no solid basis for making these assumptions.

The monsoon is not only deficient, it is poor both temporally and spatially. Only 42% of districts in the country have received a normal (-19% to +19% of normal rainfall) so far. The remaining districts are either deficient (-20% to -85% of normal rainfall) or have received excessive rainfall (+20% to +156% above normal). Key Kharif states like Easter UP, Bihar, Jharkhand, West Bengal, Maharashtra, and MP are deficient. Whereas, the western states of Rajasthan and Gujarat and the Northern states of Himachal, J&K, and Uttarakhand are in the large excess bracket. Key vegetable producing states like UP, Karnataka, Maharashtra, and West Bengal are highly deficient. Besides, the reservoir levels in the key state have fallen below long-term averages and could have some impact on Rabi crop also. Apparently, assumptions of early relief in vegetable & fruits, dairy, oilseeds, and pulses inflation are mostly based on hope.

The impact of the supply side intervention of the government post MPC meet, e.g., export duties on onions, and rice, etc., and release of onion buffer stock; fiscal support like subsidy on tomatoes, etc., could prove to be short-lived. Tax collections have started to weaken, further impeding the fiscal leverage for stimulating the economy.

Foreign flows have moderated in recent months. The pressure on INR is visible. The imported inflation, especially energy, could be a major challenge. Most global analysts and agencies are forecasting higher energy prices this winter due to depleted strategic reserves, continuing production cuts, and persisting demand.

One of the key drivers of the overall India growth story, viz., private consumption, does not appear to be in very good shape. High inflation and rates may keep the consumption growth subdued for a few more quarters at least. In any case, we are witnessing signs of heating up in personal loans and the housing market.

The other key driver of growth, the private capex, has shown some early signs of revival in the recent quarters. However, positive real rates, cloudy domestic consumption demand, and poor external demand outlook could hinder acceleration in private capex. The government is front-loaded its capex budget in the first half of the fiscal year in view of a busy election schedule in the second half. The assumption of growth acceleration may therefore be misplaced. In fact, the RBI has itself projected a much slower rate of growth for 2HFY24 and 1QFY25.

Recently, banking system liquidity has slipped into negative territory. Besides a hike in effective CRR, the RBI has been ensuring the withdrawal of ‘excess’ liquidity from the system. We may therefore see a hike in lending rates as MCLR for banks rises (even if the RBI stays put on repo rates) as we approach the busy credit season. The credit growth may be impacted due to this.

 

Monsoon, agriculture, prices (Yes Bank)

The focus for economic agents over the last few weeks was the onset of the SW monsoon, especially as the El Nino risks have been now moved to an “Alert” from “Neutral”. This year, the monsoon had a delayed start as was predicted, and its progress was also initially stalled by the cyclonic conditions that developed over the Arabian Sea. However, monsoons have now covered the whole country. From, a deficit of around 55%-60% in the initial part of June, cumulative rainfall till 3rd July shows a deficit of only 8%. This is good news, but the worry comes from an uneven spread of the monsoon. Southern Peninsula is currently seeing a large deficit of around 43% while the North-West region has a large surplus of 40%. East and North-East India sees a deficit of 16% while the deficit for Central India is 4%. Even as the IMD has predicted a normal monsoon for July, tracking the temporal and spatial progress of the SW monsoon in July and August remains important as these are the most crucial sowing months.

El Nino is forecasted to strengthen over August/September. However, apart from the El Nino, SW monsoons for India critically depends on another weather condition, known as the Indian Ocean Dipole (IOD). Currently, the IOD is neutral, and models predict a positive IOD to develop over the coming months. Only if El Nino is associated with a neutral or negative IOD does precipitation suffer. In the current situation, we are hopeful for a positive IOD developing that can neutralize the negative rainfall impact of El Nino.

As of date, Kharif sowing is 0.4% higher than last year, with rice (-26% YoY), cotton (-14% YoY), jute and mesta (- 12% YoY) and oilseeds (-3.3% YoY) registering a decline. Globally, rice market is facing significant production deficit and lower stocks, putting pressure on prices. Based on fears of lower rice supplies, mandi prices in India has started to rise. In FY23, domestic rice inflation stood at 8% YoY and in September 2022 India had banned exports of broken rice and imposed 20% export duty on non-basmati varieties, except parboiled to keep prices in check. Presently, India has adequate rice buffer stock that gives enough space to the government to intervene and keep prices in check. India has already announced open market sale of rice, even as the quantity is not known. Importantly, the major rice producing states have higher irrigation cover such as Uttar Pradesh, Punjab, Telangana, Tamil Nadu, and Andhra Pradesh.

On the other hand, pulses could be a bigger worry if rains fail as the all-India average area under irrigation is just 23%. In recent months, retail prices of vegetables and pulses have been on the rise. If late onset of rains also leads to late withdrawal of rains, onion crop can also be at risk. Having said, correlation between weak monsoons and food prices is unclear. It is a demand-supply game and food prices remain hugely dependent on global food prices and the ability of the government to draw down on domestic stocks. And domestic stocks of rice seem adequate and comfortably placed vis-a-vis the buffer norms. A recent RBI study indicates that a negative IOD (weak India SW monsoons) is a bigger risk for food prices than El Nino. IOD is currently in the neutral zone, and as indicated earlier, IOD is expected to develop into the positive zone soon.

Overall, we think that Headline CPI inflation will broadly pan out as per the RBI estimates. Our model however indicates a slightly higher average print for Q4FY24 compared to projections made by RBI. In this context and with global central banks remaining hawkish, there appears little chance for any rate cut from the RBI in FY24. The resolve from OPEC+ to keep oil prices at the current levels appear strong. Despite a not-too-robust China story, most commodity price indices appear to be finding a floor. 

Crude oil: Hubbert’s peak is here (Goehring & Rozencwajg)

Conventional oil production has now unequivocally rolled over. Unconventional production, the only source of growth in global oil supply over the last 12 years, has also significantly slowed. The only growing non-OPEC basin is the Permian in West Texas. Never before has oil supply growth been so geographically concentrated. Six counties in West Texas are now 100% responsible for all global production growth.

Conventional non-OPEC oil production peaked in 2007 at 46.2 mm b/d and now stands at 44.2 mm b/d – 4% below its peak. Including OPEC, conventional global output peaked in 2016 at 84.5 mm b/d and now stands at 81.3 m b/d – 5% below its peak. Even if OPEC has its alleged 4 mm b/d of unused production capacity (something we do not believe), conventional production would barely regain its 2016 peak.

Non-OPEC oil production between 2006 and 2015 grew by 8.6 mm b/d. Conventional oil supply contracted by 1.4 mm b/d. Unconventional oil supply more than offset these declines, surging by 10 mm b/d and broken down as follows: US shales grew by 6.8 mm b/d (65% of all growth), bio-fuels grew by 1.9 mm b/d (19% of the growth), and Canadian oil sands increased 1.4 mm b/d (14% of the growth). Please note that out of this 10 mm b/d growth figure, the Permian represents only 1.4 mm b/d or 14%.

Between 2016 and 2023, unconventional production surged by another 7.4 mm b/d, representing all non-OPEC supply growth. US shales accounted for 85% of the increase. However, whereas all the major shale basins grew from 2006 to 2015, only the Permian grew afterward. The Bakken and Eagle Ford peaked at 1.5 mm b/d in 2015, and this year are each expected only to be between 900,000 and 1 mm b/d. Significant unconventional growth also came from natural gas liquids production in the liquids-rich Marcellus and Utica, which we estimate each added 1 m b/d. This source of production growth is now set to fade, while the plateauing of the Marcellus will turn into a decline.

Between 2006 and 2015, the Permian represented only 14% of unconventional supply growth. Between 2015 and 2023, the Permian represented almost 75% of this growth.

Conventional production started declining in the non-OPEC world over a decade ago. Conventional oil production has most likely turned negative in the OPEC world as well. Over the last thirty years, global oil supply growth has come from multiple geographic areas, including the North Sea, Mexico, Brazil, West Africa, and the Former Soviet Union. Over the last decade, however, these areas have had slight growth, and specific basins, such as the North Sea, have experienced considerable declines.

Consensus opinion believed global oil demand would peak in 2019 and gradually decline through this decade. Just the opposite has occurred: demand has come roaring back post-COVID. Global demand in 1Q23 surpassed 102 mm barrels per day -- three million barrels above the 1Q19 (pre-COVID) level and almost 2 mm b/d above the International Energy Agency’s (IEA) 1Q23 estimate. Strong demand and faltering supply led OECD countries to release 250 mm barrels of oil from their strategic petroleum reserves to keep prices from surging. Given the seasonality in demand and China’s ongoing reopening, the 4Q23 demand could surpass 104 mm b/d.

From here on out, just six counties in West Texas must meet all global demand growth. Given the strategic importance of the Permian, it’s imperative to understand its underlying health. Using our neural network, we have updated our basin analysis, and the results are shocking. The Permian is likely less than a year from peaking and starting its decline. The only source of non-OPEC supply growth is now primarily tapped out.

After many false starts, Hubbert’s Peak is finally here.

 

Electronic Manufacturing: India the Next Stop (Morgan Stanley)

Reconfiguration of global supply chains from growing multipolarization is leading to major adjustments in the tech sector. Re & friend-shoring along with India's ongoing structural transformation could see India play a major role in technology-related production, while Apple and its supply chain coming to India would bring in fresh investment. We estimate a 21% CAGR in electronics manufacturing in F22-32.

Global multipolar thematic driving tech supply chain shift: Geopolitical risk, rising costs in China and supply chain diversification has seen a move from Made in China to Made around China (Global Technology: Multipolarization – The New Normal in Tech [1 May 2023]). De-risking in the form of regionalization has gathered pace as China has expanded its move toward localization for higher value-added types of manufacturing. Vietnam has been a key beneficiary but we think India will be next. Apple has made it clear that India will be the destination for fresh new investment, and recent reports have indicated Google and HP aim to boost local production,as they diversify supply chain exposure.

Outlining key implications from this tech manufacturing transition: We look at how a changing perception among multinationals towards India from one of low-cost outsourcing to one of collaboration in advanced technologies, strong supplier ecosystems, and enabling regulatory policies is the necessary path forward to ultimately evolve into a high-tech manufacturing hub. The global tech hardware supply chain is already a growing presence in India, especially in smartphone assembly, e.g., Samsung and Foxconn, though a move up the value chain towards establishing a semiconductor supply chain could take longer to play out given the complexity.

India is uniquely positioned: In our Blue Paper, Why This Is India's Decade, we said India is set to become the world’s third-largest economy and stock market by the end of this decade. One of the key pillars of this transformation is off-shoring driven by transition to a multipolar word. Indian policy makers have taken meaningful steps to boost infrastructure investment, lower corporate tax, improve the ease of doing business and launch production-linked incentive (PLI) schemes with the goal of lifting India’s participation in global supply chains.

India's electronics manufacturing (EM) at an inflexion point: We forecast structural EM growth of 21% CAGR over the next 10 years (F22-32) to US$604bn by F32 driven by: 1) rising disposable income per capita;2) increasing number of households;3) rising urbanization; 4) improving access to electricity;5) easier availability of financing; and 6) the expansion of e-commerce. On the supply side, India has a large, increasing working age population and surplus low-cost labour.

Indian pharma: On a strong footing (ICICI Securities)

Pharma companies under our coverage are likely to report revenue/EBITDA/PAT growth of 15%/33%/28% YoY in Q1FY24E. The growth is likely to be led by new launches, market share expansion in key products and acquisition in US & India. Aggregate gross margin to improve marginally QoQ (+250bps YoY) at 64.8% as higher RM cost and mandated price cut in India may offset the benefit of better margins from niche US launches. However, operating leverage may drive a 90bps QoQ (+300bps YoY) surge in EBITDA margin to 22.4%. Aggregate PAT is expected to surge 28% YoY to Rs86.6bn.

Synopsis of expected quarterly performance: Revenue for coverage universe is likely to grow ~15%/4% YoY/QoQ to Rs641bn in Q1FY24E. Growth is likely to be led by traction across key markets of US and India. Gross margin to expand 250bps YoY (+40bps QoQ) to 64.8% in Q1FY24E. EBITDA is expected to grow 33% YoY (9% QoQ) to Rs144bn, EBITDA margin may improve 300bps YoY (90bp QoQ) to 22.4%. Profit for our coverage universe was up 28% YoY (13% QoQ) to Rs87bn led by improvement in overall operating performance. Alkem, Zydus Lifesciences, Biocon, Glenmark and Dr Reddy’s are likely to grow their profits between 28-115%.

India margins to be under pressure: India business of our coverage companies is expected to grow at ~8% YoY in Q1FY24E to Rs198bn. Better volumes and acquisitions may help companies offset the impact of price cuts on growth, while margins may be under pressure. M&A may elevate the pace of growth in India business of JB Chemicals and Torrent Pharma to 20-24% while Abbott and Ajanta can grow organically at a faster pace of 15-16%. NLEM linked price hike of 12.2% will likely boost domestic growth and profitability Q2FY24 onwards.

Better market share, launches to drive robust performance in US: Aggregate US sales of coverage universe is likely to grow US$2.3bn, up ~6% QoQ and 24% YoY. Lesser price erosion in base business and improved supplies on account of few companies vacating the market may drive sequential growth across all the companies in our coverage universe. Zydus is expected to grow the fastest at 10% QoQ, driven by products like gRevlimid, gTrokendi XR, gChantix and gVascepa. Dr Reddy’s, Zydus, Cipla and Sun are likely to benefit from the launch of gRevlimid, while Aurobindo is expected to launch this product in Oct’23.

Operating leverage to drive improvement in EBITDA: RM cost is expected to remain elevated in Q1FY24E and mandated price cuts in India may further restrict the scope for gross margin expansion. We believe benefit of low-priced inventory may not be seen in Q1FY24 as companies are unlikely to have exhausted their high-priced inventory and full quarter benefit of it will likely be visible from Q2FY24. Better revenue traction in US and India to drive operating leverage and help EBITDA margin soar by 272bps YoY to ~22%. We expect significant recovery in gross and EBITDA margins for companies under our coverage in FY24E. Better traction in US may drive margins for the next couple of quarters beyond which price increase in India and normalization of RM and logistic cost are likely to play a pivotal role in restoring the margin profile.

Key risks: Adverse outcome of USFDA inspections, currency volatility and inclusion of more products under NLEM in India.

India Auto: Volume growth moderates to single-digit (IIFL Securities)

Volume growth across Auto segments came in at low-to-mid single digits in June 2023, confirming our view that FY24 would see sharp deceleration in growth, after the strong cyclical recovery seen in FY22 and FY23. PV industry volumes grew 2% YoY in June. 2W industry volumes grew only 4% YoY and came off 7% MoM, as we entered the seasonally weak period. Tractors grew 6% YoY and 20% MoM in June (seasonal spike). MHCV industry grew 8% YoY; this is an improvement vs recent months. Reversal of pre-buy impact in Jan-Mar (related to BS-VI Phase 2) had led to weak volumes in Apr-May. LCV industry declined 3% YoY, which is a continuation of weak trend in recent months.

Based on these numbers, we believe that risk to FY24 volume projections, if at all, is to the downside.

MHCV industry recovers after “pre-buy reversal” in Apr/May; LCV stays weak: MHCV industry volumes grew 8% YoY in Jun’23. MHCV SAAR, which had collapsed to 340k in Apr/May (due to reversal of pre-buy impact in Mar-2023), normalised to 385k in Jun’23. This is close to our estimate of about 400k volumes in FY24. Ashok and Tata Motors’ MHCV market shares are quite stable, at ~31% and ~47% respectively. LCV industry declined 3% YoY; we see this as a continuation of recent weak trend. We forecast zero growth for LCV in FY24.

PV growth moderates to 2% YoY: We estimate PV industry to have grown 2% YoY in Jun’23. We expect PV volume growth to stay muted in 2QFY24 (Jul-Sep). Maruti’s Jun’23 market share stood at ~41% — lower than May (43%), and is attributable to Maruti’s 1-week production shutdown in June. Tata’s market share stood at ~14% in Jun’23; similar to FY23. M&M’s UV volumes stayed at ~32.6k; volumes are not scaling up, despite high order book (close to 300k).

Tractors grow 6% YoY: Volumes grew 6% YoY in Jun-2023. The 20% MoM jump is seasonal. Sentiment for tractor sales was mixed, as markets with good rainfall saw good momentum, and markets with delayed monsoon saw soft demand. We currently forecast 5% growth for Tractor industry in FY24. If monsoon is impacted due to El Nino effect, there would be downside risk to our estimate.

Domestic 2Ws up 4% YoY; 2W exports see sequential improvement: 2W industry volumes grew ~4% YoY but declined 7% MoM (seasonal). We understand that underlying retails are clocking mid-to-high single-digit growth. Hero continued to underperform the industry with 9% YoY decline in dispatches. Coming to 2W exports, we continue to see YoY decline in volumes (down ~30% YoY). However, on a sequential basis, we saw volumes improve by high single-digit.

Roads: NHAI flags off FY24 awarding in June (nuvama institutional equities)

After a two-month pause, NHAI awarded three projects spanning ~87km in Jun-23 (compared with 303km in Jun-22). During the same period, 262km of roads were also constructed (versus 326km in Jun-22 and 413km in May-23). After Mar-23’s blockbuster awarding, NHAI’s awarding activity came to a grinding halt – no LoAs were issued during the months of Apr-23 and May-23. That said, road awarding in FY23 stood at 6,310km across 179 projects.

Pace of road construction slows down: In Jun-23, the NHAI constructed 262km of roads (compared with 326km in Jun-22; 413km in May-23). YTD FY24 road construction stands at 844km against 863km in the same period last year. In FY23, it constructed ~4,500–4,600km of roads (~4,325km in FY22) at a pace of ~12.5km/day. As per a recent media article, the ministry is looking to increase its road construction target to ~14,000km from 12,500km, at a pace of 38km/day in FY24E (link).

Outlook: A mix of hope and caution: As highlighted in our report Road awards: More speedbumps, 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). RBI’s pause in interest rate hikes, the government’s thrust on roads and the improvement in credit availability from banks are encouraging factors.

Given the 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.

Specialty Chemicals: One of the worst quarters; A similar to follow (Phillips Capital)

Indian Specialty chemical Industry is all set to face one of the worst quarters in Q1 primarily driven by a broad-based disruption in global chemical demand caused by visible economic slowdown in advanced market of EU/US, ongoing inventory rationalisation and enhanced competition from China post their Covid lock down. Not only the revenue performance, the deteriorating profitability caused by weak spreads as well as negative operating leverage look like a reality. Moreover, the likelihood of the said situation extending into Q2 and early Q3 makes the near-term earnings outlook bleak.

We estimate PC’s Specialty Chemical universe’ is likely to see 33% decline in overall earnings (-21% qoq) as the revenues decline 12% and margins face sequential correction during the quarter.

The key input prices, energy cost, freight cost has certainly moderated sequentially in Q1 but those fail to protect the margin performance of Indian Chemical industry as the final product prices corrected faster led by aggressive Chinese competition and the industry suffered negative operating leverage due to weak demand.

In fact, the average input price for Q1 saw the following trend: - crude price (-29%/-5% yoy/qoq), Benzene (-24%/+5% yoy/qoq), Toluene (-4%/+5% yoy/qoq), Phenol (-10%/+4% yoy/qoq), caprolactum (-18%/+9% yoy/qoq), Indonesian coal (-3%/-13% yoy/qoq), etc.

Key economic trends (Elara Capital)

·         Deflationary impulses seem entrenched in the global economy. We believe global inflation may surprise on the downside through rest of CY23E.

·         We see the Fed pausing even in July 2023 meet – Expect the first rate cut by the Fed in Dec-23.

·         Historically, equities perform better in a hike cycle than a cut cycle. Bonds are a better bet in run up to rate cut cycle. Gold is the preferred commodity asset through both hike and cut cycles. The USD-INR usually fails to capitalize on the overall EM FX risk on sentiment in the run-up to a rate cut by the Fed.

·         Deflationary producer prices in China suggest weakening growth in G4 – the US, the EU, the UK and Japan. We do not rule out a sub 5% GDP growth in China in 2023E. (base case 5.2%)

·         India remains in sweet spot compared with the global economy. FY24E GDP is likely at 6-6.2% YoY, CPI inflation to average 4.9% and CAD likely at 1.2-1.3% of GDP. Expect the first rate cut from the Monetary Policy Committee (MPC) in Q4FY24.

·         Expect India 10-year yield at 6.75% by March 2024E, led by low inflation, rate cut by the MPC and lower supply by the states. See US 10-year yield at sub 3% by March 2024E.

China outlook: Muddling through (Danske Bank)

After a strong start to 2023, economic data disappointed in Q2 and we have lowered our GDP forecast for this year to 5.8% from 6.2%. For the rest of 2023 our scenario implies muddling through with annualized quarterly growth around 41⁄2-5% underpinned by moderate stimulus. In 2024 our forecast is reduced to 4.8% from 5.0%.

•      The main engines of growth are set to be private service consumption and a gradual recovery in construction and private manufacturing investments. We expect export growth to remain weak as global goods demand stays soft.

•      While a leading role in many green technologies benefit China, a long list of medium term economic challenges are present, which creates uncertainty about China’s outlook. However, we still look for economic growth to be able to reach around 41⁄2% over the next 5-10 years due to a strong focus on investments in education and technology and continued support to the private sector.

•      Geopolitical tensions are set to continue with intense rivalry between US and China. However, we still see a low probability of war on Taiwan in the next 2-3 years as the costs of a war would be enormous for all involved parties. In the long term the risk is real, though. Look out for Taiwan election in early 2024.

New uncertainties: While China’s re-opening rebound in Q1 was stronger than expected, the recent economic data have slowed more than projected. In effect, we have lowered our forecast back below 6% for this year. Especially manufacturing and the housing market lost pace in April and May while the service sector has continued to grow at a more robust pace reflecting pent-up demand from the zero-covid lockdown years.

The bumpy road of the recovery leaves a high degree of un-certainty about the outlook. However, our baseline scenario is for policy makers to aim for growth around 41⁄2-5% rest of the year and that stimulus will be calibrated to hit this goal. The strong service sector activity is providing decent job growth and more support to wage growth, leaving a decent picture for household income gains. Hence we expect private consumption to continue to underpin a moderate recovery. The manufacturing sector is challenged by a weak external environment but moderate growth in investments and consumption is expected to underpin manufacturing growth at or slightly above potential growth. The construction sector is still struggling but we have witnessed a lift in home sales compared to the very low levels last year, and we should see this gradually feed through to a rise in housing starts.

In the medium term, there is little doubt that China’s potential growth rate has come down as China faces challenges on many fronts: high debt level in key sectors, falling labour supply, Western technology restrictions, geopolitical uncertainty and a difficult transition to consumption driven growth. Our baseline scenario is that China will be able to grow around 4% on average over the next 5-10 years. While clearly lower than in the past, it will still make Chinese economy significantly bigger and in our view lead to a rise in the middle class by 3-400 million people over the next decade.

Deficit monsoon and delay in kharif sowing, but not yet alarming (Nomura Securities)

First fortnight of June-23 witnessed monsoon deficit – 37% below the long period average (LPA). The onset of monsoon in 2023 was delayed by a week with Kerala receiving the first rain showers around 8 June-23. While the formation of cyclone Biparjoy resulted in surplus rainfall in the states of Gujarat and Rajasthan, it weakened westerly and south-westerly winds delaying the advancement of monsoon in Maharashtra (one of the key agrarian states in West India).

No impact in the north India region: North India agrarian states (such as Uttar Pradesh, Bihar, Punjab, Haryana, etc.) witnessed a large deficit to their LPAs; however, it is key to note that historically, the onset of monsoon in North India takes place in July and deficit monsoon conditions in June are a normal phenomenon in the region.

Pick-up in rains likely over next fortnight: India Meteorological Department (IMD) and Skymet weather team both have called for pick-up in rains over the second half of June-2023, with the advancement of monsoon in western and central parts of India; moreover, they have alluded normal monsoon conditions pan India during the first fortnight in July-2023.

Delay in kharif sowing, but not yet alarming: In 2023, the agriculture season witnessed some delay in rabi harvest in April; the delayed onset of monsoon has also resulted in some delay in the sowing of kharif crops. While the kharif sowing data for the first fortnight of June is much below 2022 levels, sowing activities are expected to pick up over the next 3-4 weeks with normalcy in monsoon conditions.

Strong reservoir levels to support irrigation: While over 65% of Indian agricultural lands are dependent on monsoon for cultivation of kharif crops (paddy, maize, soyabean, cotton, sugarcane, etc.), it is important to note that the reservoir levels are above the 10-year average and should play a crucial role if monsoon falters.

No signs of softness in consumer demand visible yet with delayed onset of

monsoon: While rural market demand has been showing signs of recovery over the past two quarters, the pace of improvement has been gradual due to the delay in agriculture activities. We note the full benefit of the harvest money is yet to be seen translating into product / consumer demand. Further, the stable / softening raw material prices have resulted in price cuts across all large FMCG categories; we believe this will likely act as a stimulus to drive volume growth in the rural markets. Hence, we do not expect any softness in consumer demand with no ebbing effect on sentiments due to monsoon conditions.

 

India Durables and Electricals (Jefferies India)

Softer offtake in Apr-May23, also impacted by unseasonal rains. But demand has improved in H1-Jun. Transition to new BEE norms is largely done for AC & Fans, and older inventory is liquidated.

Channel inventory is normal at ~3 weeks. No major price hikes in Q1, expect +1-2% in Cables & Wires (copper pass-through).

Changing Weather Patterns Influence Demand: We spoke to ~10 channel partners pan-India. Many cited weaker offtake in Apr-May23 due to softer consumer sentiment and unseasonal rains in many parts. But Jun'23 saw better demand for summer-centric products i.e. ACs, Coolers, Fans etc.

1) Fans market has now transitioned to new BEE norms. Sales have largely normalized, with higher shift to premium/BLDC models - increasing awareness for energy efficiency.

2) Cables & Wires demand stayed strong for most dealers, with minimal impact of pricing action. Offtake here is mainly driven by construction and capex / infra projects.

3) Washing Machines demand has not seen any material uptick in the last few months, with flattish sales YoY. Q1 (Summer) is seasonally weak qtr.

4) Appliances: Many dealers cited healthy demand trends, esp in Mixer Grinders, Chimneys and Hobs.

5) Water Heaters saw mixed trends with some dealers highlighting better offtake due to unseasonal rains. A few dealers cited higher inquiries, but unavailability of SKUs in summer season.

6) Weareables & Hearables demand good.

Inventory now Largely Normal: AC channel stocking commenced in Feb-Mar23. Muted traction in Mar (unseasonal rains) led to higher than normal inventory in Apr for most dealers, which subsequently declined in May-Jun as offtake improved. Now inventory is at normal levels (~3 weeks) for most dealers, as summer season ends. In Fans, inventory has normalized post BEE transition, wherein inventory of old models has largely liquidated.

Cables and wires inventory is currently normal level (~2 weeks), as supply is typically received

within a week for most dealers.

No Major Price Hikes in Q1: Post BEE transition, prices were hiked by avg 2-5% in new AC models and avg 5-8% in new Fan models in Q4FY23. Air Coolers have seen price hike of 3-5% at the start of summer season. But since then, there has been no material price hikes in Q1FY24, as many input costs have softened. With rise in LME copper prices (+5% from 10May'23), Cables & Wires category has hiked prices by avg 1-2% in May and more hikes could be seen in coming weeks.

Competitive Landscape: In ACs, post BEE transition, LG models are offering higher energy savings (technology) vs many peers. Lloyd (HAVL) sales have been good in price-conscious consumer segment. VOLT sales are healthy in the 1.0-1.5 ton category.

Retail fuel price cut an overhang for CGD stocks (Nirmal Bang Equities)

For the imminent cut in retail petrol/diesel prices. We believe this would reduce the tailwinds for OMCs. Such a cut also poses a risk to CGD companies as the latter would be forced to cut CNG pump prices to maintain CNG growth rate, which entails a sacrifice in EBITDA/scm. Such a cut and the steep YoY decline in GRMs could dent the potential upside to OMC earnings in FY24, implied at current juicy retail margins.

Impending cut in MS/HSD prices poses risk to CNG business outlook: The impending cut in MS/SHD pump prices is likely to eat into the cost savings offered by CNG over MS/HSD, currently at 40%/20%. This combined with the fact that the APM gas price is likely to remain fixed at the ceiling of US$6.5/mmbtu (GCV), as per the latest gas pricing formula, leaves no elbow room for CGD companies.

This leaves IGL and MGL vulnerable to either a hit on margins if they seek to maintain growth or cut in CNG volume growth assuming they aim to preserve margins. GGL is relatively less impacted as its share of CNG is under 30% vs more than 75% for IGL/MGL. If OMCs were to cut MS/HSD prices by Rs1-5/litre at current crude price levels, it implies 3.3-16.5%/2.3-11.3% hit on IGL’s/MGL’s FY24E EPS vs 1.3%-6.3% hit on GGL’s FY24E EPS – assuming the cut in CNG price from Aug’23 post 1QFY24 results of OMCs.

The steep correction in diesel spreads from muti-year highs by more than 50% to ~US$15/bbl combined with the decline in crude oil by 10.8% YTD and 34.5% YoY has resulted in average retail fuel margin surging to ~Rs7.2/litre in 1QFY24 vs ~Rs2.5-3/litre in 4QFY23 – petrol/diesel retail margin per litre is estimated at Rs5.2/Rs7.9. This is likely to support hefty growth in earnings for OMCs in 1QFY24, as per our first cut estimates, and perhaps in 2QFY24 as well, depending on when OMCs decide to cut pump prices of MS/HSD.

2HCY23 revival in China demand clouds retail margin outlook: IEA and other global oil watchdogs expect a revival in China’s economy to spur growth in oil demand ahead of supply in 2HCY23 and thereby boost oil prices. This is a concern cited by OMCs to go slow on the current demand for a cut in Indian retail pump prices, as a future rise in oil prices post such a cut could again put pressure on marketing margins and earnings for OMCs. NBIE Brent oil forecast for FY24E/FY25E is US$75/bbl and US$70/bbl. This compares with FY23/4QFY23 average of US$95.3/bbl and US$81/bbl. However, a recent Reuters report shows that diesel and petrol exports from China in May’23 were up 4x YoY to 0.6mn tonnes and by 67% YoY to 1.36mn tonnes, respectively. This is due to the persistent slowdown in China’s property/industrial sectors and refining throughput in May’23, nudging the record figure of 14.9mn bpd in March’23.

Volatile refining margins may find limited solace from Russian crude: The GRMs reported by OMCs are likely to see a significant decline YoY in FY24 due to the steep decline of 47.2% in diesel spreads to US$15//bbl in 1QFY24 from 4QFY23. Even with the share of Russian crude indicated at 15% in HPCL and more than 30% in BPCL/IOC, the implied savings of ~US$1.2/bbl to US$2.4/bbl is unlikely to reverse the YoY decline in GRMs. 1QFY24 petrol/diesel spread over crude is down 43%/60% YoY to US$15.5 per bbl/US$15.1 per bbl. The pressure on OMCs to cut prices overlooks the impact of declining oil and fuel spreads, which imply potential inventory losses that could eat into the gains in retail margins from the lower crude prices.

Textile: Global retailers underpin improved inventory position by EoY (JM Financial)

Global retailers continue to lighten their inventory position: Global retailers during their latest earnings have continued their efforts to reduce the excess inventory on books. GAP saw inventory decline of 27% YoY in the latest quarter and expects inventory to be down significantly more than sales as compared to FY22. TJX and Nike (apparel segment) given their sharp focus on liquidating excess inventory have been able to achieve lower inventory. Large retailers like Walmart, Target and Costco have also lowered their inventory given their cautious approach towards fresh procurement. The global demand outlook for CY23 continues to be soft.

Indian textile players expect demand revival from 2HFY24: Indian Home textile and apparel exporters expect demand to remain muted in 1HFY24 on account of excess inventory liquidation. Any normalisation of demand in CY24 amidst improved global retailers’ inventory position leaves headroom for export demand recovery by Indian exporters.

‘China + 1’ theme picking pace: China has been losing market share across the world (refer exhi. 3/4) apparel exports aided by rising labour costs and geopolitical tensions. This has led to a potential shift of exports from China towards other countries, creating new opportunities and growth in the other Asian countries for the apparel industry. Some of the biggest brands across the globe have already begun reducing their exposure to China over the past few years. We believe India’s competency across factor cost and a well-established textile ecosystem (across cotton segment) will allow it to benefit from the ‘China+1’ theme.

UK FTA offers additional growth opportunity: UK imports USD$24bn in apparel with India’s share a mere USD$1.4bn. In contrast, UK imports UD$4.5bn from Bangladesh and US$ 6.2bn from China. Indian players have lower market penetration in UK due to tariff disadvantages vs Pakistan, Turkey, and Bangladesh. However, FTA with UK will allow duty free exports to UK, improving India’s competitiveness. A ~20% market gain from China over the next 3-4 years is required to help India near double its exports to UK. Effective implementation of UK FTA could provide a clear runway for double digit revenue CAGR in case of Indian textile exporters over the coming decade.

Commodity deflation to aid margins: Decline in cotton / yarn prices over the last 12 months to the tune of ~40%/33% is likely to aid margins for Indian textile players. Lower demand and arrival of new crop are key reasons for the price correction. Further, improving scale in 2HFY24 will aid margin expansion for textile companies.

Stable duty regime and additional steps by Govt to aid the textile ecosystem: The scheme of RoSCTL that was effective from March 2019, has been extended till March 31, 2024 for exports of apparel/garments and made-ups in order to make the Indian textile sector competitive in the international market. The maximum rate of export rebate for apparel is 6.05%; while for made-ups it is 8.2 per cent. A stable duty regime is likely to benefit the sector. Further, additional initiatives like the PLI’s, Mega Integrated Textile Region and Apparel (MITRA) Parks Scheme and National Technical Textiles Mission will help in creating a conducive textile environment.

De-leveraged balance sheets offers room to chase growth: Indian textile companies have de-leveraged their balance sheet over the past few years offering room to chase growth expected from ‘China+1’ theme playing out and possible UK FTA.

Moderate valuation multiples leaves ample room for multiple re-rating: Textile companies currently trade at moderate valuation of leaving ample room for re-rating as when structural demand drivers (UK FTA/ ‘China+1’) kick-in.

Cement: Start of an upcycle (Antique Stock Broking)

FY24 volume growth could surprise—we now factor in 10% YoY growth Public capex (center, state, and PSUs) comprising 25% of total gross fixed capital formation (GFCF) is likely to grow at a healthy 23% YoY in FY24 (ahead of the upcoming Union Election), driving aggregate nominal GFCF growth by a robust ~14.8% YoY. Besides, housing demand recovery is likely in the midst of a multi-year upcycle. Accordingly, FY24 cement demand growth could surprise positively, in our view. With early cement demand trends suggesting near mid-teens YoY growth on a low base for 1QFY24 (5-yr. CAGR of 5.5%), most managements have likely extrapolated this trend and guided/ aspired for >15% YoY volume growth for FY24 during the 4QFY23 earnings call. We now factor higher 10% YoY (5-yr.

CAGR of 4.8%) demand growth for FY24 (vs. 8% earlier) to >440 mtpa leading to 3%-4% upgrade to our FY24-25E volume growth estimate mainly for large companies.

The third consecutive year of high demand (7%–10%), could drive utilization to a 14-year high Demand at 8.5% CAGR vs. 5% supply CAGR over FY22-24E would results in pan-India cement utilization inching up to a 14-year high of 77% and clinker utilization of 80% in FY24. South utilization could cross 65%, while ex-South utilization would inch closer to 84% after 14 years in FY24. Ex-South utilization (excluding 6 mtpa Sanghi and 9 mtpa JPA, which are non-operational/partially operational for FY24) is inching closer to 87%/ 88%. More importantly, our coverage universe as well as UTCEM's utilization increased from an average of 73%/74% during FY20-22 to 81%/83% in FY23 and is likely to inch up further to as high as 83%/88% in FY24-25.

Higher consolidation in the industry

The top 6 companies enjoy 80–85% capacity share across all regions except the South and with more capacity likely to be announced by large companies and with a couple of M&A transactions likely to consummate soon, capacity/market share of large companies is likely to increase further.

Costs side pressure to recede; cost efficiencies to further aid profitability

International petcoke and coal prices are down ~50%-60% from their respective highs and our recent interactions with a few coal traders/ experts suggest the possibility of a further downside. This could translate into cost savings of INR 250-300/ton in FY24. Besides, companies are focused on increasing the share of green energy, alternative fuels, logistic optimization, premiumization, etc. which could further aid profitability. We expect the average EBITDA/ton for our coverage universe to rise from <INR 800/ton in FY23 to ~INR 1,200 by FY25E and even higher beyond FY25E. Our FY24-25E EBITDAs are 5%-10% ahead of consensus. We factor <1% realization CAGR over FY24-25E and see an upside risk to our estimates.

Start of an upcycle; many stocks near life-time high: time to BUY or SELL?

In the past upcycle from FY03–10, industry average EBITDA/ton increased from INR 350/ ton to INR 1,050/ton. Even recently, average EBITDA/ton rose from <INR 900/ton in FY19 to INR 1,200/ton in FY21 aided by higher prices and lower costs. With improving demand, ex-South utilization now high at 84%, increasing capex costs (greenfield), receding cost pressure, higher consolidation and relative price inelastic demand, we remain positive on pricing and expect industry average EBITDA/ton to exceed INR 1,200 beyond FY25E. Long-term average price CAGR has been around 4% and we expect a similar trend to continue beyond FY25 driving increasing trend of EBITDA/ton.

Metals: Signs of revival fade; steel prices correct for the 9th consecutive week (MOFSL)

Long steel, which witnessed a pre-monsoon procurement last week, has come under pressure with prices correcting to Oct’21 levels. Ex-Mumbai benchmark primary long steel prices corrected INR900/t to settle at INR53,500/t.

Reduction in domestic demand from the project segment and a fall in global long steel prices due to weak global housing and infrastructure demand have dragged the domestic prices for long steel products.

Project segment customers are under ‘wait and watch’ mode and they are only undertaking ‘need-based buying’, which has plummeted the list prices further by INR1,000/t below the prevailing market prices.

Flat steel prices that had witnessed a slight uptick last week have been relatively flat WoW at INR55,400/t.

The domestic trade-level prices have inched up by INR300-400/t WoW; however, range-bound export prices have kept the overall prices under check. We had anticipated a price correction of INR1,500-2,000/t across the steel sector and the same is now fully priced in.

The arbitrary price gap in exports between India and China is currently around USD15-20/t (~USD100/t in May’23) and hence, we believe a majority of the downside has been factored in with no major price correction likely in the near term.

However, the near-term outlook remains volatile and highly monitorable with multiple mixed signals in the domestic and international markets.

I made a rudimentary assessment of the potential impact on the financial market, assuming the monsoon rains are inadequate and/or prolonged heat wave conditions persist over a large part of north and central India, as anticipated by the weather experts. In my view, investment strategy needs a tweak to make it ready for a hotter and drier summer.

Asset allocation

An inadequate monsoon would essentially mean (i) persisting higher food inflation; (ii) higher fiscal support to the rural sector; (iii) high food credit demand; and (iv) higher short term yields.

Raise some tactical cash

I shall therefore like to raise some tactical cash from my equity allocation and deploy it in short term or liquid funds. I however do not see any case for changing the strategic allocation at this point in time. A sharper than presently anticipated correction in equity prices will motivate me to increase my equity allocation to “overweight” from the present “standard”.

Sectoral impact

I am no expert in equity research or economics. I mostly manage my investment strategy by applying learnings from my travels; observation of behavioral patterns and public information about economic trends. From my experience of working with rural communities and traveling to hinterlands, I have observed some broad sectoral impact of a deficient monsoon. Few examples are listed below.

It is pertinent to note that inadequate monsoon usually does not mean a pan India drought. Hence, it is more likely that different regions (and regional players) experience a divergent impact of a deficient monsoon.

Farmers’ economic behaviour

In case of a deficient monsoon, farmers quickly adapt to “drought mode” – deferring discretionary spend, e.g., on marriages, jewelry, vehicle, pilgrimage etc. and changing to shorter cycle crops. In the past two decades a tendency is growing amongst farmers (especially the young ones) to defer paying their dues to government and lenders etc.

It is pertinent to note that as per the latest NSSO statistics over 50% agriculture households are indebted with an average outstanding debt of Rs74121. More critically, only 57.5% of loans taken by agriculture households are for agricultural purposes, the rest are for personal purposes.

Given that most of the rural population is now assured of free/highly subsidized food under various government schemes, the sustenance farming (growing for self-consumption) is gradually reducing. A substantial number of small and marginal farmers is moving to cash crops that have usually higher input cost. A crop failure thus causes more stress to small and marginal farmers as compared to a decade ago. The insurance coverage to these farmers is highly ineffective due to a variety of reasons; unclear land title being one of the major reasons.

Energy intensity of water

In case of deficient monsoon, the energy intensity of water rises materially, as farmers rely on exploitation of ground water. Though the use of solar power for ground water extraction has increased materially in the past few years; the reliance on the grid is still very high. If we add to this the increased household (mostly urban) demand for cooling, the demand for power usually rises significantly. The demand for diesel (and diesel genset) could also be higher to meet the additional load of water extraction.

Livestock

Livestock is worst affected due to rain deficiency. Poor winter rains have already created severe fodder shortages and rise in milk prices. The dairy and meat production could be further impacted by deficient rains – impacting the income of farmers and food inflation adversely.

Important to note that about 25% of agriculture GDP is contributed by livestock.

Labor migration

The demand supply equilibrium for farm labor usually shifts down during deficient monsoon seasons. The real wages could see a sharp decline. The labor migration towards non-agriculture jobs is also higher. The availability of unskilled labor for construction in particular rises materially.

Food transportation

Traditionally, deficient monsoon years used to witness significant rise in the quantity of food transported across the country as part of the drought relief work. However, given the fact that the public food distribution system is now adjusted to free food for almost 800 million people, the incremental food transportation may not be as significant as it used to be a decade ago. Nonetheless, there could be some additional food movement in case of a material divergence in spatial distribution of monsoon.

I would therefore consider the following in my overall investment plan:

Negative List

Farm input – agri chemical, fertilizers, seeds.

Rural consumption – jewelry, gold, footwear, alcohol, home upgrade, personal vehicles, etc.

Dairy, poultry and edible oil production

Cotton yarn

Close watch

Rural lending, especially microfinance

Farm equipment, especially tractors

Crop insurance

Construction

Water intensive industries like paper, alcohol

Sugar

Positive List

Short term bonds

Diesel genset

Air cooling appliances like Fans, Coolers, Air conditioners

It is pertinent to note that La Nina conditions are known to cause normal to above normal rains in India, while El Nino conditions are known to cause rain deficiency in India. Neutral ENSO conditions help a normal (+ 10% of long term average) monsoon.

In India La Nina conditions have prevailed during the past three monsoon seasons (2020-2022), resulting in good overall rains; though spatial (regional) and temporal (time wise) distribution of the rains was erratic causing floods in some regions and drought in some other regions. The most populated Gangetic plains are suffering from severe drought conditions since last summer.

Kharif (monsoon) crop sowing suffered due to delayed or deficient rains in many parts of the country. Besides, the 2022-23 Rabi season has witnessed deficient rainfall in most parts of the country (see here).

Even though so far El Nino conditions have not developed for India, some professional forecasters have predicted development of these conditions as early as June 2023, resulting in deficient monsoon rains in India. For example, the US government weather agency, National Oceanic and Atmospheric Administration (NOAA), has said that El Niño is expected to begin within the next couple of months and persist through the Northern Hemisphere spring and early summer.

Skymet Weather has said that “El Nino threat during the Indian monsoon 2023 is growing big.” It further said, “El Nino projection based on initial conditions of Feb 2023 is finding semblance with Feb 2018. Both are evolving El Nino, albeit 2023 appears to be stronger than 2018.  El Nino share starts with 30% in June, reaches 50% by July and climbs to >/= 60% during 2^nd half of the season.”

Admittedly, it may still be early to conclude about a deficient monsoon this year. Nonetheless, the erratic weather pattern and early onset of summers across north, central and western India is indicating prevalence of unusual weather conditions over the next few months. Obviously, this will have implications for the economy and therefore financial markets.

Economy and monsoon

Over the past seven decades the share of agriculture and allied activities in the overall GDP of India has consistently declined. Agriculture and allied services accounted for almost two third of India’s GDP at the time of independence; and now it accounts for less than one sixth. The proportion of population relying on agriculture and allied activities for their livelihood has also declined from about three fourth to two fifth. The declining importance of the agriculture sector in the overall economy has resulted in under investment in the sector over the past 3 decades in particular.

The importance of monsoon for the Indian agriculture sector has seen a steady decline. Self-sufficiency in the area of food grains broadly means that impact of a deficient monsoon is mostly limited to (i) temporary food inflation; (ii) financial stress for small and marginal farmers’; (iii) additional burden on fiscal condition (loan waiver and food subsidy); and (iv) consumption demand of the affected population. Adequate food grain stock and an effective public distribution system minimises the cases of starvation in case of drought.

Besides, in the past seven decades the crop area fully dependent on rains for irrigation has fallen from ~80% to 50%. Out of a total of 141 million hectare net sown area, only about 70million hectare is rain fed; the rest of the area uses water supplied by irrigation channels. (see Under the Shadow of Development: Rainfed Agriculture and Droughts in Agricultural Development of India, R. S. Deshpande, NABARD)

Regardless, drought can hurt some areas and some crops disproportionately. For example, in the state of Maharashtra still over 81% agriculture area is rain fed. Besides, rain-fed areas produce nearly 90% of millets, 80% of oilseeds and pulses, 60% of cotton and support 60% of our livestock.

Adequate water in reservoirs

As per the latest bulletin of the Central Water Commission (CWC) as on 02 March 2023, , the live storage available in 143 reservoirs is 93% of the live storage of corresponding period of last year and 116% of storage of average of last ten years. States of Odisha (-20%), Bihar (-38%), UP (-21%) and West Bengal (-44%) have water availability in reservoirs which is below normal range; while most other states have large surplus.

Regardless, the current storage is significantly lower than the total reservoir capacity in all the regions. Thus in case of a severe drought the hydro power generation as well as area irrigated through channels could also suffer.

 

I would like to review my investment strategy in light of the probability of a poor monsoon. I shall share my thoughts on this coming Tuesday.