Vijay Kumar Gaba

Global Economics Intelligence executive summary, October 2023 (McKinsey & Co)

The global outlook is unchanged despite weaker readings in trade, consumer confidence, and business activity. Still-elevated inflation and interest rates are acting as headwinds to economic growth.

According to the International Monetary Fund’s (IMF) October World Economic Outlook, global growth is forecast to slow from 3.5% in 2022 to 3.0% in 2023 and 2.9% in 2024 (Exhibit 1). This is similar to April’s report, which forecasted global growth of 2.8% in 2023 and 3.0% in 2024. Furthermore, the October report states that, although the likelihood of a hard landing has decreased over the past six months, China’s property sector crisis could deepen. Near-term inflation expectations have increased and, in turn, could contribute to the persistence of core inflation pressures. Furthermore, more than half of low-income developing countries are in or at high risk of debt distress. The Conference Board shows that US real GDP increased by 4.9% in the third quarter. In the eurozone, third-quarter economic growth was weaker than expected, with GDP falling by 0.1% quarter-over-quarter (for a 0.1% year-over-year rise). In the emerging economies, China’s GDP growth in the third quarter slowed to 4.9% year-over-year (compared with 6.3% in the second quarter), reflecting the fading influence of the base effect. During this time, GDP expanded by 5.2%.

There are mixed signals from global trade. Exports rose for Russia and the United States but fell for Brazil, China, and the eurozone; imports increased for Brazil, Russia, and the United States but fell for China. In China, cross-border trade continued to decline in the third quarter, with a year-over-year drop of –10.2% (–6.0% in the second quarter), exports dropped by –10.8% in the third quarter (compared with a –5.4% decline in the second quarter). Imports decreased by –9.4% (–7.0% in the second quarter). In addition, the Container Throughput Index increased to 129.6 points in August, compared with the previous month (128.0 points revised). European throughput fell, while Chinese ports continued to strengthen.

Overall consumer confidence declined, primarily due to elevated interest rates. Notably, households in Brazil are the exception because they remain more inclined to spend than save. On this point, consumer confidence in Brazil increased to 97.0, the highest reading since February 2014. By contrast, confidence deteriorated in the eurozone, dropping 17.8 after recovering from last year’s historic low. The United Kingdom also saw steep decline. There, the cost-of-living crisis, a slowing jobs market, and the uncertainties posed by the conflict in the Middle East are contributing to a growing unease in consumer sentiment. The view is a bit more nuanced in India. The sales growth for September was 9% year-over-year, which suggests that consumer sentiment remains optimistic, despite economic uncertainties.

The manufacturing sector has been in contraction for 13 consecutive months. In the eurozone, purchasing managers’ index (PMI) numbers for manufacturing remain in contraction primarily because of declining demand.

Similarly, momentum in services is weakening, with most countries experiencing either stagnation or contraction (only India and Russia are exceptions). In the United States, the services PMI decreased to 50.1 (50.5 in August). 

Q2FY24 Review: In-line earnings despite topline miss (Elara Capital)

Earnings growth continue to be fueled by domestic cyclicals

Aggregate topline performance of Elara coverage universe (235 stocks) disappointed, up just 3.6% YoY, falling short by 2.6% versus our expectations. Earnings growth of 65.8%, however, was in-line, led by Energy. Ex-Financials EBITDA margin stood at 17%, expanding 609bps YoY and 10bps sequentially.

A 6.3x profit surge for Energy, led by oil marketing companies (OMCs), spiked earnings of Elara coverage universe by 66% for Q2FY24. Excluding Energy, earnings growth was healthy at ~32%, primarily led by domestic cyclicals sectors such as Auto and BFSI.

Earnings for Auto, ex-Tata Motors, grew 57.4%, led by a combination of better product mix, lower commodity costs and operating leverage.

Earnings growth for BFSI was broadly in line, owing to steady loan growth and robust asset quality even as margins compressed further.

Elara Cement universe reported double-digit YoY volume growth for the second quarter. A YoY uptick in realization and a YoY drop in operating cost (due to normalization of fuel cost post the spike during the Russian-Ukraine war) sharply improved YoY margin.

Beat-to-miss ratio improved to 1.1x in Q2

Within Elara coverage universe, 36% of the companies saw earnings beat (actual results exceeded estimate by >5%), while 32% of the companies saw an earnings miss. The beat-to-miss ratio improved marginally from 1x in Q1 to 1.1x. This uptick was primarily driven by Banks, Industrials and Metals that outperformed expectations.

Diving deeper, large-cap companies demonstrated stronger resilience, with a beat-to-miss ratio of 1.5x. Mid-caps also fared better with a ratio of 1.4x. But small-caps underperformed with a beat-to-miss ratio of 0.8x.

Earnings see upgrades but breadth low

We raise FY24E earnings expectations for Elara coverage universe by 3.3%. Commodity-oriented sectors saw the highest earnings upgrade of 9.1%, but the breadth of revision remained concentrated in Energy and Cement. Industrials and Real Estate were the other notable sectors to see healthy earnings upgrades, while Metals and IT were the main laggards, with 60% and 36% of the companies seeing earnings downgrade.

We increase our earnings growth expectations for FY24E by 3.3ppt to 35.7% and for FY25E by 2.8ppt to 11.9%.

Twenty-two companies have seen ratings upgrade post Q2 results, of which six are large-caps. Seventeen have seen ratings downgrade. Within large-caps, Tata Motors, Ambuja Cements, Bharat Petroleum, ONGC, Cholamandalam Investment and Larsen & Toubro have seen a ratings upgrade, while SBI Cards and Payment Services and Tata Power have seen a ratings downgrade, in Q2.

Quant Research: Mean-reversion and momentum – a dynamic duo (Kotak Securities)

There are two major driving forces in financial markets: mean reversion and trend. We have written at length about momentum portfolios. In this note, we look at how to create mean-reversion portfolios. We try to strip the stock-specific return component from the total returns of the stock and run the mean-reversion strategy on it. We divide our universe into different clusters and create a long-short portfolio that picks stocks from each cluster.

Mean reversion and momentum

Mean reversion and momentum are the two major driving forces in financial markets. Mean reversion is the tendency of recent winners to underperform and recent losers to outperform. On the other hand, momentum is the tendency of the winners to continue to outperform, while the losers continue to underperform. We have written in detail about momentum in the past (Strength in Diversity). In this note, we use similar principles to create a mean-reversion portfolio.

Focusing on stock-specific returns help

While constructing a mean-reversion here, we use stock-specific returns only. The key idea is that returns that are not affected by the key market themes (e.g., re-opening after Covid-19 lockdowns, some sectors catching a tailwind, ‘value’ stocks having a strong recovery) are more likely to revert. To strip out the stock-specific returns, we use a technique called Principal Component Analysis (PCA). PCA is a statistical method used to reduce the dimensionality of data by identifying the most significant patterns and relationships among variables.

It achieves this by transforming the original variables into a new set of uncorrelated variables called principal components. This process aids in identifying the key factors driving variability and facilitates a more straightforward analysis of the underlying structure within the data. We also divide the universe in clusters and pick the best-performing stock from each cluster in the short portfolio and the worst-performing stock in the long portfolio. The portfolios are weighted in the inverse of the stock volatility, giving higher weight to lower-volatility stocks. While constructing the long-short portfolio, we short 0.8 units of the short portfolio for a 1-unit long.

Long-short mean-reversion portfolio delivers consistent returns

The long-short mean-reversion portfolio delivers close to 12% annualized returns with a volatility of 12%. These returns are uncorrelated to the market. In addition, there has been only one calendar year where the returns of the long-short mean-reversion portfolio have been negative. The long-mean reversion portfolio outperforms the index significantly, delivering 18.2% annualized returns, compared to 10.2% annualized for the Nifty-50 index. When we combined the optimized momentum long-short portfolio as described in Strength in Diversity with the mean-reversion long-short portfolio, the combined portfolio delivers ~12% annualized returns at 7.5% volatility.

Logistics: Continuous optimism in sight (ICICI Securities)

Q2FY24 was a mixed bag. Key points: 1) Rail companies trumped surface express companies. 2) Volume growth across companies. 3) Street raises TPs for BlueDart Express (BDE), CONCOR and Gateway Distriparks (GDI), but slashes for Mahindra Logistics (MLL) and VRL Logistics (VRL). 4) Street lowers EBITDA estimates for all companies. 5) Post- results, stock reaction was best for CONCOR but subdued for MLL and VRL. We believe that earnings for most of the companies in this space could improve in Q3FY24 with the quarter being dotted with festivities. Additionally, we will keep an eye on the EXIM trade imbalance.

A mixed big

Performance of the companies under our coverage was mixed with rail companies having a distinct edge over surface express ones. Key points: 1) Shipments/volumes increased across all the companies, especially, BDE (up 13.6% YoY), VRL (up 8.4% YoY) and CONCOR (up 7.6% YoY). 2) Profitability improved for all the companies under coverage, except MLL and VRL. 3) In the case of ICDs/CFSs, weakness in EXIM volume (overall) and EXIM imbalance remain key concerns, though the demand scenario is improving.

Overall, we saw both profit margins and volume inching up across the companies (predominantly for CONCOR and BDE) though VRL’s performance was subdued, mainly due to delayed festive seasons. The companies across the spectrum retained their volume guidance for FY24 and expect Q3FY24 to be better owing to the festive season.

Street’s post-earnings moves

Post-Q2FY24 earnings, while Street has trimmed FY24 EBITDA estimates for most of the companies, especially MLL (12.4%), FY25 EBITDA estimates have been broadly retained, except for MLL (slashed by 8%). Similarly, TPs (largely based on FY25E performance) have been cut by 6-7% for TCIE and MLL, but, raised by 6% for CONCOR. In our view, street’s raised multiples for CONCOR and BDE are possibly due to better growth outlook; albeit reduced slightly TCIE‘s case.

Our post-earnings stance

We are now more positive on the industry as margins have seemingly troughed for most of the companies under coverage and volume growth will likely remain healthy. Except notably for CONCOR (up 8.6%), factoring in the sharp upswing in its domestic business.

NBFCs: Customer acquisition driving growth; asset quality healthy (ICICI Securities)

New customer acquisition has gathered pace post covid and, more specifically, it has accelerated during the past six months. This is reflected in 6mn unique borrower addition between Dec’22 and May’23, implying a monthly run-rate of 1.2mn customers’ vs 0.7mn between Mar’22 and Dec’22. As a result, bulk of incremental AUM growth during the past one year was driven by new customer acquisition and flattish average ticket size. AUM grew 18% since Mar’22, of which growth driven by new borrower stood at 16% and the rest 1% was contributed by an increase in the outstanding per borrower. Notably, underlying asset quality trend continues to be robust as reflected in PAR 30-90 DPD bucket at system level of 1% as of May’23.

New customer acquisition gathers pace

Incremental growth in industry has been largely driven by accelerated new customer acquisition since Mar’22. MFI industry has witnessed robust 18% AUM growth between Mar’22 and May’23, of which 16% growth was driven by new customer acquisition. As a result, outstanding per borrower broadly remained flat at ~INR 50,000 between Mar’22 and May’23. During covid phase (Mar’20-22), AUM grew 11% and was entirely driven by higher ticket size as reflected in outstanding per borrower increasing to INR 50,000 by Mar’22 from INR 40,000 in Mar’20, implying an increase of 12% between Mar’20-22.

New customer acquisition run-rate increased to 1.2mn per month between Dec’22 and May’23 from 0.7mn per month during Mar-Dec’22. Unique borrower base at industry level increased to 70mn by May’23 vs 58mn in Mar’22 and 59mn in Mar’20. Net borrower base between Mar’22 and Sep’23 has grown by highest 23% for Fusion, followed by 13% for CA Grameen and 10% for Spandana.

Underlying asset quality trend continues to be robust as reflected in

collections (ex arrears, including NPA) at ~97-98% ...

Collection efficiency remained robust in FY23 and sustained in Q2FY24. Broadly, collection (ex arrears but including NPAs) remained at around 97%-98% with collections for CA Grameen at 98.7%, Spandana at 97.7%, Utkarsh at 97%, Fusion at 95.5% and Bandhan at 94%. Robust collections also led to PAR 1+portfolio (ex Bandhan) settling at average 3% with 1.3% for CA Grameen, 2.6% for Ujjivan, 3.2% for Satin, 3.4% for Spandana and 6% for Utkarsh.

...except Punjab and Haryana

While collection efficiency remained robust across states, industry data suggests Punjab and Haryana are facing some challenges as reflected in PAR >30 increasing to 6.6% by Jun’23 from 6.3% in Mar’23 for Punjab and 5% from 4% for Haryana. PAR >30 for rest of the states has either improved or remained flat QoQ between Mar’23 andJun’23.

Our view

Cleaner balance sheet, negligible stressed asset pool as of Jun’23 and revised MFI regulations (removal of pricing cap and mandatory comprehensive bureau report) would continue to act as strong industry tailwinds going ahead.

Chemicals: 2H to be better than 1H – Unanimous guidance (Centrum)

Q2 was a disappointing quarter all across the chemicals segment however agrochemicals results were a mixed bag. Severely impacted by demand weakness in exports markets coupled with pricing pressure, chemical companies reported their weakest performance in past several quarters. China dumping slowed down, however inventory destocking still continued in global market impacting the exports performance. Agrochemicals, reported mixed performance and were impacted by dry spell in August. Fluorochemicals too suffered from export demand weakness coupled with pricing pressure. ECU decline continued in Chlor-Alkali segment with average ECU at ~Rs26,000/ MT. In Q2, on 2^nd August, domestic Soda Ash prices were revised downwards by ~6% to Rs29,800/ MT (Tata Chemicals). Soda Ash prices averaged at ~Rs30,400/ MT while demand was impacted due to increasing imports particularly from Russia, US, and Turkey. For chemicals sector some pain from exports market may prevail in Q3FY24E due to lean inventories by global companies. However, generally managements unanimously guided 2HFY24E to be better than 1H.

Management comments on operating environment

RM environment – High cost inventories are largely exhausted during 1H and now the low cost RM shall start reflecting in financial performance. China dumping has slowed down, however, volatility due to volatile crude prices still remains.

Energy/ power/ coal costs – Power/ coal costs have again started moving up which were on a downward trend since past few quarters. Utilities cost has thus started going up slowly. Both domestic and international logistics costs have been normalised.

Exports – Exports remained under pressure in Q2 as the global inventory destocking continued. However, the destocking in chemicals is now approaching the end and normalised demand shall start in near future. Agrochemicals still faces inventory challenges and is likely to remain under check at least for the next couple of quarters.

CRAMS/ CSM/ Fluorochemicals – Fluorochemicals demand in exports market suffered in Q2 and prices also remained under check. CRAMS/ CSM other than fluorochemicals reported mixed performance.

Agrochem – Erratic rainfall and dry spell in August impacted demand for agrochemicals during the Kharif season. Pricing pressure due to lower generics prices globally too impacted overall performance. Some agrochemical companies witnessed good demand for their products with leaner channel inventories while others suffered from higher channel inventories coupled with pricing pressure in certain generic molecules.

Operating performance of Chemical companies in Q2FY24

Total 38 (excl. Tata Chemicals) – Gross margins (GMs) contracted 128bps QoQ and 54bps YoY signifying some pricing pressure despite lowering RM cost inflation. EBITDA margins contracted 25bps QoQ primarily impacted by GM pressure. Despite YoY contraction in GMs, EBITDA margins expanded 61bps YoY signifying benefits from lower opex including lower energy, power, fuel, and logistics costs

Large 17 (excl. Tata Chemicals) – Gross margins contracted 103bps QoQ and 173bps YoY while EBITDA margins contracted 45bps QoQ and expanded marginally by 6bps YoY

Mid-size 14 – Gross margins contacted 14bps QoQ while expanded 75bps YoY (benefit from YoY RM cost deflation). Lower operating costs led to EBITDA margin expansion by 101bps QoQ and 171bps YoY

Small 7 – Gross margins expanded 117bps QoQ while contracted 229bps YoY, EBITDA margins expanded 68bps QoQ while contracted 221bps YoY

Operating performance of Agrochemical companies in Q2FY24

Total 10 (excl. UPL) – Gross margins expanded 318bps QoQ while contracted 76bps YoY while EBITDA margins contracted 71bps QoQ and marginal 6bps YoY

Financial performance in Q2FY24

Total 39 chemical companies – Revenues declined 9.3% YoY impacted by demand challenges and pricing pressure, however remained flattish QoQ. EBITDA declined significantly by 20.4% YoY led by operating deleverage. Sequentially too EBITDA declined 6.5% impacted by demand issues particularly in exports market. PAT plummeted 30.3% YoY while 6.2% QoQ

Steel: India imported highest steel in Oct’23 in one year (Centrum)

The steel price in domestic market was able to hold its ground while China was facing demand slowdown leading to fall in prices. This resulted a premium of >10% compared to landed cost of imports from China and South Korea. Due to huge profitable arbitrage, buyers preferred imported steel over domestic and hence total steel imports in October 2023 stood highest at 0.73mt in last one year. Currently, the difference has closed down to just 1.7% over landed cost of imports.

Steel production in China has declined for the fifth month in a row; below 80mt mark first time in 2023 In October 2023, Chinese steel companies scaled back their steel production by 3.7% MoM/1.8% YoY, reaching a total output of 79.09 million tons. China steel production is consistently reducing highs of 95.7mt in March-2023. Steel production in the country fell majorly due to soaring iron ore and coking coal costs along with dampness in demand from real estate sector.

International iron ore price shoots up despite demand weakness in China; China iron ore inventory at 7 years low Iron ore price has been above USD100/t throughout CY2023. Further, despite bleak demand outlook owing to stress in housing, it has surged to 8 month high and is up by 10% MoM. The primary reason is due to falling demand, the supply chain stayed away to build inventory while steel production remain steady and is up 2.5% YoY YTD resulted into iron ore inventory touched 7 year low to 105mt in mid-November. Along with series of stimulus efforts and recent announcement of selling 1 trillion yuan bonds for infrastructure projects boosted demand recovery prospects and supported sharp surge in iron ore prices. Concerns over disruption in supply due to possible strike in BHP Australia has also played its role. However, uncertainty on demand recovery, steel production cuts and any steps taken by government to curb spike in prices could add bearish risk for the iron ore market.

ArcelorMittal expects Europe steel consumption to turn negative in CY23 ArcellorMittal expects Europe’s apparent steel consumption to further degrade in Q4CY23 and can end in negative growth territory for 2023. The steel consumption is expected to be below bottom end of its forecast between 0.5% decline and 1.5% growth due to weak demand and construction activity. Although, global ex China apparent steel consumption is expected to remain on positive front of 1-2% in 2023.

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.

July CPI Inflation Jumps to 7.4% on Food Prices (CARE Ratings)

Retail inflation has sustained its upward trajectory for the second consecutive month, surging to 7.4% in July from 4.9% in the previous month. Consequently, the Consumer Price Index (CPI) inflation has breached the Reserve Bank of India's (RBI) target range for the first time since February 2023. This marks the highest reading observed since the peak in April 2022 at 7.8%. The notable surge in vegetable prices and elevated inflation in other food categories such as cereals, pulses, spices, and milk have driven this increase. Notably, the contribution of food and beverages to the overall inflation has risen significantly to 65%, surpassing their weight in the CPI basket.

Specifically, vegetables alone have contributed nearly 30% to the headline inflation figure, despite having only a 6% weight in the CPI basket. Encouragingly, the core inflation has moderated to 5.1% in July, down from 5.3% in June, thereby falling below the headline inflation rate for the first time in four months.

Concurrently, the data on wholesale inflation released earlier today showed the continuation of the deflationary trend. The wholesale price index contracted 1.4% in July. The divergent trend between the two inflation measures is primarily because of the compositional differences. WPI inflation is largely influenced by global commodity prices which have been on the declining trend. Furthermore, in comparison to the CPI basket, the WPI basket gives nearly one-third of weightage to food items. Consequently, any fluctuation in food prices has a greater impact on the CPI inflation.

Food and beverages inflation (CPI) surged to 10.6% in July, the highest in about 3.5 years. Within the group, inflation in sub-groups such as cereals (13%), milk (8.3%), pulses (13.3%) and spices (21.6%) continued at elevated levels. However, the main culprit for the upswing in food inflation was a significant increase in vegetable prices during the month due to a combination of factors including high temperatures, erratic rains and virus outbreaks. Additionally, flooding in certain areas due to heavy rains also resulted in transportation and logistical challenges adding to the price pressures. Vegetables witnessed a 37% (y-o-y) inflation in July from a marginal deflation during the previous month.

Way Forward

Even though the rise in vegetable prices is transient, the sustained price pressures in categories like cereals, pulses, spices, and milk can keep food inflation elevated in the near term. Higher food prices for longer could impact households’ purchasing power and dent consumer sentiment. This could have a bearing on the growth prospects, especially amid external headwinds and uncertainty regarding rural recovery. The RBI is aware of these challenges and will closely monitor these evolving trends to decide on its future policy course.

However, given the supply-driven nature of these inflationary pressures, RBI has limited space to act. Hence, the government’s timely supply-side interventions are essential to close the supply-demand gap before the upcoming festive season.

Though the moderation in core inflation is reassuring, the possibility of elevated headline numbers in the upcoming months has pushed the expectation of a rate cut by the RBI to the next fiscal.

 

Goods trade deficit widened in July (Kotak Securities)

July goods trade deficit widened to US$21 bn while the services surplus remained firm at US$12.3 bn. In FY2024, we continue to see the current account buoyed by a narrowing goods trade deficit, and steady services surplus. However, we see non-oil imports being relatively stronger than nonoil exports and, hence, revise up our goods trade deficit estimate. We revise our FY2024 CAD/GDP estimate to 1.4% (from 1% earlier).

Lower oil exports weighed on July exports; non-oil exports marginally higher Exports in July contracted 16% yoy to US$32.3 bn (June: US$34.3 bn), led by a sharp fall in oil exports to US$4.6 bn (June: US$6.8 bn). Non-oil exports increased only marginally to US$27.7 bn (June: US$27.5 bn)—lower by 8.3% yoy (Exhibits 3-5). Non-oil exports were propped up by engineering goods, and organic and inorganic chemicals (Exhibit 6). Further, in 4MFY24, engineering goods were the top export, followed by gems and jewelry, and organic and inorganic chemicals (Exhibit 7). The sharp fall from July 2022 reflects the impact of lower commodity prices and gradually weakening global demand.

Imports remained broadly steady in July July imports, at US$52.9 bn (June: US$53.1 bn), declined by 17% yoy. Non-oil imports were higher at US$41.2 bn (June: US$40.6 bn), but it was offset by lower oil imports at US$11.8 bn (US$12.5 bn). Non-oil imports were buoyed by electronics and machinery imports, while gold imports contracted sequentially (Exhibit 6). Further, in 4MFY24, main imports were electronic goods, machinery, coal, coke and briquettes, and gold. Consequently, the July trade deficit widened to US$20.7 bn (June: US$18.8 bn). The trade deficit in 4MFY24 stood at US$77 bn (4MFY23: US88 bn)

Credit-Deposit Ratio Falls, HDFC Merger Pushes Credit Growth (CARE Ratings)

Credit offtake continued to show robust growth, increasing by 19.7% year on year (y-o-y) to reach Rs. 148.0 lakh crore for the fortnight ending July 28, 2023. This surge continues to be primarily driven by the impact of HDFC’s merger with HDFC Bank, as well as growth in personal loans and NBFCs. Meanwhile, if merger impact is excluded, credit grew at a lower rate of 14.7% y-o-y for the same fortnight.

•      Deposits too witnessed healthy growth, increasing by 12.9% y-o-y for the fortnight (including the merger impact). On a pro forma basis, deposits grew by 12.3% y-o-y during the same period. The growth in deposits has not been at the same pace as credit since the larger proportion of liabilities of HDFC was by way of borrowings rather than just deposits.

•      The outlook for bank credit offtake remains positive, with a projected growth of 13-13.5% for FY24, excluding the merger's impact.

•      Deposit growth is expected to improve in FY24 as banks look to shore up their liability franchise and ensure that deposit growth does not constrain the credit offtake.

•      The Short-term Weighted Average Call Rate (WACR) stood at 6.39% as of August 04, 2023, compared to 4.72% on August 05, 2022. Banking system liquidity remained in surplus through the month, at an average monthly surplus of around Rs 1.7 lakh crore in July. A temporary provision of incremental cash reserve ratio for SCBs was introduced to manage liquidity, CareEdge Economics expects this new measure to absorb liquidity worth Rs 1 lakh crore from the system which is also likely to impact short term rates.

The outlook for bank credit offtake remains positive, supported by factors such as economic expansion, increased capital expenditure, the implementation of the PLI scheme, and a push for retail credit. CareEdge estimates that credit growth is likely to be in the range of 13.0%-13.5% for FY24, excluding the impact of the merger of HDFC with HDFC Bank. The personal loan segment is expected to perform well compared to the industry and service segments in FY24. However, elevated interest rates and global uncertainties could potentially impact credit growth in India.

1QFY24 Results Review

Motilal Oswal Securities (MOFSL)

After a solid 23% earnings CAGR over FY20-23, Nifty posted 32% earnings growth in 1QFY24, a beat vs. our expectations of 25%. MOFSL Coverage Universe recorded the highest earnings growth in the last eight quarters, fueled by domestic cyclicals, such as BFSI and Auto. Healthcare has made a strong comeback with 24% earnings growth after six consecutive quarters of flattish earnings.

·         MOFSL Coverage Universe recorded the highest earnings growth in the last eight quarters, fueled by domestic cyclicals (such as BFSI and Auto). BFSI coverage universe recorded a 60% YoY profit growth while Auto posted a significant profit of INR179b (vs. a profit of INR13b only in 1QFY23). OMC's profitability surged to INR305b in 1QFY24 vs. a loss of INR185b in 1QFY23 due to strong marketing margins. Healthcare made a strong comeback with 24% earnings growth after six consecutive quarters of flattish earnings. Around 15 of 21 sectors have either met or exceeded expectations.

·         We raise our FY24E Nifty EPS by 2.5% to INR988 (earlier: INR964) due to notable earnings upgrades in TTMT, JSTL, Bharti, SBI, and KMB. We now expect the Nifty EPS to grow ~22%/16% YoY in FY24/ FY25

The beat-miss dynamics: The beat-miss ratio for the MOFSL Universe was largely balanced as 36% of the companies beat our estimates, while 38% missed estimates at the PAT level. For MOFSL Universe, however, the earnings upgrade to downgrade ratio has also been a bit unfavorable for FY24E as 66 companies have reported earnings upgrades of >3%, while 76 companies’ earnings have been downgraded by >3%. EBITDA margin of MOFSL Universe (ex-Financials) rose 330bp YoY to 17.6%.

Heavyweights drive the quarter: Earnings performances of both MOFSL Universe and Nifty were led by heavyweights. The top five companies within MOFSL Universe contributed 84% to the incremental YoY accretion in earnings (three OMCs contributed 59%, followed by SBI – 13% and Tata Motors – 12%). Similarly, within Nifty, five companies (BPCL, SBI, Tata Motors, HDFC Bank, and ICICI Bank)

Key sectoral highlights – 1) Technology: IT Services companies reported weak performance in 1QFY24 with flattish median revenue growth QoQ in CC, in an otherwise seasonally strong quarter. The weakness in key verticals continued through 1Q with BFSI and Retail reporting a median USD revenue decline of 1.2% and 0.4% QoQ, respectively. 2) Banks: The banking sector posted a mixed 1QFY24, driven by healthy loan growth and sustained improvement in asset quality; however, margin trajectory reversed due to a sharp rise in funding costs. 3) NBFCs – Lending: Most of the NBFCs (except HFCs) reported a sequential contraction in NIM, surpassing our initial projections. For a majority of the NBFCs, the principal reason behind this NIM compression was the substantial increase in borrowing costs. 4) Auto: The quarter saw upgrades for FY24E largely to factor in the benefits of better gross margin, thus aiding overall profitability and commentaries related to a sequential improvement in exports. 5) Consumer: The overall performance of MOFSL Universe was a mixed bag with a few companies reporting healthy volume growth while others posted healthy value growth during the quarter.

The top earnings upgrades in FY24E: JSW Steel (34%), Tata Motors (28%), Dr Reddy’s Lab (15%), Bharti Airtel (13%), and M&M (10%).

The top earnings downgrades in FY24E: Tech Mahindra (-10%), UPL (-7%), Tata Steel (-5%), Apollo Hospital (-5%), and HUL (-4%).

 

China: PBoC cuts rates amidst data weakness (ING Bank)

Rate cuts show that concern is mounting The 15bp cut to the medium-term lending facility (MLF) was unexpected. Almost all forecasters expected China's central bank, the PBoC, to wait until September to cut again. MLF lending volumes of CNY401bn were in line with expectations. The PBoC also cut the seven-day reverse repo rate by 10bp, which now stands at 1.8%.

The market responded abruptly. The CNY rose to close to 7.29 immediately after the decision, though eased lower soon after. And 10Y Chinese bond yields dropped about 6bp to 2.56%. From a macro perspective, today's policy decisions are somewhat helpful. They will help improve the debt-service ability of cash-strapped local governments and property companies. But this isn't a game-changing outcome, and so we doubt that market sentiment will dramatically improve just on this.

Activity data remains extremely poor The activity data release contained no bright spots, and quite a few downside surprises. Perhaps the worst of these was the 2.5% YoY growth in retail sales. This has declined sharply from an admittedly base-effect inflated 18.4%YoY growth rate in April as the re-opening briefly led to a retail sales surge. Now the idea of a consumer-spending-led recovery is looking very vulnerable. In year-on-year terms, industrial production slowed to 3.7% YoY, from 4.4% in June. Year-to-date, production growth remained at 3.8% for the second month. Property investment slowed at a faster pace in July, falling at an 8.5%YoY pace, weaker than the 7.9% YoY decline achieved the previous month. Property sales growth also slowed to almost a standstill in July, rising at only 0.7% YoY YTD, down from 3.7% in June. And fixed asset investment slowed to 3.4% from 3.8% YoY YTD. Topping all of this off, the surveyed unemployment rate rose to 5.3%.

What does this mean for policy?

The question of the day based on the number of times it has been posed to this author is "Does this mean the PBoC will undertake Quantitative Easing (QE), and if so, when?" At the current juncture, QE does not seem to be the right response to what we are seeing. Nor does a large dollop of fiscal stimulus.

China is undergoing a painful transition to a less debt-fuelled, less property-centric and more consumer-driven economy. An "emergency" policy like QE that primarily inflates real and financial asset prices does not appear to have a strong role to play here. QE would also put the CNY under further weakening pressure, which it is very clear the PBoC does not want and would make it much harder for them to manage the CNY. It would also raise the risks of capital outflows, which they will also be keen to avoid.

More policy measures will be needed and more will certainly be delivered. The PBoC has not ended the rate-cutting cycle yet, and there will be further iterations of policy rate cuts along the lines of what we have seen today.

As for government stimulus policies, these, we think, will tend to be along the lines of the many supply-side enhancing measures that we have already seen. The way through a debt overhang is not to print more debt, though it may be to swap it out for lower-rate central government debt, or longer maturity debt to ease debt service. Enhancing the efficiency of the private sector will also play a key role, though this and all the supply-side measures will take a considerable time to play out.

The tiresome chorus clamouring for more stimulus is unlikely to stop in the meantime. And we will continue to see weak macro data for the foreseeable future. It is a necessary part of the adjustment and is far preferable to resurrecting the debt-fuelled property model that propelled growth previously. But we do need to lower our expectations for China's growth.