Vijay Kumar Gaba

 The macro economic data released last week produced further evidence of the Indian economy struggling with stagflationary conditions; notwithstanding the denial by various authorities.

Inflation impact widening and deepening

The consumer price inflation date for the month of April 2022 was a negative surprise. The consumer prices escalated at a rate of 7.8% (yoy) during the month. The higher inflation was, to a large extent, a consequence of imported inflation which added almost 2% to the headline inflation number. Though, the inflation due to rise in domestic prices at 6.4% was also no comfort.

With worsening current account (and depreciating INR); continuing supply chain disruptions; protracting Russia-Ukraine conflict; extreme weather conditions and tight fiscal conditions (little chance of duty cuts) and rising cost of capital – it is unlikely that we shall see any material easing in prices in the next few months; even though the headline inflation number begins to ease from October 2022 due to statistical reasons, as the high base kick in.

Contracting consumer demand constricting the growth

On the other hand, the recent data about the growth in Industrial Production raised many red flags. The IIP growth for 4QFY22 has come at a dismal 1.6% (vs 2.1% in 3QFY22).

The consumer goods production (both durable and non-durable) contracted 4.3% in March 2022, recording its sixth consecutive decline. This clearly shows the stress in the consumer demand. Growth in capital goods was a poor 0.7%. Manufacturing growth in March was also poor at 0.9% yoy. 

Normalizing for the sharp dip in 2020 due to the pandemic induced lockdown and subsequent sharp spike in 2021, India’s Industrial Production has been dismal in the past decade.

Poor suffering the most

Notwithstanding the claims of some politicians, the poor seem to be hurt most by the rising inflation and slower growth. As per the latest NSO data, the inflation rate is much higher in most populous states like West Bengal (9.1%), Madhya Pradesh (9.1%), Maharashtra (8.8%), Uttar Pradesh (8.5%0, Odisha (8.1%0 and Rajasthan (8.1%). These states may be home to a large proportion of the poor population in the country.

Kerala (5.1%) and Tamil Nadu (5.4%) are suffering relatively much lower inflation.

Besides, the real interest rates have fallen deep into negative territory in the past couple of years, as monetary stimulus to mitigate the pandemic effects has brought the rates lower while inflation has stayed high. Obviously the poor savers and pensioners who rely on meager interest income for survival are suffering a great deal.

For the past two years, I have been highlighting to the readers of this blog that almost two third of the Indian population is experiencing conditions that qualify to be termed stagflationary. Their incomes have been stagnant or declining in many cases, while their cost of living has risen materially.

Stagflation is an economic environment with rapidly rising prices, a weak labor market, and low GDP growth.

The recent corporate commentary throws light on some important economic trends. These trends, which might have been developing for few years, are becoming more established on ground now.

The most discussed trend since demonetization (November 2016) and GST (July 2017) has been the transfer of market share from smaller unorganized businesses to the large organized businesses. Import substitution (Make in India) has been another trend that has gained significant currency in past 4-5 years. This has manifested most prominently in the capacity building in chemical and renewable energy space. These trends have obviously helped the larger publically traded companies to grow bigger and more profitable. The buoyancy in stock market, a representation of these larger companies, is aptly reflecting these trends.

One trend that has escaped the popular narrative and closer scrutiny is selective stagflation in the economy. We may say this is an integral part of the overall ‘K” shaped economic growth. The rising inequality and falling affordability of a larger part of the population has happened with sharp rise in prosperity in the top decile of the society.

The recent corporate commentary hints that this divergence in affordability might have started to impact their performance now.

Mass affordability worsening with rise in premiumization

As per a recent survey conducted by the brokerage firm Nomura Securities the affordability of mass segment has been adversely impacted, leading to slowdown in consumption demand. In the case of automobiles, the survey indicates that festive season sales for two-wheelers and entry segment cars have been slower whereas for premium segment (cars priced >INR 1mn, mostly SUVs) has been significantly strong as higher income segments continue to do well (SUV mix up from ~39% in FY21 to ~55% in Sep-21). The sharp price increase for vehicles since Mar-20 seems to have impacted affordability for the mass market.

In the case of Consumer segment, rural market growth for FMCG (as per Nielsen) has seen a substantial slowdown in Aug/Sep (+2.5% y-y) vs. Jan-Jul (+12.5% y-y). In contrast, urban consumption has held on much better due to the easing of restrictions. Since rural consumption is driven more by mass segments, poor affordability has likely hit the demand. On the other hand, urban consumption should benefit from re-opening-led recovery. In the case of Durables segment as well, while retail sales sustained healthy growth in July, the momentum has slowed substantially from August with likely low single-digit growth in Sept. In electricals, while housing sales have picked up, supported by a cut in stamp duty rates, they are still annualizing close to 2018-19 levels only.

The brokerage concludes that the prices of white goods/appliances have increased by ~10-15% and W&C by ~35% in the past one year. Current commodity prices (Aluminum and Copper) are further up ~20% q-q. Unless commodities/oil cool off, firms will face a difficult choice of raising prices further and risk demand impact or endure margins pressure. The brokerage believes latter is more likely.

…as consumption demand return to pre Covid levels

The brokerage firm India Infoline highlighted in a recent note that “FY22/23 sales for some consumer sectors can be higher than even previous pre-Covid estimates, as unaddressed demand, in addition to the normal demand, is fulfilled. We have seen this play out in paints, and believe that this is now unfolding in jewellery too. Further, this could also materialise, albeit to a lesser extent, in Apparel. While there is no pent-up demand in Grocery, a full normalisation is not built into the consensus estimates We believe that in QSR, though, significant normalisation is already built in.”

The note emphasizes, “Apart from market-share gains from the unorganised segment and

income impact on the target audience being lower than on the overall economy, return of unaddressed demand is a big factor in certain sectors.”

Inflation replaces the pandemic as risk in the Corporate commentary

The ongoing corporate quarterly results reporting season is progressing rather well. Most of the companies that have reported till now appear to have recovered from the Covid-19 pandemic shock. The business leaders appear to have gained market share. Balance sheets have strengthened with deleveraging and/or higher cash. The working capital management has improved sharply across businesses. This may reflect on slightly lower RoE for now. Margins are under pressure, as the companies have not been able to pass on the raw material to the customers.

Employee cost a mixed picture

The sectors like manufacturing and construction have witnessed cut in employee costs, whereas the IT Services etc. have seen rise in employee cost. Read with strong inflationary trends, this clearly indicates that a large section of population may be facing Stagflationary situation.

Rural vs Urban demand

The trends in rural demand growth vs urban demand growth are also mixed. For example, Colgate reported strong rural demand, while Nestle & HUL reported moderation in rural demand.

Market consolidation accelerates

Most market leaders emphasized focus on market share gains at the expense of profitability, while mid and small cap companies emphasized focus on protecting the profitability. Obviously, we are witnessing a shift from small to large in terms of market share.

Covid-19 no longer a key concern

The commentary for future prospects is much better this quarter, as compared to the previous 4-5 quarters. In the last quarter, most companies had highlighted the likely third wave of the pandemic as a key risk. However, in this season, the Covid-19 is not highlighted as a key risk by most of the companies which have reported so far.

Banks’ results have not shown any notable rise in stress on asset quality due to the pandemic; though credit growth remains below par.

Ecommerce and organized distribution channel growing fast

Most consumer facing companies have reported acceleration in growth in ecommerce channel.

Working capital improvement

Most companies are reporting substantial improvement in working capital due to better channel financing, efficient inventory management, internal controls, efficiency in collection, etc. This is reflecting on credit growth, especially short term borrowings from banks.

Highlights of corporate commentary

The following are some of the key results of the consumer facing companies, that are indicative of the underlying economic and industry trends.

Polycab India Limited (Wires, Cables, Home Appliances) – Earnings downgraded

The revenue for the quarter was 48% higher yoy, with cables growing 44%; Appliances growing 41% and EPC revenue was higher by 60% yoy.

Cable business, where the company is market leader, saw increased competitive intensity, as the demand environment was poor. Most of the revenue growth in cables was due to price hikes. Though the price hikes were inadequate to cover for the raw material inflation. Gross margins contracted sharply by 690bps while operating margins were down 510bps. PBT was down 7%.

The company was however able to gain market share across categories. The management emphasized that for now the focus shall remain on market share gain, rather than margin improvement. Accordingly, the management has guided for low double digit EBIDTA (11-13%) margins in the second quarter.

RoE of the company is expected to decline by 200bps in FY22 to 16.5% from 18.5% in FY21, despite marginal improvement in EPS. Working capital improved.

Havells Ltd (Wires, cables, lighting, switches, Appliances) – Earnings downgraded

Revenue grew 31% yoy, driven by (a) strong volume growth due to higher demand from real estate, industrial and infra segments; and (b) higher prices due to sharp rise in raw material cost. EBIDTA margins declined 340bps yoy, due to lag in taking price hikes to pass on the higher raw material cost. Steep cut in advertisement and promotion (A&P) cost helped in checking the sharp decline in margins.

The company reported market share gains from unorganized sector. The management expects the trend to continue. It also expects the margins to improve as price hikes are taken. Working capital improved.

Management buoyant on 2HFY22 prospects; though the rate of growth could be lower due to higher base effect.

Market feedback: Some MSME component supplier to the appliances manufacturers have reported significant order cancellations, delays in payment, and poor inventory levels at smaller and mid-sized OEMs. There are clear indications that the market consolidation trend may continue and accelerate in coming quarters.

Orient Electric (Consumer electronics) – Earnings retained

The company reported 37% yoy rise in revenue and 290bps lower EBIDTA margins. PAT was up 7%.

ECD segment margin were impacted due to steep rise in input costs, however, Lighting segment saw improvement in margins due to high growth in consumer lighting business. Discretionary spends was lower than normal, whereas expenses other than discretionary resumed to normal levels.

The management highlighted Strong recovery in B2C demand; unorganized share will shrink more with change in star rating. OEL will gain market share, backed by its strong team, brand, and distribution (increasing presence in south and rural India).

Working capital has improved due to better channel financing and internal controls.

Colgate-Palmolive (Oral Hygiene) – Earnings downgraded

Colgate reported 5% yoy rise in revenue with 4% rise in volumes. EBIDTA margin declined by 220bps due to higher raw material cost; employee cost and ad spend. The management expects the cost pressures to continue in 2HFY22.

The management apparently stays focused on market share gains rather than margins. Increased promotional intensity and new product innovation is driving volumes with lower realization.

The management does not see any pressure on rural demand, which continues to remain resilient. Market share gains continue, with strong penetration trends.

Nestle (FMCG) – Earnings downgraded

Revenue grew by 10% yoy, whereas EBIDTA grew 6% due to margin contraction of 90bps. Gross margins were down 240bps due to surge in raw material and packaging material prices. Lower employee cost checked the margin decline.

The company reported moderation in rural growth, while the urban growth remained resilient. The management stays focus on volume led sales growth with new sales channels and new capacities coming on stream.

Hindustan Unilever (FMCG) – Earnings downgraded

HUL reported a strong 11% yoy sales growth and 9% EBIDTA growth. Gross margins declined by 140bps, despite 7% price hike across portfolio. Cost savings helped cheking the margin decline, but raw material inflation is expected to continue to keep margins under pressure.

The management highlighted improving trends in urban markets, while the rural demand has moderated. The management feels that the rural demand moderation appears transient, but this could be a risk to growth ahead.

Tata Consumer Products (FMCG) – Earnings retained

Tata Consumer reported a yoy revenue growth of 9% YoY and EBITDA margin contraction of 70bp. The margins compressed mainly due to higher A&P and other expenditure.

Revenue in India Branded Beverages/Foods grew 13%/23% YoY. Revenue from Tata Starbucks grew 128% YoY.

The company managed to reduce its working capital days by 16 days in 1HFY22 as it has moved towards a cash and carry model for the general trade channel.

The company had gained market share in Tea (+190bp YoY) and Salt (+160bp YoY) in FY21. The trend continued in 1HFY22). It doubled its direct reach to 1.1m by Sep’21. The company is establishing a strong S&D channel, which would act as a key growth driver.

Jubilant Foodworks (Food) – Earnings upgraded

The company reported 37% yoy rise in revenue and 33% rise in EBIDTA. Lower staff cost helped in protecting the margins.

Delivery and takeaway continue to drive growth with 36.8% and 72.2% growth respectively vs pre-Covid levels. The Management commented that there was an initial dip in delivery as dine-in started to recover, but it still continues to be meaningfully ahead of pre-Covid levels.

Company highlighted meaningful demand uptick helped it to more than make up for lost operating hours in closed stores. Growth was seen across town classes, with stronger growth in smaller towns and non-metros; stores are now operational at ~95%.

The management highlighted that the Ticket sizes are higher compared to pre-Covid levels and company expects it to remain high due to change in channel mix (delivery mix to remain elevated even as dine-in normalizes) and increase in delivery charge. Apart, the company is also using premiumization and personalization to drive ticket sizes higher.

Kajaria Ceremic (Building material) – Earnings upgrade

The company reported a 36.6% yoy rise in revenue and 25.6% higher EBIDTA. The maker of premium tiles operated at full capacity, as unorganized players in Morbi struggled with higher gas prices and poor export demand due to higher freight cost.

The company managed to pass on the higher raw material and logistic cost; improved working capital materially.

The management commented that Demand from tier II/III/IV towns is very positive and urban demand is good owing to keenness for large premises. The company is expanding tile capacity by 12.4m sq.mtr. by Q4 FY22 at Rs2.5bn-2.75bn capex. Despite the expansion, the headcount will be the same for the next three years.

The management highlighted that Freight costs increased from $1500-2000/container to $7000-8000 for China whereas gas prices increased by 300-400% in Europe in the last 1.5 months leading to €1.5/sq.cm cost increase.

Asian paints (Building materials) – Earnings retained

Asian Paints revenue grew 32.6% yoy. The company witnessed strong growth momentum in both urban and semi urban areas. The company reported strong market share gains from both organized as well unorganized firms. It strongly expanded its ‘Rurban’ footprint by adding 40k new retail points in the past two years.

The management highlighted that Pick-up in industrial activities and housing construction have led to strong double-digit growth in the industrial coatings business and in the bath and kitchen businesses.

Margin pressure (gross margin down 966bp YoY in Q2) was high, due to sharp cost inflation (20% YoY inflation impact on raw material basket). However, if input prices remain stable, APNT is confident of improving margins in the next couple of quarters – It guided for margin normalization by Q4, led by price hikes, efficiency in raw material formulations and overhead cost savings.

The company also reported RoE contraction and working capital improvement.

Titan Company Limited (Consumer discretionary) – Earnings upgraded

Titan reported 64%.6% yoy rise in revenue and 209% rise in EBIDTA. Lower staff cost and other expenses protected the gross margins which were down 690bps.

Jewellery sales grew 65% YoY and margin was up 500bp YoY to 12.2%. Watches sales grew 71.8% YoY to INR6.9b with EBIT margin coming in at 13.1% in 2QFY22 as against -3% in 2QFY21.

The company is witnessing market share gains across every region and city according to the management. TITAN has a strong growth runway, given its market share of less than 10% and the continuing struggles faced by its unorganized and organized peers.

 As per the latest survey conducted by RBI, the Consumer Confidence in India remained at an all-time low level in September with the general economic situation worsening during the month. This data read with the dismal IIP growth (-8%) and elevated consumer inflation (7.34% highest since January 2020) indicates that (i) the recovery from lockdown is slower and belies the enthusiasm shown by some of the analysts and economists; and (ii) we shall struggle to reach the pre lockdown level of economic activity for at least 2 more quarters and any improvement in the growth trajectory normalized for lockdown impact may still be far away. Remember, the economic growth in India was declining much before the pandemic forced a complete lockdown in March 2020.

The key highlights of the Consumer Confidence Survey (September 2020) are as follows:

·         As per the survey, the consumer confidence (current situation) continued to slip for third successive month and is presently at all time low. Presently, the respondents perceive further worsening in general economic situation and employment scenario during the last one year. Though some improvement is expected a year later.

·         21% respondents reported curtailment in overall spending during the past one year, when compared with the last survey round. While 59.8% reported cut in non-essential spending.

·         Even though consumers expect improvements in general economic situation, employment conditions and income scenario during the coming year; the discretionary spending is however expected to remain low in the near future.

·         Households’ median inflation expectations remained elevated for both three months and one year ahead periods.

83% households reported rise in cost of living. 75.9% expect cost of living to rise further in next 12 months.

An astounding 81.7% household reported worsening of employment expectations in past one year. Though, 54.1% respondents hope that the employment conditions will improve in next one year. A significant 36.1% of respondents believe the employment conditions will worsen in next 12 months.

·         62.7% household indicated lower income in past one year; while only 8.9% reported higher income. 53.2% household expect income to rise in next one year, while 10% expect it to decrease further. Overall, 79.6% respondents felt that general economic conditions have worsened in past one year; while 34.8% respondents continue to believe that the conditions will worsen further in next 12 months. Only about 50% respondents believe the conditions to improve in next 12 months

Every day the stock markets in India (and other parts of the world also) are cheering the "positive data" and rising towards the previous highs. In my view, it may be a case of total cognitive dissonance. The market participants are selectively choosing the data that gives them hope of better days ahead; completely ignoring plethora of evidence indicating that economy is tottering on a long and winding road entering the dark woods with only scattered sunlight and no end in sight. Many experts have highlighted this case of dissonance between equity markets and economy, questioning optimism of investors and corporate managements. For example—

• The incumbent RBI governor Shaktikanta Das recently highlighted that "There is so much liquidity in the system, in the global economy, that's why the stock market is very buoyant and it is definitely disconnected with the real economy. There will definitely be a correction but we can't say when."

The minutes of the Monetary Policy Committee's last meeting also highlighting the regulators' concerns about the specter of stagflation, clouding the visibility of further rate cuts and also bringing on table the probability of change in RBI's accommodative stance over systemic liquidity.

• The former RBI governor (2008-2013) who sailed the Indian economy through the rough waters of global financial crisis also reportedly termed the recent positive macroeconomic as mere mechanical rebound, highlighting that India's short- and medium-term growth prospects continue to remain grim and the government should not read too much into the economic activity coming back from the depressed base of lockdown.

He categorically told PTI in an interview that "I don't believe we should read too much into the green shoots that you refer to. What we've been seeing is just a mechanical rebound from the depressed base of the lockdown; it will be misleading to see it as a signal of a durable recovery."

• The brokerage firm Kotak Securities highlighted in a recent research note that "certain high-frequency indicators show some level of stagnation—(1) diesel sales declined 19.3% in July 2020 versus 15.4% in June 2020; diesel volumes are a good indicator of freight movement and general economic activity, (2) daily e-way bills in August 2020 are 18% yoy lower versus 10% yoy lower in July 2020) and (3) electricity demand is still marginally lower in August 2020 than previous period level after being higher in the month of July 2020.

• As per a recent research note of Edelweiss Securities, "PMIs have moved up from all-time lows. However, this leading indicator is stalling now, showing the effect of state-level lockdowns and absence of demand stimulating fiscal support While market is cheering the denominator managed positive data, a number of experts are questioning the validity of green shoots."

• As per the brokerage firm, Nomura Securities, "medium-term outlook of lower inflation and the growth challenge remains largely unchanged – we estimate GDP growth to average -5.0% y-o-y in 2020 – falling to -15.2% y-o-y in Q2 2020 and recovering to a still-subdued -5.6% in Q3, -2.8% in Q4 and -1.4% in Q1 2021."

  Numerous other economists and strategists have also highlighted that growth trajectory may remain poor for longer. Surprisingly, the corporate leaders are not echoing this sentiment and are showing agreement with the political view of an imminent recovery! Either they are scared of speaking the truth or the experts are totally out of synch with reality. As Shakespeare said, "There are many events in the womb of time which will be delivered." I do not mind waiting for the labor pains to get over and the child be delivered. Till then, I shall stay cautious and conservative on my asset allocation (see here)