Cook your own meal

Have you ever been to the vegetable market after 9:30 p.m.? The market at 9:30 p.m. is very different from the market at 5:30 p.m.

At 5:30 p.m., the market is less crowded. The produce being sold is good and fresh. The customer has a larger variety to choose from. The customer is also at liberty to choose the best from the available stock. The vendors are patient, polite, and willing to negotiate the prices.

As the day progresses, the crowd increases. The best of the stuff is already sold. Prices begin to come down slowly. The vendors now become a little impatient and less polite and mostly in "take it or leave it" mode.

By 9:30 p.m., most of the stuff is already sold, and poor-quality residue is left. The vendors are in a hurry to wind up the shops and go back home. The prices are slashed. There is a big discount on buying large quantities. Vendors are aggressive and very persuasive.

Customers now are mostly bargain hunters, usually the small & mid-sized restaurants, caterers, and food stall owners. They buy the residue at a bargain price, cook it using enticing spices and oils, and serve it to the people who prefer to eat out instead of cooking themselves, charging much higher prices.

The cycle is repeated every day, without fail, without much change. Everyone complains, but no one tries to break the cycle. Implying that all participants are mostly satisfied.

A very similar cycle is repeated in the stock markets.

In the early cycle, good companies are under-owned and available at reasonable prices. The market is less volatile. No one is in a hurry. Smart investors go out shopping and accumulate all the good stuff.

Mid-cycle, with all top-class stuff already cornered by smart investors, traders and investors compete with each other to buy the average stuff at non-negotiable prices. Tempers and volatility run high.

End cycle, the smartest operators go for bargain hunting. Strike deals with the vendors (mostly promoters and large owners) to buy the sub-standard stuff at bargain prices. Build a mouth-watering spicy story around it. Package it in an attractive color and sell it to the latecomers and lethargic at fancy prices.

The cycle is repeated every time, without fail, without much change. Everyone complains, but no one tries to break the cycle. Implying that all participants are mostly satisfied.

If my message box is reflecting the market trend correctly, we are in the end cycle phase of the current market cycle. I get very persuasively written research reports and messages projecting great returns from stocks that no one would have touched early cycle or mid-cycle.

The stories are so persuasive and the packaging so attractive that I am tempted to feel "it's different this time." But in my heart, I know for sure, it is not!

If you are tempted to say that I have been saying this crap for almost two months now, I agree unashamedly with no regrets whatsoever.

Have a look at the top 50 price gainers at BSE in the past six months. The earnings of most of these companies are not congruent with the rise in market price. In some cases, it has been even lower. The stories are truly enticing and even inspiring in some cases.

Out of 8500 odd BSE listed companies for which data is available, over 5000 reported negative or marginally positive EBIDTA in the last results. More than 1000 companies trade at EV/EBIDTA higher than 25. In the early cycle more companies trade at lower PE ratios.

Make your own assessment of what I am trying to say.

Time to clear bills and take inventory of cutlery

 The latest G20 Summit, hosted by India ended on a cheerful note. Apparently, most delegates and dignitaries enjoyed the Indian hospitality, especially the colorful ambiance and brilliant food. It was perhaps for the first time ever that a host country added so much festivities to a G20 summit. The city was virtually shut down to control traffic, minimize air pollution, and allow safe passage for the delegates.

Overall, the theme appeared similar to the famous three-day-long fat Indian wedding. The guests were welcomed in the same manner as a traditional Indian household would welcome a bridegroom’s family. They participated in a variety of events, unrelated to the G20 geo-economic agenda. The main venue of the summit (Bharat Mandapam) was decorated like a grand marriage pandal with colorful lighting, décor, traditional dancers, and all welcoming staff dressed in fine attires.

The bride’s family displayed its finery (UPI, rich culinary traditions, classical architecture, colorful attires, traditional dances etc.) to impress the guests.

Like all weddings, we had mixed experiences with the guests. Adorable younger Jija ji (Prime Minister Sunak) gave many couple goals to millions of Indians. Rebellious cousin (Prime Minister Trudeau) was mostly ignored. Slimy phupha (President Biden) was given top attention but he still chose to ridicule the host and criticize sharply as soon as left the country (press conference in Hanoi within hours of leaving India). The son of the elder brother (Russian foreign minister Lavrov) was delighted to have a valuable return gift (no explicit criticism of Russian aggression in Ukraine). The son of the sulking elder Jija (Prime Minister Li Qiang) also did not complain much. The friends and other relatives (German, Australian, French, Arabs, Indonesian, Brazilian etc.) generally appeared pleased with hospitality or at least had the decency to not show any displeasure. The distant poor relative (representatives from the African Union) appeared awestruck by the opulence. Now that the wedding is over and the guests have departed, it is time to clear the bills and take inventory of the cutlery.

In my view, the key achievements of the summit could be listed as (i) a consensus joint declaration that calls for greater global cooperation to tackle, inter alia, the critical issues of climate change and acts of transborder hostilities; thus avoiding any conflict with the major constituents Russia and China; (ii) conceptual agreement to build a trade corridor connecting Indian sub-continent with Middle East Asia and Europe; and (iii) announcement of a global biofuel alliance.

It may be pertinent to note that Bali G20 declaration of 2022 also skirted the issue of naming Russia and China as aggressors. The Belt and Road Initiative (BRI) of China has not yielded many positive results so far while entailing significant financial and social costs for the stakeholders. The International Solar Alliance (ISA) conceived jointly by India and France in 2015, which now has over 116 countries as members, took a long to show any quantifiable outcomes. So, the benefits for India would depend upon how fast and effectively we build on these initiatives.

Insofar, as the enhancement of India’s stature in the global order is concerned, I believe that it has been a secular trend for the past two decades, and this summit would just help in sustaining that trend. I do not visualize any major upward shift in this trend merely due to G20 summit.C

Mice chasing the pied pipers

 In the past few days, I have picked up many red flags that have further strengthened my conviction that the markets may be running far ahead of fundamentals. In my recent posts, I have pointed out how the market participants have been extrapolating events like ISRO Moon mission (see here).

For example, the following three occurrences underline greed's dominance and gradually permeating irrationality in investment decision-making.

1.    Recently, one popular finfluencer tweeted a list of some small and micro-cap stocks highlighting that their market cap is less than their current order book. Many of these stocks witnessed heightened buying interest, apparently from small household investors, following the tweet. The message was fervently circulated on other social media, like WhatsApp. I received the message through at least nine forwards from different sources.

All forwards appeared to endorse this seemingly manipulative message. No one on social media questioned the correlation of market cap (or enterprise value) with the order book. No one bothered to highlight the sudden jump in the order book, not substantiated by the overall economic activity. No one bothered to check the margin profile of orders received.

In fact, there are many instances in the market where the stock rises 10-15% just on the news of receipt of an order. One mega-cap company’s stock rose 5% in a day on the back of a news item that the company may have received two orders worth US$4bn from a foreign entity, to be executed over the next five years. The annual execution of this order would be less than 3% of the company’s annual revenue, and the margin profile of the order is still unclear. In the past, such orders have not been too profitable for the company.

2.    On August 10, 2023, the Prime Minister, replying to the debate on the no-confidence motion, said in jest that stock market investors should invest in PSUs, which have been criticized by the Opposition parties in the past. Most PSU stocks registered material gains after the PM’s statement (see here). A case in point is the share price of a trading public sector company, which has incurred operating losses in the past four quarters. The share price of this company rose over 80% within three weeks after the PM’s statement.

3.    A large reputable brokerage yesterday sought to caution the market by dropping its midcap recommended portfolio. The brokerage noted, “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.”

A strategy note released by the brokerage highlighted that “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 small-cap and mid-cap indices recorded strong gains yesterday, mostly ignoring the caution to the wind.

Fx cover – some red flags to be watched closely

 The total foreign exchange reserves of India stood at a comfortable US$594.8bn; appx 16% of the estimated FY24 nominal GDP of US$3.6trn. To put this number in perspective, in the last twelve months, India’s trade deficit (Export-Imports) was US$229bn. For FY23, the total current account deficit was US$67.1 while net receipts of capital account were US$57.9bn.

Notably, the forex reserve position of India has not changed materially in the past five years. The forex reserves of India stood at US$422.53bn at the end of FY18, appx 16% of FY18 nominal GDP. The reserves peaked in September 2021 at US$642bn as Covid-19 induced lockdown resulted in the collapse of trade. The recent low was recorded in October 2022 (US$531bn). Since then the Reserve Bank of India has recouped over US$60bn of reserves, bringing the reserves to a comfortable position.

For records, the forex reserves broadly include foreign currency assets (89%), Gold (7%), Special Drawing Rights (3%), and reserve position in IMF (1%). The share of USD or US denominated assets in total forex reserve is usually 60 to 70%; similar to the composition trade invoicing of India. Hence, USDINR movement impacts the reserves materially. 

The forex reserve movement during FY23 has however highlighted a few red flags that need to be tracked closely, especially in view of the slowing global economy (cloudy export outlook), rising energy prices (rising import bill) and shrinking US-India yield differential (pressure on USDINR exchange rate).

·         FY23 The Current Account Deficit of India increased to US$67.1bn against US$38.8bn for FY22.

·         Net capital account receipts were lower at US$57.9bn vs US$86.3bn in FY22. Foreign Direct Investment (FDI) was lower at US#28bn vs US$38.6bn in FY22. Foreign portfolio investment remained negative (-US$5.2bn) after an outflow of US$16.8bn in FY22

·         External Commercial Borrowings were also negative (-US$8.6bn) against a net ECB inflow of US$8.1bn in FY22.

·         High cost NRI deposits (+US$9bn vs US$3.2bn in FY22) were notable contributors to the capital account.

·         INR exchange rate weakness contributed negatively to the overall reserve position for the second consecutive year.

A major global credit event may not put India in a crisis situation like 2008 or 2013. Nonetheless, a significant deterioration in the reserve position may put pressure on the INR exchange rate, credit spreads, and bond yields.

Statistics – good for discussion, not necessarily for investment

 I indicated yesterday that I see markets fast moving to a point where it becomes worrisome. The argument for fresh buying or taking a leveraged position is vitiating every day. The sentiments of Greed (making some quick money) and Fear (of missing out on a rally) are already beginning to dominate the conventional wisdom, in my view.

To put things in perspective, the latest market rally, particularly in the broader markets, was driven initially by a combination of macro improvements and undervaluation. But now most of the macro improvement seems to be tiring. In fact, it is very much possible that during 2HFY24 we may actually see some of the macros like growth, twin deficit, consumption and investment growth, gradually deteriorating.

On a micro level, the earnings upgrade cycle might peak with 2QFY24 results; and we may actually see some downgrades occurring due to poor rains (poor rural demand); further clouding of global demand outlook; margin compression for banks; and the rise in raw material prices (chemicals and metals); etc.

The current valuations are close to the long-term averages and leave little margin for error whatsoever.

As a broader benchmark, under the current interest rate and inflation expectation scenario, a conservative investor like me would be comfortable with a PER between 15-25 for non-cyclical businesses. For cyclical commodity businesses, the comfort would end in an 8-10 band.

I am usually not comfortable valuing asset-heavy businesses with relatively longer and unpredictable revenue cycles on price to book (P/B) or replacement cost basis; because it goes against the principle of going concern. If at all these businesses might be valued at Net Realizable Value (NRV) for limited purposes of judging solvency conditions.

Evaluating financial stocks purely on the basis of net book value is also mostly not a good idea. It is also important to consider the profitability and reliability of the book for corroborative evidence.

These days any query on a corporate database would throw a long (ominously long) list of stocks trading at EV/EBIDTA ratio of over 20. (EV = Market capitalization plus Net Debt; and EBIDTA is earnings before interest, depreciation and tax). It is even scarier to read research reports early in the morning which find stocks with EV/EBIDTA ratio of 20+ as attractively valued.

In case you find this blabbering of mine too academic, I agree. Whenever I suffer from indecisiveness or I am confounded, I go back to textbooks in search of a solution.

In my view currently, the following three are the primary drivers of equity prices in India:

(a)   Hope of material improvement in corporate earnings. The rise in public expenditure (both revenue and capital) and hope of revival in rural consumption is fueling the earnings upgrade. Though not completely baseless, in my view, hopes of 18%+ earnings CAGR in FY24-25 may not materialize. The prices may therefore have crossed over the line of reasonableness; though still not entered in the territory of bubbles.

(b)   Incessant flow of domestic funds. Still low equity exposure of domestic investors, even after a significant rise in the past three years, is motivating many investors and traders.

On valuation, there is another rather strange argument being relied upon heavily.

Many analysts and fund managers have argued that the current PE ratio of Nifty is much below the peaks seen in previous bull markets, and therefore, the market is nowhere close to a bubble territory. This could be a valid argument on aggregate levels and thus relevant to the investors investing solely in Nifty ETF or Index funds.

Investors who are investing mostly in broader markets need to assess the valuation of their respective portfolios. Anecdotally, I find that the individual portfolios are presently highly skewed toward the very richly (or crazily) valued stocks. These investors may need to restructure or re-balance their portfolios rather urgently.

Remember, the average life expectancy in India is close to 70yrs. This definitely does not mean that people below 60yrs of age need not take care of their health as they are not likely to die anytime soon!

Déjà vu

My discussions with a variety of market participants in the past couple of weeks indicate that we are at a stage in the market cycle when the investors and analysts begin to change their valuation arguments. Extrapolation of one-quarter performance to the next ten years, “story” pages of corporate presentations, political visions of growth, etc. begin to dominate the assumptions in the valuation matrices. Three to five years of forward earnings are being considered for arriving at twelve-month price targets.

My experience of the past three and half decades suggests that this kind of deviation always leads to mispricing of stocks and eventual sharp corrections.

It is important to remember that the return on the investment in publicly traded equities is a function of three factors: (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend.

The earnings growth is a function of multiple factors, e.g., (a) capacity (production capability); (b) demand environment (market leadership); (c) competitive landscape (pricing power, cost advantage); (d) innovation and technology advantage; (e) resource availability (raw material, labor, capital, managerial bandwidth, etc.), etc.

Price-earnings ratio (PER)

The price-earnings ratio (PER), one of the most popular equity valuation criteria, is the ratio between the earnings of a company and its market value. It broadly signifies that at the current rate of earnings how many years it will take for the company to add the value that an investor is paying today. Principally, an acceptable PER for a company's stock is defined by (a) the return on equity or capital employed (RoE or RoCE) a company is able to generate on a sustainable basis and (b) the growth rate of earnings that could be achieved on a sustainable basis. A company that could generate higher RoE/RoCE consistently and is likely to grow faster, is usually assigned a higher PER as compared to the ones that generate lower RoE/RoCE or have low or highly cyclical earnings growth.

Re-Rating

A rise in PER, if not commensurate with the rise in earnings profile needs deeper scrutiny. Sometimes the rise in PER occurs due to correction in anomalies (undervaluation) of the past. This is a welcome move. Sometimes, PER changes (re-rates) due to relative forces, e.g., a rise of PER in comparable foreign markets or a change in the return profile of alternative assets like bonds, gold, real estate, etc. This is usually unsustainable and therefore a short-term phenomenon. Many times, demand-supply mismatch in publicly traded equities also drives the re-rating of PER (excess liquidity chasing few stocks and vice versa). This is again usually a short-term phenomenon.

Dividend

A sustainable rise in dividend yield could be a sign of improvement in (i) profitability; (ii) stronger financial position (B/S improvement by deleveraging); and/or (iii) stronger cash flows. In some cases, however, it could reflect stagnation in growth. Investors need to assess the reasons behind higher dividend yield before getting lured by it. A higher dividend for lack of growth/reinvestment opportunities would often lead to the de-rating of PER, thus reducing overall return for investors.

Some notable research snippets of the week

Growth steady; sequential momentum decelerates (Nirmal Bang Institutional Equities)

Early data for July’23 suggest that 68.8% indicators were in the positive territory on YoY basis, up from 65.6% in June’23. Final data indicates that 70.8% indicators were in the positive territory in June’23.

On a sequential basis, 31.25% indicators were in the positive territory in July’23, down from 37.5% in June’23. Final data indicates that 45.8% indicators were in positive territory in June’23.

Rural recovery remains mixed, although July’23 did see a dip in rural unemployment, aided by a pick-up in monsoon. The Manufacturing sector remains resilient despite some sequential deceleration. In the Services sector, formal job creation is under pressure while traffic indicators witnessed a sequential deceleration.

Rural recovery mixed: Rural unemployment moderated to 7.9% in July’23 from 8.7% in June’23, aided by pick-up in monsoon and kharif sowing activity while urban unemployment rose marginally to 8.1% in July’23 from 7.9% in June’23. Central government’s expenditure was growth supportive in June’23, up by 17.3%YoY and 31.9%MoM. Tractor sales were up by 6.2%YoY in July’23 but declined by 40.5%MoM.

Meanwhile, 2W sales declined by 7.2%YoY and 3.7%MoM in July’23. On the other hand, Passenger Vehicle sales were up by 19.2%YoY and 6.9%MoM in July’23 while Commercial Vehicle sales grew at a muted pace of 3.2%YoY and declined by 2.7% MoM. Overall, Motor Vehicle sales declined by 2.3%YoY and 1.6%MoM in July’23.

Manufacturing resilient: The S&P Manufacturing PMI continued to hold up at 57.7 in July’23 vs. 57.8 in June’23. Manufacturing, as measured by the index of industrial production (IIP), grew by 3.1%YoY in June’23 vs. 5.7% in May’23 and declined by 1% MoM. Capital Goods production was up by 2.2%YoY and 4%MoM in June’23 while Capital Goods imports grew by 9.7%YoY and 15.5%MoM, implying sustained capex recovery. External sector headwinds persisted, with a sustained decline in exports and imports. Exports declined by 15.9%YoY while imports declined by 17%YoY and Non-oil, Non-gold imports declined by 12.1%YoY in July’23.

Formal jobs under pressure; traffic indicators decline MoM: The S&P Services PMI sustained at an elevated level of 62.3 in July’23 vs 58.5 in June’23. Traffic indicators sustained their downtrend on MoM basis despite some improvement from June’23 on YoY basis. Rail freight traffic was up by 1.5%YoY in July’23 after a 1.9% decline in June’23. Air passenger traffic was up by 24.4%YoY July’23 vs. 18.8% in June’23 while major port traffic was up by 4.3%YoY in July’23 vs. 0.4% in June’23. Diesel consumption was up by 3.9%YoY while petrol consumption was up by 6.2%YoY in July’23, but both sustained their decline on MoM basis. GST E-way bill generation was up by 16.4%YoY and 2.2%MoM in July’23.

The Naukri Jobspeak Index declined by 18.8%YoY in July’23, indicating pressure on the formal services sector. Non-food bank credit growth (ex-HDFC merger) slowed marginally and stood at 14.8%YoY in July’23 vs. 16.4% in June’23. The credit-to-deposit ratio stood at 74.6% in July’23 vs. 75.1% in June’23. While deposit rates continue to rise, lending rates (particularly MCLR) are flattening out. 

Utilities (JM Financial)

In an endeavour to improve our understanding of the emerging contours of development in India’s power sector amidst the tri-axial relationship of Climate change, Energy security and Economic growth, the first week of Aug’23 was truly enriching. We got the opportunity to meet senior officials from MNRE, CERC, CEA, SECI, NHPC Ltd. and SJVN Ltd. in Delhi in addition to hosting CMD & Directors of NTPC Ltd. in Mumbai. Our discussions were largely oriented towards the future of coal, developments around power markets, growth momentum in renewables, perspective on hydropower, knowing more about pumped hydro storage and the emergence of wind and nuclear on the ‘To Do List’.

Now, we know that the pumped hydro storage projects (PSP) have received unprecedented support from policymakers and the private sector. The 2,700MW of capacities (1,200MW Pinnapuram, 1,000MW Tehri, 500MW Kundah) are expected to be commissioned by 2025.

Projects totalling over 70GW are in various stages of finalisation (pre-construction). Capacity addition is likely to gain traction from 2027 onwards. We could sense the CEA’s confidence in exceeding 19GW of capacity addition by 2032. CEA looks at energy storage in totality, and PSP (19GW by FY32E) and BESS (39GW by FY32E) as the two ways to achieve it. Any shortfall in BESS (and a shortfall is increasingly becoming evident given sticky cost, lack of technology maturity and import dependence) is likely to increase contribution from PSP going forward.

NHPC, through its JV NHDC Ltd, plans to construct a 525MW PSP near Indira Sagar Dam, Khandwa, Madhya Pradesh using the existing reservoirs Indira Sagar and Omkareshwar of its Indira Sagar hydropower project.

During the last decade, India has seen an annual run rate of a meagre 700-800MW of hydropower generation capacity additions. We could sense a lot of enthusiasm among NHPC, SJVN and CEA (Hydro group), as the country is likely to have around 10GW of hydropower capacities in the next 5 years.

The government has been pushing central utilities (NTPC, NHPC, SJVN, SECI) to enhance their renewable portfolio beyond their respective core businesses. To our pleasant surprise, there appears to be constructive competition among central utilities in bagging more solar/wind projects (while remaining profitable, as they claim).

India is firmly committed to meeting its global commitments towards climate change. So, the government remains focused and determined to enhance the share of renewables in the energy mix while addressing the challenges of grid stability, power availability and affordability.

The consistent increase in solar power capacity in the generation mix requires the share of variable power and energy storage to improve, going forward. The addition of wind helps in addressing part of the problem by increasing CUF from 20-25% for solar and 30-35% for wind to 45-50% for SW hybrid power projects. MNRE is evaluating comments from various stakeholders on the draft Wind Repowering Policy. Attempts are being made to issue the revised policy soon, making repowering financially attractive for the original owners of the high-potential wind sites.

It was interesting to know that stray cases of renewable power curtailment in India are largely due to financial reasons and not due to technical issues like grid balancing as generally believed. The outstanding dues of discoms towards gencos are no longer a concern. However, in some of the places, we could read between the lines that it may suppress the demand for power in future.

We can’t wrap up the interactions during our Delhi visit without touching upon the most debatable and uncertain factor, i.e., coal, (still) the king of the power sector. Recent weather events (Himachal floods), the unseasonal rains during 1QFY24 and a relatively dry spell during 2QFY24 have led to large variance in power supply vis-à-vis the plan. During 1QFY24, hydropower generation from NHPC/SJVN declined YoY by 3%/23% despite a 1.3% increase in power demand. Similarly, the CUF of Torrent Power’s wind plants declined to 30.5% in 1QFY24 from 33.4% in 1QFY23 due to the Biparjoy cyclone in Gujarat. Such uncertainty in 6 CUF – Capacity Utilisation Factor power generation from non-coal power plants and global experience post-Ukraine crisis is gradually building momentum to kick-start coal-fired capacity additions. We heard that there has been an increase in the number of reviews on this issue by the ministry in recent months.

Accordingly, NTPC is targeting to order 7.2GW of thermal capacity by FY25. Recently, coupling in power markets has been under discussion across the sector. We also broached this issue with various officials to get a sense. To encourage active participation of other players in the power exchanges remains the priority. However, the government is evaluating various mechanisms given the operational and technical challenges in implementing any new structure.

Thermal power: Momentum is gradually building to kick-start coal-fired capacity additions. We heard that there has been an increase in the number of reviews on this issue by the power ministry in recent months. Accordingly, NTPC is targeting to order 7.2GW of thermal capacity by FY25.

Pumped hydro storage (PSP): Projects totalling over 70GW are in various stages of finalisation. Capacity addition is likely to gain traction from 2027 onwards. We could sense the CEA’s confidence in exceeding 19GW of capacity addition by 2032. Any shortfall in BESS5 is likely to increase contribution from PSP going forward.

Hydropower: India is likely to add around 10GW of hydropower capacities in the next 5 years from an annual run rate of a meagre 700-800 MW during the last decade.

Wind power: MNRE is evaluating comments from various stakeholders on the draft Repowering policy. Attempts are being made to issue the revised policy soon, making repowering financially attractive for the original owners of the high-potential wind sites.

Discom dues: The outstanding dues of discoms towards gencos are no longer a concern. However, in some of the places, we could read between the lines that it may suppress the demand for power in future.

Market coupling: The government is evaluating various mechanisms given the operational and technical challenges in implementing any new market structure. However, they are committed to encouraging broad-based participation. This was also echoed by CMD and Directors of NTPC during our interaction.

India re-designing – from charkhas to chips (Phillips Capital)

India's semiconductor industry, including software, AI, and hardware, is set to outpace global growth. The market is expected to reach US$ 110bn, at a CAGR of c.22% from FY20 to FY30, contributing 10% to the global semiconductor market by FY30.

As India’s aims for electronics production worth c.Rs 103.7tn (US$ 1,120bn) by FY32, with a major contribution from mobile phones, PCBA, IT hardware, etc, we expect India to develop as a strong manufacturing ecosystem. It shall be supported by the following factors: (1) China+1, (2) increasing government initiatives, (3) major investment announcements by MNCs, (4) huge exports opportunity, and (5) OSAT being the new growth driver. Indian EMS companies are foraying into backward integration (like OSAT/ATMP, Fabs, design, semicon, silicon) – this will lead to significant opportunity both in domestic + export market. This will also cause working capital to improve – with the component ecosystem developing in India.

Government allocated a fiscal support of c.Rs 2,550bn (US$ 30bn) for electronics manufacturing, out of which c.Rs 850bn (US$ 10bn) is towards developing the semiconductor ecosystem (display, fab manufacturing, OSAT, etc.). 

Credit Offtake Remains Robust, Deposit Growth See a 6 Year High (CARE Ratings)

Credit offtake continued to grow at a similar pace sequentially, increasing by 19.7% year on year (y-o-y) to reach Rs. 148.8 lakh crore for the fortnight ended Aug 11, 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 14.8% y-o-y fortnight compared to last year.

•      Deposits too witnessed healthy growth, increasing by 13.5% y-o-y for the fortnight (including the merger impact). 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 6.68% as of August 18, 2023, compared to 5.09% on August 19, 2022, due to pressure on short term rates basis recent incremental cash reserve ratio (I-CRR) norms by RBI.

Chemicals (IDBI Capital)

The consistent fall in chemical prices was arrested to some extent in July. Most of the management commentaries do point to slow global demand offtake and significant channel destocking especially in the agrochemical segment. China has been aggressively entering various segments and impacting them by steep pricing and volume dumping.

We expect pricing pressures to sustain for commodity chemicals with Chinese resurgence. However, realignment in the global supply chain to diversify from China and strong interest from global MNCs to source from India bode favourably for the Indian chemical sector.

Companies with long term contracts which have price variation clauses embedded in them will fare better owing to better revenue visibility and margin protection. Companies who are higher up the specialty chemicals value chain stand to perform better in the current environment.

Pricing Pressures remain: We chart out price data for various chemicals further in this report and present select highlights here. Mono Ethylene Glycol (MEG) prices increased by 9% MoM. MEG is more commonly used as a polymer precursor and as an antifreeze application. India Glycol is a major manufacturer of MEG domestically. Caustic Soda Lye prices have declined by 9% MoM as the industry is facing challenges in terms of weak demand and slow sales leading to higher inventory levels. Acetic acid prices have risen by 12% MoM. It forms a key input for manufacturing ethyl acetate and acetic anhydride. Soda ash (Dense) prices have risen by 2% MoM to Rs 41/kg . Toluene and Acetone prices are up by 20% and 12% MoM respectively.

Outlook: We believe that commodity chemicals segment would be under pressure especially in the wake of increasing competition from China. We prefer specialty chemical players with decades of rich experience, deep chemistry prowess and strong R&D and execution capabilities. Companies that are delivering value added products and moving up the value chain will fare better as compared to pure commodity plays. 

Nano fertilizers (IIFL Securities)

Nano fertilisers are nanotechnology-based fertilisers — modified form of bulk fertilisers. Nano fertilisers deliver nutrients to the crop in one of the following ways:

• Encapsulated inside nano-materials, such as nanotubes

• Nano-porous materials, coated with a thin protective polymer film

• Delivered as particles or emulsions of nano-scale dimensions

Nano fertilisers have a high surface to volume ratio and are said to be more effective than the traditional bulk fertilisers. They are also said to reduce soil toxicity and the use of excessive chemical fertilisers. Some research also suggests that they boost crop output and optimise

nutrient utilisation.

While nano fertilisers can be applied by either foliar application or soil application, studies to determine the more efficient method are ongoing. Only ~30-40% of the traditional fertiliser is estimated to be absorbed by the plant; however, the absorption rate for nano fertilisers is estimated to be ~80-90%. As per reports, nano fertilisers are also easier to mix with water vs the traditional ones.

…will Indian farmers adapt?

The recently launched nano fertilisers (urea and DAP) have been in the limelight and should farmers adopt these products, the same are expected to reduce the government subsidy bill significantly. In this note, we discuss the selling proposition of these products, their likely impact on the government-subsidy expenditure and the changing industry dynamics.

IFFCO’s nano-urea has foliar application: IFFCO has recommended that the nano-urea it launched last year be “sprayed” on plants for effective use. It claims that the product can help improve yields by up to 8%. However, adoption by the farmer has been a bit slow, as the job of mixing with water and then spraying across the field is labour intensive.

Adoption of nano-DAP could be better than nano-urea: For the last five years, the average share of imports for urea and DAP stands at ~20% and ~40% respectively. Should the government be successful in replacing this demand with nano fertilisers, it could save ~Rs485bn in subsidy (at FY23 rates). However, adoption of nano fertilisers by farmers is slow. The nano-urea bottle is priced similar to the MRP of a conventional bag and provides little incentive for the farmer to switch products. Conversely, nano-DAP will provide greater incentive to the farmer - being priced at ~50% of the current MRP.

Several capacities coming up: In addition to IFFCO, Meghmani Organics has also announced a capex of ~Rs1.5bn to set up a 50mn bottle plant for nano-urea. NFL and RCF have also tied up with IFFCO and intend to manufacture ~50mn bottles each by FY25. Additionally, Coromandel has recently launched nano DAP; Chambal Fertilisers continues to watch this space closely.

Capacities coming up for nano-DAP are unclear, yet. Till date, only IFFCO (expected to launch soon) and Coromandel (expected to launch product in CY23) have announced capacities.

Should the government be successful in replacing imported fertilisers (Urea and DAP), it is likely to save Rs485bn in subsidy outflow (~28% of FY24 estimated expenditure). The savings are accentuated at ~Rs784bn, if it can replace ~50% of total consumption with the usage of nano fertilisers. However, the product’s acceptance is facing severe headwinds and thus, we believe that replacing ~50% of urea and DAP consumption is currently improbable.

Over the moon

It was the spring of the year 2006. Prime Minister Manmohan Singh and President of the United States George W. Bush (Jr.) signed a historic civil nuclear cooperation deal on 06 March 2006 at New Delhi. The markets were obviously very excited about this new chapter in the strategic relationship between the two largest democracies in the world. The benchmark Nifty would rise ~17% (3185-3750) within 10 weeks of signing the deal. However, Nifty fell 30% (3750-2647) in the following five weeks as the deal faced strong opposition from the left parties that were part of the ruling UPA-1 alliance, as well as the opposition parties like right-wing BJP, etc. Eventually, the deal was signed in August 2007, after the prime minister won a no-confidence motion in the parliament on this issue.

After the deal was signed, the government fixed a target to install 20GW of nuclear power generation capacity in India by the year 2018. Presently, there are 22 nuclear reactors operating in India with a total power generation capacity of 6.8GW. Interestingly, only 3 reactors (2.2GW) have been added in the fifteen years after the civil nuclear deal with the US.

The pertinent point to note however is that the euphoria created by the ‘deal’ in the equity markets led to a hyperbolic rise in stock prices of many companies that were directly or remotely related to the construction of nuclear power plants. Most of these stocks corrected sharply in the following years, as none of them got the business the market was anticipating.

The market reaction to the successful launch of India’s latest moon mission is giving me a sense of déjà vu. Many random stocks that have some remote connection with ISRO projects have run up 20% to 80%. A project that costs under US$100m, including wages, IPR, and logistics costs, has seen the market capitalization of vendors rise by over US$10bn. The analysts and traders have started building an astronomical rise in their order books and profitability. The arguments are running wild. For example, a prominent market participant advanced a theory that global space agencies will now engage Indian vendors who have demonstrated good quality products at very economical costs.

I am sure most Indian vendors engaged by ISRO are indubitably very competitive in terms of quality and costs. The questions however are:

·         How many of these companies have a scalable business? Would additional capex requirements merely for space programs justify their current valuations?

·         Whether 500 space missions by ISRO and other space agencies that would like to source material from India, in the next 10 years yield enough profit to justify the current valuations of most of these companies? Remember, countries like Russia and China usually do not source material from outside for their space missions. Private agencies operating space missions, like Elon Musk’s SpaceX, are very few and may not justify the revenue and profitability assumptions being made by the market participants.

Space is a very big and lucrative business opportunity. It is therefore major story for investment. However, investors who want to make money must be focused on technology innovators, IPR holders who supply mission critical equipment. Investing in steel, nut bolts, plastic pipes, fuel tanks, and fan blade suppliers could lead you only in one direction - that is down. It would, therefore, be advisable that investors who are over the moon, return to the Earth and do some basic numbers.

Sailors caught in the storm – Part 2

Recently released minutes of the meeting of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) highlighted that the latest policy stance is primarily ‘Wait and Watch”. This stance is driven by the hopes of:

(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.

 

Sailors caught in the storm

 I have often seen that when we fail to find solutions to our problems with the help of science and economics, we tend to look towards the heavens and seek to find answers in philosophy. It is not uncommon for businesses, administrators, and policymakers to seek divine intervention when science and economics are not helping to resolve a problem. The global policymakers and administrators seem to have reached such a crossroads one more time, where the conventional practices, accumulated knowledge, and past experiences do not appear to be of much help. Their actions appear driven more by hope than conviction.

The war in Ukraine; the economic slowdown in China; and the monetary policy dilemma in the US and India are some examples of problems where the administrators and policymakers seem to be hoping for divine intervention. I see the recent speech of the US Federal Reserve Chairman Jerome Powell at the Jackson Hole symposium and the minutes of the last meeting of the monetary policy committee of the Reserve Bank of India in this light.

After 16 months of aggressive monetary tightening, the Fed is not confident whether they have done enough; or they have overdone with tightening or they are lagging behind. He reiterated that the policy is restrictive enough to anchor inflationary expectations, but still expressed fears that the high inflation might get entrenched in the economy and may require treatment at the expense of higher unemployment. Chairman Powell indeed sounded more like a sailor trapped in a storm, when he said, “We are navigating by the stars under cloudy skies”.

The situation in the US, as I see it from thirty-five thousand feet above sea level, is as follows:

·         The US Federal Reserve has hiked the key policy rates from near zero (0.25%) in March 2022 to 5.5% in August 2023. This is one of the steepest hikes in the past four decades.

·         The US financial system faces a serious challenge as MTM losses on the bond portfolios are accelerating; retail delinquencies have started to build up;

·         The positive real rates in the US are now 2% or higher. Despite these restrictive rates, the economy is not showing much sign of cooling down. The probability of growth acceleration in the US economy in the next couple of years is therefore remote.

·         Inflation continues to persist above 4% against a committed target of 2%. The household savings may therefore continue to shrink at an accelerated pace.

·         The mortgage rates are well above 7%, the highest in two decades. Housing affordability is at its worst in history.

·         The US government is paying close to US$1trn/year (about 20% of revenue) in interest on its borrowing, which is an unsustainable level.

·         The cost of borrowing (and interest burden) for the US government shall continue to rise for a few years at least as the Fed reduces its balance sheet, foreign governments cut on their demand for the US treasuries, and the rating of the US government’s debt face further downgrades. The fiscal pressures thus remain elevated.

·         The money supply (M1) in the US at US$19trn is about 4.5x of the pre-Covid levels. It may take years to normalize at the current speed of quantitative tightening (QT) by the Federal Reserve.

·        
The “Lower for Longer” narrative has metamorphosed quickly into “Higher for Longer”. However, analysts, economists, and strategists who are in their 30s may have never witnessed a major rate or inflation cycle in their professional careers. Their assessment of peak rates and peak inflation may be suffering from some limitations.

….to continue tomorrow