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).
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.
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.
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.
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.
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
2nd 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
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.