Our Annual Conference was right after the 2 major announcements of the week, which provided a great opportunity for fund managers to get the first impressions directly from corporates.
By now you already have a basic sense of the macro impact of the 2 announcements, however uncertain it may be, eg demonetization (ST pain in Eco/ LT gain, Interest rates to crash) and the US elections (USD appreciation, Trade wars, Infra push in US, etc).
To get a finer view, we have now talked to a host of Cos and dealers across industries on their sense. Please find overleaf, the sector-wise takeaways from these conversations. Please note that these are NOT necessarily our opinions, but their views. Do note that fixed costs of companies being sticky, high operating leverage Cos would get hurt over the next 2 quarters, apart from the obvious ones such as rural, NBFCs, retail, etc.
Defensives in this environment, to different degrees, include Oilngas, Utilities, Pharma and non-ferrous Metals. Given the hockey stick nature of growth expected after 6 months due to a crashing of interest rates and resumption of Consumption, and the fact that affected stocks have fallen a lot (though they could fall further), sectors to watch and buy at apt prices are CAB (Cement, Auto, Banks) and other durables.
Sector wise takeaways from our conversation with companies and dealers across industries
Demonetization has negatively impacted agri-input demand due to: (a) stress on farmer’s cash flows as we are near end of Kharif harvest season, (b) decline in agri-input offtake by dealers ahead of Rabi season (lack of liquidity and delayed payments by farmers) – this could affect the Rabi (winter) harvest too. Note that tier 2/3 towns have more self-employed people who are severely stressed.
However, Direct Benefit Transfer for fertilizers will be a game-changer for rural India. In the long-term, government may club soil health cards, bank/Jandhan accounts, procurement record (through DBT) and crop insurance, which will not only improve nutrient content in soil (by selective allocation of fertilizers as per soil health), but also reduce subsidy leakage.
Companies remain cautiously optimistic on demand growth, as recent demonetization can offset benefit of strong monsoon and Kharif harvest. Demonetization was thus the main discussion point at our conference given the expected near term impact on all Auto segments
For 2Ws, cash transactions account for 40-50% of sales. While these purchases don’t necessarily stem from unaccounted cash, the temporary dry up in liquidity will hurt volumes for the next 2-3 months. Beyond that, given that rural accounts for >50% of 2W sales, the effect on farm incomes from the liquidity impact on kharif crop realisations and rabi crop sowing preparation will have to be seen.
For cars, cash transactions currently account for 20-25% of sales (would reduce even further now). While the liquidity impact is relatively lower than it is for 2Ws, overall car sales could suffer given that high discretionary purchases get postponed in uncertain times.
For CVs, cash is <10% of sales, hence impact from a liquidity standpoint on purchases is less. However, we see a sharp dip in utilization of trucks in the near-term as movement of trucks depends on cash availability (tolls, fuel, food, etc. are all paid in cash). Needless to say, a prolonged capex/consumption slowdown hurts freight availability and thereby utilization further.
Discounts continue to be high at 3-5% on cars and 8-10% on MHCVs
Demonetization will lead to spurt in CASA balances and consequently lower interest rates (supported by adequate liquidity). New generation banks with small customer base like Yes Bank, Kotak Bank & IDFC Bank to garner a significant share of new savings account (aided by higher SA rates being offered, new age tech platforms and ample bandwidth).
Overall cash in the system will fall and so will cash velocity, which will impact growth rates. Expect negligible credit growth in next few months with entire workforce of banks focusing on handling the demonetization exercise (may also impact collection efforts/ recoveries).
NBFCs with significant share of cash collection (MFIs, used & new CV/ 2 wheeler/ white good/gold loans) will be impacted with lower availability of cash in the system, asset quality challenges and lower growth rates.
HFCs will get impacted due to possible fall in property prices and LAP too will slow down (as was instrumental in deployment of black money into real estate and back in business/other activities). While an impending correction in real estate prices and lower interest rates will usher in significant housing demand in the medium to long term, HFCs and Banks may witness some slowdown in growth initially, as home-buyers await clarity on the extent of correction in real estate prices. This effect may be more pronounced in price-sensitive areas like the southern states. LAP loans would see heightened stress as economic activity slows and property prices correct.
T&D capex turning around driven by investments in renewable energy (esp. Solar). Benefits of SEB restructuring scheme ‘UDAY’ has commenced with orders from State transmission utilities rising by 20-30% during last 6 months. T&D industry is currently operating at 60-65% of its capacity and rising demand would bode well for margins in the near term. Moreover, capacity can easily be increased to catch-up with demand growth due to shorter gestation and low capital intensity. Demonetization (lower interest rates) coupled with implementation of GST would be beneficial for the sector in the long term through increased share of organized sector and reduction in interest rates. However, short term blips in execution likely due to disruption in supply chain specifically from SMEs.
Long-term cement demand potential is huge due to government thrust on infra spending and low cost housing coupled with revival in rural demand. This time around demand pick up will not be accompanied by capacity addition. Limestone mine auctions and problems with land acquisition are deterrents.
New greenfield project would take 6-7 years to commission. Hence sector to benefit from low capacity addition and exit of high leveraged players. With rising capital cost, new capacity is economically viable only at Rs 2,000/ton EBITDA.
In the short-term, negative impact of demonetization is visible with dispatches of various cement companies are down between 30-70% as compared to dispatches on 7th Nov (day before demonetization was announced). Cash crunch, payment and transport bottlenecks due to demonetization of select notes are key reasons. Due to drop in shipments, there could be risk to production discipline/prices as leveraged/marginal players try to sell more cement in an overall shrinking market.
FMCG & Retail
The festive season was good and there was some stability seen in the demand situation. The demonetization issue has disturbed the demand momentum that was building up nicely.
The demonetization issue will impact demand only in the short term. However, large ticket items and rural economy will be hit more.
Mix of demonetization and GST implementation is positive in the long run as it will help accelerate shift from unorganised to organised.
Retail might benefit if real estate prices come off due to demonetization
Major events impacted FY17 growth: Macro slowdown, Brexit, US Elections
Headroom for growth remains high as only 28% of global IT spend is outsourced. Client mining opportunity too remains high within G2000 client base (largest player TCS has 36 clients with USD 100 mn annual revenue run rate). In Infrastructure Management Services (IMS), ~50% of business is yet to be outsourced and renewal market is high at ~USD 150 bn. Business pressure is not structural. Growth rates can revert to base levels (mid-teens) if macro overhangs recede.
Structural growth drivers include rising technology intensity of businesses, shortening tech shelf-life offering greater propensity to outsource
Discretionary spend are weak in BFSI. Growth in BFSI is driven by both banks and fintechs. In line with seasonality, December quarter will remain soft for the industry (particularly Retail vertical)
Currently IT industry passing through digital transformation amidst a challenging macro – hence deal TCVs (total contract value) are smaller and tenure of shorter duration
Brexit impact – structurally positive in the long term as lower growth in UK will be more than offset by new business opportunities due to increased compliance and multiple trade pacts
Cash-on-Delivery (CoD) volumes to be impacted adversely for B2C logistics players (E-Commerce) as CoD accounts for almost two-third of its volumes
Truck operations to be adversely impacted as they operate primarily on cash. This, coupled with GST implementation to drive shift in road volumes from unorganized to organized players in the medium term
Overall Ad growth to soften given slower ad spends from FMCG; higher ad spends from E-commerce, Telecom etc may partially compensate
While TRAI’s final order on content parity regulations is awaited, industry expects significant execution challenges - this may delay its effective implementation; earlier content deals to continue till then
Demonetization drive to result in cash collections delays from LCOs in the near term; however this may help distributors to implement prepaid billing (vs postpaid currently), which will boost transparency and ease working capital requirements in the medium term
Trump’s plant to invest USD 1 trillion to build infrastructure in US is positive for most base metals. Severe slowdown in metal & mining capex over last two years can result in upswing in select metal prices.
In the short-term, demonetization has impacted trade and shipment (particularly for steel).
Pricing erosion in the US market has been higher (high single digits) than expectations (mid-single digits) across companies due to increasing impact of channel consolidation
Companies see enough opportunities in the US and continues to invest in R&D (complex/limited competition products), leading to higher R&D costs
Repealing the Affordable Care Act (ACA) as propagated by the President elect Donald Trump, have lots of repercussions and would be very challenging. So the impact could only be gradual
Demonetization impact: The distribution channel largely operates through the banks (less cash transactions), but retail buying happens in cash. Most of the players don’t see any major impact on the channel currently. Retail channel growth has seen some initial impact, which would impact the near term growth. If the cash crunch continues, it would impact the overall domestic growth. However, industry remains hopeful that the situation would stabilize in the next 10-15 days
Revival of merchant tariffs contingent on turnaround in demand from Industries: Factories with captive power plants are selling their surplus power at marginal cost. Further, low demand from high paying industrial customers prompted SEBs to reduce supplies to agriculture and residential sectors (low tariff) to maintain average tariffs. Revival of Industrial output implies surplus captive power consumed in-house. Further, demand from industry would also lead to higher supplies to agri and residential, thereby boosting merchant tariffs.
Revival of stranded assets and kick starting capex through scrapping old plants: Government is working closely with the States to accelerate phasing out of 30-35 GW old inefficient plants over the next 2-3 years. This implies immediate fresh PPA demand from SEBs of the plants that have been phased out which would aid revival of current stranded plants and also kick start capex.
Slowdown in growth in output of Coal India (YTDFY17 was flat YoY).
Sharp spike in cost of imported coal (up~40% in last 2 months)
Success of SEB restructuring via UDAY scheme is contingent on tariff hikes and reduction AT&C losses, as most
SEBs are running EBITDA losses. Just restructuring of debt is only delaying the problem
Renewable industry capex to continue, driven by foreign investors with low cost of capital looking for stable long term yields
While residential demand across micro markets remains muted, there is a clear polarization of buyers towards reputed developers which have seen strong response to their new launches
Impact of RERA*: Industry up for a major consolidation – tier 2/3 developers will face cash flow crunch (increasing no. of tier 2/3 developers are already offering/tying up their projects with reputed developers) . Tier 1 developers have already adopted practices which are in line with RERA (escrow mechanism, all approvals prior to launch, sticking to delivery timelines, etc).
I-REIT^: Demand for investing in I-REIT is very high on account of strong economic growth, steady demand for commercial space (thus positive outlook on rentals and capital appreciation), improving regulatory environment, etc. I-REITs will offer high IRRs of 14-15% (vs. 8-10% globally) over a period of 5-6 years or more. Foreign investors are better placed than domestic investors due to the taxation structure (only 5% withholding tax for foreigners vs. 10% for domestic)
Demonetization will mainly impact land transactions and secondary market sales (15-20% price correction expected). Customers will now have no incentive to go to tier 2/3 developers and thus will shift to tier 1 developers. Thus tier 1 developers may be able to hold onto their pricing, but tier 2/3 developers will have to cut prices to monetize their inventory. With land prices expected to come off, future projects may get launched at lower prices.