Q4 guidance of India Inc. brave, but misguided: IIFL Capital Services

21 Jun 2022 , 10:36 AM

Overall, analysts at IIFL Capital Services feel the commentary is a bit too optimistic. Companies are guiding to: 1) strong near-term demand momentum, 2) the price-hikes taken having minimal impact on demand, 3) cost inflation and supply-chain issues put behind (Q2 margins to improve after Q4/Q1 hits), and 4) strong near-term growth outlook despite acknowledging macro headwinds.

They see a triple whammy in the form of volume hit (macro slowdown), cost inflation (margin hit) and stiffer interest rates impacting companies’ earnings and valuations. Continue with defensive / large-cap orientation.

5-20% price hikes in FY22 enough for now

Companies have taken 5-20% price hikes in FY22. FMCG companies noted inflation-induced down trading. FMEG players sounded cautious on further hikes denting consumer sentiment, but real-estate companies are guiding to further hikes in FY23. Softening metal prices may obviate further hikes.

Strong near-term demand commentary

Capital goods companies complained about supply bottlenecks leading to unmet demand. Auto companies have not even considered this — they expect strong demand, regardless. Infra companies indicated a 2-3x FY22 book-to-bill. FMCG/MFI pointed to rural tailwinds. Banks noted strong corporate balance sheets, although they maintained silence on core capex, which cap goods companies expressed optimism about. IT players said companies would focus more on IT spending, especially in a slowdown. Broadcasters, however, advertised ad-spend cuts unambiguously. Banks cautioned on high interest rates impacting home loans.

Wake up, smell the coffee

Analysts at IIFL Capital Services think elevated prices of crude / food will keep inflation high in the foreseeable future. This will hurt discretionary consumption, directly and through forcing interest rates up. Capex revival will also be delayed. Signs of weakness in developed markets include recent weak retail sales numbers in USA (-0.3% MoM) and the EU (-1.3% MoM) and struggling home sales in USA (April SAAR of 5.6m, the lowest since Jun-2020). The US Fed will double its balance sheet run-off from US$30bn/m in Sep-2022, thus sharpening global liquidity contraction. Sharp interest-rate normalization in USA will result in large capital outflows incrementally, and they see a risk to US$/INR.

Some ameliorating factors

However, China re-opening, global supply-chain easing, a potential finished-goods supply-glut (unfavorable for white goods companies) and softening of metals (copper/aluminium prices down 13%/30% from the March peak) could help fight inflation. On growth, a strong domestic policy environment, government support on infrastructure, China+1, rural recovery prospects due to resilient agri activity and govt. support may act as tailwinds. On balance, stay defensive, though in their view, the last phase of correction is on.

IIFL Capital Services’ views on key themes, given inflation impact on demand

Themes	Management Speak
Preferred…
IT	No slowdown, rather IT spend will be resilient in a downturn
Government spends	Strong on rural and infrastructure capex
Rural/FMCG	Good monsoon, government support to rural, high agricultural output prices
Trucks	Strong agriculture, softer metal cost, improved pricing scenario
Chemicals	Tightness in key products good for realization
Banks	Strong corporate B/S, but VF AUM strong, mortgages can hurt
Telecom	Macro not an issue; but chip shortage has made devices costly

Source: Company, IIFL Research

Themes	Management Speak
Avoided…
Housing and Cement	Considerable pent-up demand and government thrust on low cost housing
FMEG/White Goods/Discretionary	Avoiding taking further price hikes; cautious on demand
Private Capex	Banks tight-lipped about private capex, but capital goods players positive
Media and Broadcasting	Impending ad spend slowdown from FMCG and startups

Source: Company, IIFL Research