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Dec 07, 2016, 08.21 AM | Source: CNBC-TV18

See sharp cuts in FY17 earnings; rural most hit: Religare Cap

Unless currency disbursements improve and liquidity returns to the system quickly, the impact of demonetisation on economy and corporate performance could be much more severe than anticipated; that is the feedback from a survey done Religare Capital Markets through a road-trip that concluded recently.

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See sharp cuts in FY17 earnings; rural most hit: Religare Cap

Unless currency disbursements improve and liquidity returns to the system quickly, the impact of demonetisation on economy and corporate performance could be much more severe than anticipated; that is the feedback from a survey done Religare Capital Markets through a road-trip that concluded recently.

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Gautam Trivedi (more)

Managing Director, Religare Capital | Capital Expertise: Equity - Fundamental

Unless currency disbursements improve and liquidity returns to the system quickly, the impact of demonetisation on economy and corporate performance could be much more severe than anticipated; that is the feedback from a survey done Religare Capital Markets on a recently concluded road-trip.

A team comprising Religare’s MD & CEO Gautam Trivedi, MD & Head of Research Varun Lohchab and Vice President Navin Sahadeo went round the country to assess the cash crunch impact.

Speaking to CNBC-TV18, they said there is chance that not only FY17 earnings will have to be trimmed, but even FY18 first half estimates could be hurt. In case liquidity does not return into the market then It could be tough for companies to compensate the business lost during the second half this year, Lohchab says.

The fact that rural regions are either not exposed to or not adept at digital payment transactions makes them the most vulnerable. Due to lack of cash availability farmers are using older seeds and refraining for pesticide purchases which will lead to lower yields.

Similarly, commercial vehicles sector which was already under stress before demonetisation was announced will go further down as freight operators do not see much reason for new vehicle purchases.

Cement and housing, which were expected to get a fillip from the implementation of pay commission have also now taken a beating. However, in certain regions cement may see good traction due to a low base, says Sahadeo who tracks the sector closely.

While nearly 80-90 percent people across the covered area currently appeared happy with the demonetisation move, Trivedi quickly notes if the currency crunch does not get sorted in time, this could turn into anger.

Below is the verbatim transcript of Gautam Trivedi, Varun Lohchab & Navin Sahadeo’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy on CNBC-TV18.

Anuj: How are things looking right now, because November sales didn’t really look that problematic but you think going forward there would be some pain in the system?

Trivedi: We will have to focus on December numbers; I think the December numbers will invariably end up surprising people. Not necessarily as we just come back from 10-day road trip and we have seen the pain that is out there within the country but the reality is that most of the places we went to people have not even seen the new Rs 500 note, let alone the Rs 2,000 note. The people who have got their hands on the Rs 2,000 note unfortunately are saying we can’t use them because there isn’t enough change on the other side. This is going to have a significant negative impact immediately on sales that is one.

Two, if you look at the auto sector in the two-wheeler space, we have seen a massive contraction in sales. Again that is also because most two-wheelers are below the Rs 2,000,000 Permanent Account Number (PAN) card radar and 50-60 percent of their sales are indeed in cash as a result. So, that is where we are seeing a lot of pain, we met the dealers of most of the big manufacturers. Unfortunately that is the case, so that pain will continue for some more time.

Latha: I wanted to ask you about the sowing itself, if you all got any details? We were told that the net sown area is not very different from last year’s same time. However, because of lack of money people are not able to put in inputs. Did you get a sense that this agricultural season as well might give less in terms of income?

Lohchab: The feedback was slightly different from state to state, so Maharashtra and Madhya Pradesh (MP) we saw that sowing is progressing well as per schedule. Uttar Pradesh (UP) typically goes for a rabi sowing a bit late, so out there it is delayed a bit further due to this demonetisation.

Apart from sowing, so I think overall sowing number may not come down dramatically but if you look at the internals of that a lot of people are using older seeds like the last year crop for the new crop plus they are using government seeds in which case the yields could be a bit lower. They are not going to use too much of fertilisers and pesticides. So the essentials, again out there the essentials, the seeds are still seeing some off take but pesticides and anything, which enhances the yield we are seeing a sharp drop out there. It will be difficult for yields to be maintained on a rabi crop. Therefore even though the area under the acreage might look good but you might have a lower crop output.

Latha: So, general purchasing power could take a hit?

Lohchab: We believe because kharif -- again the realisations have got impacted especially for the perishable. So, cereals we have still seen good realisation for farmers but for perishable whatever yields were good this time around in kharif got negated to some extent by the lower realisations.

In the rabi case we believe the yields itself might be lower. So, for both kharif and rabi compared to what the expectation was in terms of the realisation for a farmer the farm income will take a hit and therefore the rural demand might take a bit longer than expected. That is the view we are getting.

Sonia: Just to brighten things up, are there any states which have or any pockets which are moving seamlessly to sort of cashless transfers and are being able to cope up with demonetisation quickly?

Trivedi: We haven’t seen too much evidence of that as yet unfortunately. However, Indians can adapt fast when the guns put to their head and frankly this is what Primer Minister Modi has done. So, we didn’t see much use of Paytm. Some people said what is Paytm? I think this is a new concept to them but I think Unified Payment Interface (UPI) which for some reason is not being as heavily advertised as Paytm is by the RBI or by the government, I think they should promote that because that is SMS based and you really don’t need a smart phone. So, finally that has started to happen, but people will have to adapt and change to the new environment.

Anuj: The other issue is on housing and cement because that is the other big worry, what has happened in that space, especially in the hinterland.

Trivedi: On the housing bit -- again in all three states that we went to, everyone said that land should correct 30-40 percent and built-up real estate should correct anywhere from 15-25 percent depending on who you speak to. But the problem is, that has not happened yet. No transaction has taken place as yet. So, it is very early days and until we do not see a transaction happening, and of course, logically they should correct because the cash elements have been sucked out at least for the time being.

Sahadeo: In cement, what we have seen certainly first is of course the knee-jerk reaction. So, in November, most of the large stockists which we met, they said that their sales on a year-on-year basis, were down almost about 20-30 percent. But when we interacted with the retailers, the small time cement dealers, for them the sales in fact was a much higher 50-60 percent. Now, for December, the general expectation on the street is that the numbers in absolute volume terms could be better as compared to November. But, to our surprise, the feedback is that the December numbers could well be at par to November or in fact could be a tad lower than that.

Latha: Can you give us some regional colour on this?

Sahadeo: If I were to talk about Uttar Pradesh first, now the sand related issue, specific to this state, has been impacting demand right from July. October, as a month, they saw a severe brunt of it, wherein as compared to September the numbers were down almost 20 percent in October already. And because of this demonetisation, there is a further dip of almost about 15-20 percent on that low number in the month of November.

Latha: South?

Sahadeo: South was not part of our road trip, but of course, prior to this, we did make a visit there. Now this is very region specific. That same period last year, November, in Tamil Nadu in particular, there was a huge impact of heavy floods there. So, on that low base, November could turn out a very big surprise of 20-30 percent growth for companies. But now, as we speak, as recent as yesterday, dealers are definitely worried in terms of their offtake which is seeing a slowdown now.

Very quickly, I want to highlight to your point about adaptability to that new mode of transaction. The general feedback is that in south, the resilience to this new payment will be far bigger. A very quick observation there being that even today, you see queues outside banks and ATMs even in Mumbai, leave aside the other place like north or central or west. But in Chennai, I was surprised to see hardly any such queue and even if there was a queue, it was a fairly small queue, just 2-3 people there, particularly in Chennai.

Sonia: What about the trucker’s space because a lot of people tell us that long haul operators have faced quite a bit of issue and they have a lot of their payments that happen in cash when they move from one state to another. How much pain do you still see there and when do you see recovery in the commercial vehicle (CV) space?

Lohchab: Commercial vehicles, the consistent feedback, which we were getting was that it was anyway weak before this demonetisation issue. The fleet operators, profitability and the freight was anyway on the weak side, so the space has been under pressure for last almost 12-18 months across most of the regions and this is an additional hit.

So, we saw that the movement of goods was still happening. So, it is not that things have come to a grinding halt in terms of the transportation, but, anyway, the volume offtake for the freight operators was weak and it has weakened further after this demonetisatiion. The expectations of recovery in that space were quite weak compared to a lot of other segments when we look at that partly because the underlying fundamentals were anyway weak.

And in terms of the commercial vehicle financiers also we met, the used truck demand has fallen and therefore the rates have fallen out there and there is no incentive for a freight operator to go and buy a new truck either, a new one or a used one. So, CV transportation industry will remain under pressure in our view for some more time at least and that will have a ripple effect on the CV industry as well.

Trivedi: Let me just add something to that. The other thing which is interesting is that one of the dealers that we met, he said that the body of the truck, it is actually completely unorganised. It is mom and pop shops who actually make the body of the truck. So, when you buy a truck, you do not get the whole body with it, you only get the front cabin and the rest of the truck. So, that entire industry is cash based and that has come to a grinding halt as well as a result.

Latha: Speaking of banks in your rural trip, did you notice that credit quite efficiently substituted cash, there was this very interesting article by JR Varma of IIM saying that why are we making so much ofcash, so much can happen on credit did it. People were saying okay you wouldn’t pay me, but you can pay me month down the line, two months down the line was that smoothening out issues?

Trivedi: Yes, that has basically become sort of a go between until the people adapt to the new environment. My fruitwala who sits very close to where I live said the same thing, I have a credit card and I don’t have any cash -- I did that on purpose just to test if he was going to accept the credit card and he said, I don’t have a machine yet, I said when you are going to get it, he said I am thinking about it and I said hurry up and get it. He said, “sahab kyun tension le rahe ho, baad main paisa do”, so he was willing to give me credit in Mumbai.

Latha: But in cement in big industries like that was there the ability to get by with business, because ultimately you will pay you are not insolvent, you have a liquidity issue?

Lohchab: In consumers what we saw is lot of the companies have started giving better terms to distributors just to ease of the credit crunch, so they are giving longer credit to their distributors who in turn are passing it on to retailers.

Latha: Is it that you saw more of it in auto, auto ancillary’s supplier’s credit?

Sahadeo: My point is companies are doing obviously whatever they can to push as much as possible from their side or offer -- let me put it this way to offer whatever best support they can from their side, so be it in terms of increase in the number of their debtor days is possible. Ultimately, you have to understand that there is a credit limit every dealer enjoys and that dealer in turn will have a credit limit for every consumer. If their genuine consumer itself is taking a backseat, how much more you would want to extend credit.

Lohchab: In the interiors what we observed is lot of these say the contract labourers who are not getting cash flow on a daily basis, they are going and getting credit from the local kirana from where they used to buying, but again it is very much trust based, so people whom you have interacted with over the years you are able to get credit. However, agri input dealer when he is giving credit to a farmer or when he is selling input to a farmer, because that farmer goes only twice a year to him that the relationship is not there, then you won’t get the credit -- so in rural I would say there is a lot of this credit thing which is working, but all of it works only for a short period of time.

If liquidity eases out by say December end, January then we are fine, but there is a limit to which you can get credit and that would probably remain so for another month or so, things can move around, but post that we need the real liquidity to come into the rural market.

Anuj: So based on your road trip are you pretty sanguine that you will have to cut overall earnings estimate and market valuations?

Lohchab: Yes, so when we are doing bottom up numbers, so FY17 second half obviously there will be a cut for most of the stocks and the cut could be quite sharp, because we believe that recovery may not happen in Q4 also and in certain cases even on the staple side things might take almost first half of FY18 to get normalised.

In fact FY17 gets cut for sure driven by second half, but even FY18 because the percentage growth may not be good enough for you to compensate the loss sales of FY17 and it might take time for some of the discretionary categories within staples to come back to the normalcy.

FY17 and FY18 both would be at risk for lot of sectors. Obviously, the extent of cut for FY18 would depend on how fast the liquidity comes back into the market -- that is the big assumption that one has to see how it progresses by come January-February if liquidity normalises in the rural hinterlands then probably FY18 may not get impacted, but my view is driven by FY17 and FY18 earnings will also get a cut for most of the sectors.

Sonia: We did not check with you guys about how the financial framework is in the rural areas with respect to banks and how the cash is getting disbursed. A lot of ATMs are dry even in the urban markets like Mumbai, Kolkata, etc. But what did you guys notice in the rural areas?

Trivedi: On farmers in particular, we met a bunch of agricultural dealers as well and also, farmers later on in Uttar Pradesh and Madhya Pradesh. What we found there is that the cooperative banks, basically have stopped giving money, so that is number one.

Latha: They were not allowed to exchange.

Trivedi: There is a liquidity problem with farmers. The farmers have had a bit of a double whammy. So, we have seen their produce price come down significantly and the cost of farm labour has gone up anyway from 50-80 percent year-on-year.

Sonia: And that is cash based right?

Trivedi: It is completely cash based and it is a real problem that the farmers are facing. So, until liquidity does not come back, a lot of that, consumption is going to get impacted significantly.

Latha: So you would be more worried about the rural facing industries, you are cutting the earnings forecast more for them?

Trivedi: Absolutely.

Lohchab: What we are seeing is the low ticket urban seems to be the least impacted because the switching to digital or credit cards or debit cards is much easier out there. Anything big ticket in urban is also getting hit, but low ticket urban is probably the safest place as of now.

Rural, everything is impacted, be it low ticket, be it big ticket as of now. Low ticket is still working on credit, which can continue for the next 1-2 months. But as of now, it looks like rural might get impacted a bit more than urban.

Latha: Your sectors? How do you look at earnings?

Sahadeo: To start with cement -- earnings cut is certainly there, because from November till March, I would expect a drop in industry volume numbers on a year-on-year basis thought marginally.

Latha: So it is not slowdown, it is contraction?

Sahadeo: There has to be in the sense that November, as we said, the general feedback is at 20-30 percent drop at the wholesalers and retailers. So, eventually, the system has to slow and like I said, December seems to be like a further slower month.

One point again I missed in the initial comments is that until now, your Rs 500 notes were accepted at diesel station for the trucks to ply. With that also being hauled, there is a further hit and not just in cement, in unorganised building materials like sand and brick movement. So, that trade was continuing because you could still utilise that money to get Diesel at the petrol pump. So, that impact will come in December.

The feedback in general, we have an opinion is that in March, you will certainly see a negative -- on a marginal single digit number, but it will still be a negative. For FY18, you would expect something like a 3-4 percent growth. Second half of course, because of this low base will be much better.

Earnings cut --mdefinitely, needless to say that but to me, in cement, I would also see a risk to the valuation multiple in the sense that all this while, the cement stocks entirely were on a dream run given the fact that there were multiple positives. Now, as you see, turn by turn, each of that is getting unwinded. So, to me it is a multiple risk also rather than the earnings risk. In particular, I would see an earnings cut.

Sonia: Anything positive apart from the dhaba food that you guys enjoyed through the trip?

Trivedi: 80-90 percent of the people that we met, more towards 90 rather than 80, are extremely happy with the move. And the reasons are as follows, in spite of the fact that they have an immediate cash crunch. First and foremost, they are very happy that Prime Minster Modi has had the guts to go after the corrupt. At least this is the perception that this is going to help at least the first step in rooting out corruption. And people in general are saying that yes, if we have to bear pain for the next 45-50 days, that is their perception that it will not be more than that. But my concern is if the disbursement of the new currency does not accelerate, then this could quickly turn into anger, which we have seen some pockets like in Lucknow, we saw some rioting outside the Syndicate Bank , but I hope it does not become nationwide. That is the only concern. Otherwise, everybody loves the move.

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