Currency, rates and oil: Slippery for some; advantage few

For Indian equity markets, the macro landscape is getting murkier with each passing day. While our traditional Achilles Heel, crude oil, continue to be the root cause, the scenario has been complicated by a strange confluence of global and local headwinds.

Inflation and a falling currency set the perfect backdrop for the hardening of rates, not to mention the liquidity scare caused by the default of a large institution, which can only add fuel to the fire. Monsoon, which had started on an optimistic note, is beginning to end with a tad disappointment as well. The confluence of all the macro headwinds could take away the sheen from the growth story, at least in the short term.

In light of the above, we have attempted to ascertain how the worsening macros could broadly impact earnings of the benchmark index like Nifty as also the key sectors.

In the quarter so far, the rupee has depreciated by close to 6 percent against the US dollar, following a roughly 5 percent depreciation in the previous quarter.

While the IT sector, being a net exporter, is a beneficiary on average, the magnitude would depend on the individual company’s revenue mix in US dollar (exposure to North America could serve as a proxy), onsite-offshore revenue mix that determines the net exposure and the hedging policy. While midcap IT is a clear beneficiary, thanks to its large exposure to North America, largecap IT also stands to gain.

The pharmaceutical sector with a significant exposure to US also stands to gain amid the pricing challenges it is facing in the US generics markets. The domestic business would typically remain insulated from emerging macro headwinds.

The significant hardening of the 10-year benchmark doesn’t augur well for the investment books of banks. An overall slowdown would not support the loan book, especially if retail credit feels the heat of rising rates. The high credit-to-deposit ratio could have a negative impact on margins if wholesale funding rates continue to firm up.

Non-banking finance companies (NBFCs) have started facing the heat of rising cost of funds. While NBFCs can increase lending rates to protect margins, it is difficult to pass on the rising rates to borrowers in a highly competitive market. The valuations of most NBFCs prices in continued strong loan growth – implying increasing funding requirements.

Steel companies will tend to benefit as the rupee depreciation would discourage imports and increase import parity steel prices. Companies like SAIL and Tata Steel would be a major beneficiary. However, on account of higher input cost, relatively-less integrated players (JSW Steel, SAIL) could be negatively impacted.

Input cost would also mean pressure on profitability for the non-ferrous companies like Hindalco and Vedanta. While Vedanta may be insulated because of diversification in the other segments, Hindalco could face cost pressure considering its leveraged balance sheet.

In case of oil and gas marketing companies, the depreciating rupee and rising oil and gas prices mean higher input cost. For oil explorers like ONGC, Oil India etc, this is a positive as their billing is dollar denominated and will result in higher realisations. However, a steep uptick in crude exposes upstream oil companies to the risk of subsidy burden. With cheaper supplies flowing in from US LNG, GAIL benefits from higher gas price, as its leads to a higher delta between US LNG cost and Asian spot LNG.

In the case of the chemical sector, segments with high export intensity like dyes and pigments tend to benefit from currency depreciation. The food colours segment might be relative immune as it has a natural hedge.

But import-dependent product segments like ABS (Acrylonitrile Butadiene Styrene) and aliphatic amines where manufacturers largely cater to domestic clients may be impacted on account of elevated input cost.

In the agrochemical space, manufacturers, which have a substantial share of imported raw materials stand to lose due to higher input costs. Moreover, the rising cost of gas increases input costs for fertiliser players thereby straining margins. In case of UPL, the currency situation can be a benefit as it has substantial exposure to Brazil, and the rupee’s depreciation (versus the US dollar) has been lower than Brazilian real’s depreciation.

In case of the auto sector, companies with large export volume (Bajaj and Eicher) are expected to benefit from the rupee depreciation.  However, companies such as Maruti, which imports significant amount of electronic components, could feel margin pressure. Rising crude prices are expected to increase total cost of ownership of vehicles thereby impacting demand.

The aviation sector is expected to be under a lot of pressure of the back of rising fuel cost (forms around 35-40 percent of net sales) and rupee depreciation (most of their expenses such as lease payment and aircraft maintenance cost are dollar denominated).

Further, the domestic FMCG business is impacted by elevated levels for oil-linked raw materials like Liquid alkyl benzene and packaging cost. Food inflation has been relatively moderate but is expected to perk up due to MSP and higher transportation cost. In light of this, companies across the sector have recently increased product prices. Fragile but improving rural demand would be tested in coming quarters.

The adverse movement of currency has made import of raw materials expensive for a majority of the companies in the consumer durables sector. This could impact margins. At the same time, a possible levy of duties on gold imports could be a dampener for branded jewellery companies. Revenues of export-focused home-textile majors are expected to gain traction because of better realisations and improved demand from US-based clients.

Generally, engineering companies might face cost pressure because of the depreciating rupee and higher crude prices. Higher interest cost would mean a few of these companies face a significant jump in interest outgo as some of these businesses are funded through short-term working-capital loans.

Companies in the construction business would go through similar pain largely as their working capital loans put pressure on interest cost. Further, in case of the cement sector, input costs are expected to inch up on account of rise in diesel prices and import of pet coke.