Wednesday, October 19, 2011

>Thematic: Milk Inflation (MACROCENTRIC ISSUE)

Its cost and not affluence that is causing inflation shocks

Protein consumption has declined structurally: In spite of higher economic growth, per
capita calorie and protein consumption during the past 27 years has declined. Between 1983 to
2004-05 per capita daily protein intake fell 12.1% in rural areas and 4.6% in urban (as per NSS).
Milk & milk products contribute only a part of protein intake (9.3% in rural areas and 12.3% in
urban, 2004-05) and has been growing only modestly in per capita terms: CAGR 1.25% in rural
and 0.95% in urban between 2004-05 and 2009-10. Incorporating the rise in proportion of
households consuming milk we estimated that overall growth in milk consumption (NSS based)
may have grown at 4% CAGR during FY05-FY10. While this may be to an extent an
overstatement, we believe production growth far exceeded consumption: Total consumption
multiplied 1.6x during the survey periods 1993-94 & 2009-10 while production multiplied 1.9x.

The implausible excess demand argument: Contrary to the NSS data, expenditure GDP
shows a structural decline in growth of real expenditure to 3.5% during FY02-FY10 (high GDP
per capita growth phase) vs 6.6% during 1990’s. Trend decline in consumption growth is
accompanied by a decline in production growth. Hence, the declining trend in milk inflation
from an average of 10.7% during FY89-FY94 to 2.6% during FY02-06 seems natural. Therefore, from a structural standpoint the sudden spike of 20% in milk inflation during FY10-FY11 seems abnormal. Importantly, 3.8% production growth during FY07-FY10 was higher than consumption growth at 2.7%, which should ideally imply excess supply.

Sustained net exports of milk products indicate surplus: Sustenance of net exports of milk
powder during 2000’s coincides with declining milk production and consumption growth,
thereby corroborating the presence of excess supply. Since FY00 India has been a net exporter
of milk powder. It averaged 17.3% of total production during FY01-FY10 and domestic
consumption declined to 75% of total supplies during FY05-10. Significantly, despite the large
import of milk powder by government in FY11 in the wake of rising domestic milk prices, India
still remained trade surplus in milk and milk products.

Our empirical analysis and survey refute the affluence syndrome: Our long term empirical
analysis shows that real per capita GDP growth is not relevant in determining milk consumption.
The correlation (FY84-FY10) between real per capita GDP growth and milk inflation is found to
be negative. The negative coefficient (-0.41) for milk inflation in consumption function indicates
that rise in milk inflation causes a decline in milk consumption growth, thereby refuting the
view that milk inflation is caused by a rise in consumption. Our inflation function highlights the
predominance of various cost variables. The feedback from our primary survey of cattle sheds in
Mumbai corroborates our empirical findings. In particular, steep rise in costs, rising land prices
and limited pass-through are making milk production unviable.

Cost linkage in protein inflation: As per NDDB (Jun 2011) the cost of inputs like dry fodder, oil
cakes, and cattle feed have grown at a much higher rate compared to the price which farmers
gets for milk from either cooperatives or other milk procurers. Oil seed cakes, an important
component in cattle feed and key source of crude protein that gets converted into milk protein
have seen a steep rise in prices. Similarly other fodder components have also undergone
significant price escalation: price of de-oiled rice bran nearly doubled in 2011, since 2005-06,
molasses increased 140%; rape seed extraction increased 130%.

Burst of income flows do not cause enduring rise in demand for milk: Increase in public
consumption spending through fiscal stimulus, employment guarantee programs (NREGA),
farm debt waiver as well as salary hike of government employees (Sixth Pay Commission)
resulted in sudden burst of income flows which collectively caused a surge in consumption in
the past and may have spilled over to demand for milk as well. But such sudden spurts in
demand do not cause permanent rise in consumption as price shock neutralizes the positive
income effect quickly, without adding to absolute consumption of milk. The slowing of real
expenditure on milk & milk products in FY10 corroborates this phenomenon.

To read the full report: MILK INFLATION

>Metals & Mining – Q2FY12 Preview

Q2FY12 was very eventful for the entire Metal and Mining space. The sector is facing many demons all at a time (fear of global recession, ongoing slump in Indian markets, regulatory blows on mining and industry unfriendly mining bill). Nevertheless, Q2FY11 numbers would be better than anticipated earlier as companies are able to hold on higher prices inspite of lull demand. Thus the contraction in margins will be much lesser than earlier expectations.

Stable realization lessen contraction of EBITDA/ton for ferrous players
Inspite of lull demand, steel prices remained more or less stable during the quarters due to ongoing mining crisis in Karnataka. Stable realizations will help companies to somewhat mitigate higher raw material prices. EBITDA/ton of ferrous players are expected to fall by ` 1000-1500/ton during Q2FY12.

Non-ferrous results would be better, mining to take a hit
Base Metals prices have marginally corrected during the quarter due to credit crisis in Europe and credit tightening in China. However the correction is very marginal to have a material impact on company’s financials. Sterlite and Hindustan Zinc are expected to report good numbers due to volume ramp up in Zinc and power business and improved Tc/Rc margins. NALCO and Hindalco are expected to benefit from high alumina and aluminum prices. Mining segment is hit hard by ongoing mining crisis and very heavy rains. Both volume and profitability of mining companies are expected to remain subdued.

We continue to maintain our cautious view on the sector as slump in demand is much higher than expected and thing are still not moving on ground. Moreover fear of recession in the western world and sovereign default risks of Euroland has made things very difficult for the sector. We believe that H2FY12 is going to be tough for metal and mining space and companies will see margin contraction and lower growth. Inspite of negative view, we believe that there are few structural stories unfolding in the Indian Metal and Mining space and the correction should be used to accumulate good quality stocks. Our top picks in the sector are – Tata Steel and Sterlite Industries.

To read the full report: METALS & MINING

>AUTOMOBILE SECTOR: Monthly Numbers update September 2011

September sales brought some cheer for the domestic automobile industry as the 4W players recorded positive growth (incl unlisted players) sequentially with start of festive season and the 2W players continued the robust growth. New launches in the PC segment, increasing discounts and attractive financing scheme supported sales with beginning of the festive season. Tata Motors recorded strong growth as PC sales grew for the first time in the year while M&M continued its strong traction (higher exposure to strong rural market). So while M&M, Tata Motors, Hero Motocorp, Bajaj Auto and TVS Motors clocked growth on y-o-y basis Maruti Suzuki reported a decline of 21% as labor related issues disrupted production.

Bajaj Auto: September sales came in at record 417,686 units representing a growth of 18% on a y-o-y basis and up 9% m-o-m. The company has recorded highest quarterly volumes and we expect company to report strong Q2 results (strong quarter for three wheelers).

TVS Motor: TVS reported total vehicle sales of 219,369 units up 17% y-o-y and up 13% m-o-m as motorcycle growth surprised us positively.

Hero MotoCorp: Hero MotoCorp recorded another month of sales more than 5lacs units with beginning of the festive season, we however expect competition to intensify in H2 FY12.

Mahindra and Mahindra: Mahindra & Mahindra continues to grow across segments, with total vehicle sales up 20% y-o-y to 82,656 units driven by higher tractor and automotive segment (especially LCV segment).

Tata Motors: Total vehicle sales grew 22% to 78,786 units as the strong PC sales supported growth in CV segment. Exports grew 23% y-o-y and 48% m-o-m to 6,220 units.

Maruti Suzuki: Subdued PC sales coupled with disruptions at Manesar plant resulted in total vehicle sales declining 13% y-o-y to 91,442 units. Exports surprised with sales up 18% y-o-y to 14,356 units. YTD FY12, total sales are down 8% to 448,268 units.

We list vehicle sales of other unlisted players to just give an idea of how competition is shaping up in the Indian automobile industry.

We remain positive on 2W industry on the back of rising rural demand, shift in consumer taste towards higher end bikes and expect Bajaj Auto and TVS Motors to be the primary beneficiary (see valuation snapshot in appendix). Tata Motors (not rated) trades at favorable valuations with JLR recording strong volumes and domestic sales pick up ahead of festive seasons. We remain cautious on passenger segment post festive season as macro uncertainties still persist. We do not expect interest rates to come down until end FY12 (though another hike remains a tail event) and expect it to negatively impact PC and M&HCV growth in current fiscal.