March 15, 2022

Economic Update: CPI inflation during February 2022 came at 8-month high and marginally above RBI estimates

CPI inflation during February 2022 surged to an 8-month high on higher food prices, with outlook further likely to worsen given the commodity-supply disruptions caused by Russia-Ukraine war. Reported headline number came at 6.1% in February against the streets’ expectation of 6.0% vs. 6.0% in Jan 22 and 5.0% in Feb 21. Sequentially, , inflation rose by 24bps vs. 30bps decline during previous two months led by price rise across the board except for few food articles.
Core inflation remained elevated (grew 51bps MoM), but eased further on YoY basis to 6.0% in February 22 vs. 6.2% last month. Highest MoM rise was seen in Fuel and light segment (MoM: 1%), followed by clothing & footwear (0.7%), housing (0.6%), services (0.4%) and pan/tobacco (0.3%). Prices for food and beverages fell by 0.1% MoM, at 5.9% YoY vs 5.6% in the last month. Softening in food prices were led by lower MoM price of vegetables (3%), egg (2%), sugar (1%) and pulses (0.1%) while fruit prices were stable. Deviation between rural and urban CPI rose slightly – rural inflation rose to 6.4% YoY vs. 6.1% in the last month while urban inflation fell to 5.8% vs. 5.9% in the last month.
CPI has stayed above the RBI’s tolerance band for the second month and also overshot RBI’s Q4FY22 estimate of 5.7% by 20bps. Global brent price surge impact is currently not reflected because retail fuel price has been kept stable by the government. Hike in retail fuel prices, other input commodity prices and logistics are likely to emerge as an upside risk to the inflation forecast. We believe uncertainty due global geo-political issues is likely to force the RBI to revisit its inflation and growth forecasts at its policy meeting next month.

Pharma Sector: Resurgence of Covid in key global markets continues to benefit the sector

Resurgence of Covid (Omicron variant – B1.1.529) despite optimal vaccination raise concerns of continued presence/impact of Covis in the world market. Recent global data show surge in covid cases again in key countries of Europe, Asia and China (announced lockdown of Changchun, Jilin, Yanji, Siping, Dunhua yesterday) in recent days.  This resurgence in key advanced countries despite near full vaccination of >60-85% of the eligible population certainly indicates about the emergence of a new Covid wave soon. We expect Divi’s and Cipla to be the key beneficiaries.
DIVI could be a key beneficiary of visible resurgence in Covid cases mainly driven by multiple antiviral drug supplies (including Molnupiravir).  As per the management, fresh variants of covid need newer covid drugs and newer mechanism of action. Divi’s is working on various antiviral covid drugs (in market  as well as in pipeline) with big pharma. Expect to benefit from the new technologies and new synthetic chemistries required to quickly develop/ manufacture/ supply these drugs. Thus, the covid situation to remain dynamic for the next 1-2 years and DIVI (having strong chemistry skills and enough capacity to handle sudden surge in demand for such drugs) is well positioned to capture the visible opportunity. Expect strong Q4 based on visible supply opportunity. Apart from covid opportunity, we believe DIVI is only one Indian pharma co with 5 year growth visibility led by its recent mega capex of Rs 30 bn over FY19-22 and announced capex of >Rs 20bn over next 2-3 years and Huge opportunity to replace China (supplying APIs/Intermediates worth USD 35bn annually) supply chain in APIS/intermediates.
Similarly, CIPLA, which has been the biggest beneficiary of earlier Covid waves and having wider global presence could grab from the visible spike in Covid cases globally. Apart from Covid, we expect a qualitative profitable growth for CIPLA on account of – A) strong US growth (visible albuterol ramp-up and key launches like – gAdvair, gRevlimid, gAbraxane, etc), B) robust domestic business aided by its strong respiratory franchise, and C) steady exports momentum to EMs.

Commercial Vehicles: Outlook remains positive

In our view, the conditions are ripe for a sustained upcycle in the CV space.
Sales of trucks in the CV segment are estimated to touch 340,000 units in FY22, an over 50% expansion compared with 225,301 units last fiscal year. The growth is expected to be more than 50% in FY23 too, according to experts, as they predict opening up of the economy after Covid-related restrictions and almost all sectors returning close to normalcy driving demand for the carriage of goods.
Policies such as the scheme for scrapping old vehicles and production-linked incentives will also play a role in driving the demand for commercial vehicles. The average age of India’s truck fleet is at a record high, which means the vehicles are getting older and inefficient.
Close to half a million trucks are due for replacement, based on the average retention period of the first buyer. The proportion of replacement demand was 30-35% in the past two years; this is likely to move to 50% in the coming year. The utilisation rate of trucks is moving up to 80% and profit from a vehicle after excluding interest and all expense has increased to INR 4.5 lakh despite high fuel prices (on running a minimum of INR 1,00,000 kms a year), compared with just INR 1.5 lakh a year before.
Daimler India expects the medium and heavy truck market to grow 25-30% in CY2022, followed by low double-digit growth in the next 2-3 years. In the auto space, we remain most positive on the CV makers including Ashok Leyland and Tata Motors. Ashok Leyland is more of a pure play on CVs than Tata Motors and hence is more leveraged to the CV cycle. We also like Tata Motors for its strong positioning in the CV space and market share gains in SUVs and EVs. However, the company remains vulnerable to any disruption due to global supply chain.

Avantel: Large order win should propel profits in the medium-term

Avantel has received order for supply of Loco devices for implementation of RTIS phase – 2 (Real Time Train Information system) for an amount Rs. 1.25 bn. Avantel Limited is engaged in the business of designing, developing and maintaining wireless and satellite communication products, defense electronics, radar systems and development of network management software applications for its customers majorly from the aerospace and defence sectors.n
The company has an established track record of over two decades in the electronics and telecom equipment business which has enabled it to offer a unique combination of embedded systems and related software used in the defence sector, as well as RF systems used in the civilian telecom segment. The founder and managing director, Dr. A Vidyasagar, has experience of around two decades in the industry. The company derives core business strength from its in-house R&D capabilities.
We note that the order value is significant as it is 1.5x its FY21 revenues. This order gives the company immense revenue visibility for the next two years. The company’s balance sheet is strong, which is a major positive to be considered by investors. It has no debt on balance sheet and has decent cash surplus. The stock has made a 52W high of Rs 949, but has corrected to Rs 744. It is trading at PE of 17x TTM (trailing twelve months) basis. Valuations are not cheap but are neither expensive considering that niche technology/defence companies get premium valuations.
We would like to highlight that in the defence manufacturing business, the ordering is often lumpy which results in volatility in yearly/quarterly earnings. Investors prefer to invest in consistent growth companies; defence companies fall short on this count.  Also, as most of the business is tender-driven, revenue and profitability depend on the ability to bid successfully and based on proper risk-based framework.