Since the outbreak of COVID-19 contagion assumed dangerous proportions, stock markets across the globe have been bleeding post Valentine day (February 14) and everyone associated with it have been forced to undergo quarantine in terms of their investment. With the COVID-19 outbreak declared as apandemic by the World Health Organisation (WHO), panic gripped the financial markets across the globe including Indian markets.
The volatility witnessed is on account of several reasons. The first and foremost reason is that there is a strong fear that World economy will grow at a tepid pace in next four to six quarters. In the following lines we make an attempt to analyse how this slow-down, particularly in Chinese Industrial sectors, will impact Indian companies operating in these sectors and its resultant impact on their earnings based, on research undertaken by prominent brokerage houses; Geojit Financial Services(Geojit), JM Financials (JM) and leading rating agency CRISIL.
Geojit in its report said, Indian chemical industry sources raw material from China, but most companies have adequate inventory to cater to demand in the near-term (at least for the current quarter) and with gradual resumption of work in Chinese factories, supply issues are expected to be resolved. Additionally, crude derivatives as raw material for chemical companies will be positive for the gross margins given drop in oil prices. Domestic specialty and Agro-chemicals players with strong supply chains and backward integration are likely to benefit.
The feedbacks received from the traders of fluorspar indicate that prices have increased by c.20 per cent in the past two weeks as the stocks are very low. They expect the supply to restart only in April. Over the last few days, as COVID-19 started subsiding in China, the prices of some of the basic chemicals have begun to drop, JM Financial (JM) said in its report.
Geojit report said, most Indian pharmaceutical companies are export oriented with high exposure to US and Europe. These economies are expected to slow down with precautionary measures on trade, which could have a cascading effect on domestic pharma manufacturers. At the same time prices of raw materials like APIs have increased due to cut in availability from China which is the largest source, impacting profitability of the sector. On a positive note, these raw materials are derivatives of crude oil and the current huge drop in oil prices will benefit them in the medium-term as businesses normalise. Supply bottlenecks of APIs are expected to be resolved as soon as Chinese factories resume production.
JM Financial said, though companies have stated that the manufacturing of APIs has gradually resumed in the affected regions of China, albeit with fewer workers now reporting to work, companies are yet to receive incremental supplies from China. Companies have attributed this to the possibility of the first batch of supplies being directed to higher realization geographies.
CRISIL report said, India imports 69 per cent of its total pharma-bulk drugs intermediates from China Players have sourced their raw materials and created buffer stocks for 2-3 months, ahead of holiday period in China. It is expected to have neutral impact in wake of adequate inventory stock.
Impacted by supply chain issues, the currency depreciation is also likely to increase the raw material cost, as most of the companies have 10-15 per cent import content. The industry is reeling under the pressure of lower sales due to increase in vehicle cost (owing to BS-VI transition) and competition in the last one year. The industry is looking at the impending scrappage policy which is due to be announced by the government in the near future, Geojit in its report said.
On the basis of our checks with Original Equipment Manufacturers (OEMs), JM said in its report that current status of supply chain disruption arising from COVID-19 for the automobile sector is as follows: a) Companies are not anticipating major impact on production till end of Mar’20, b) Supplies from China have resumed as supplier plants are back online albeit at a lower capacity, c) Companies are making alternate sourcing arrangements (in case it is needed), d) In case of critical components, companies like JLR and Bajaj Auto are airlifting components, e) Companies like Maruti Suzuki India (MSIL), which have limited sourcing from China are closely monitoring situation in Italy as certain CNG related parts are sourced from Italy and , f) BS6 ramp-up is happening along with improvement in supplier position in China easing the condition for few OEMs.
India imports 18 per cent of its automobile components and 30 per cent of its tyres requirements from China. The inventories for these two segments are sufficient for the short term, but lack of single critical component can hurt OEMs. Local Indian auto-component manufacturers can not immediately capitalize on the void created by China as it takes time for OEMs to recalibrate their supply chain, CRISIL report said.
Being export oriented and also with high exports exposure to China, demand outlook remains subdued. The companies could not emerge as an alternate destination for the global textile industry because of dependence on inputs from China like zippers, buttons etc. Withdrawals of key incentive schemes like Merchandise Export from India Scheme, indicates lower earnings outlook. Apparel business in India will benefit in the long-term as client’s interest to shift business from China to other emerging countries like India.
After an initial delay due to COVID-19 impact, shipments from China to the US have resumed to normal levels. Feb/Mar’20 has seen strong home textile demand in US due to higher than average stocking by global retailers, as per our channel checks, said JM in its report and added this demand is likely to taper off in Q2CY20.
The sector’s dependency on exports is low. India exports 1 per cent of total ready-made garments (RMG) it produces annually to China. Due to rising costs, sourcing of apparel is shifting to low cost destinations such as India. COVID-19 outbreak is expected to provide further opportunities for the Indian Textiles and RMG sector, CRISIL said in its report. However, for Textile Cotton Yarn sector it said, the sector is highly dependent on exports as China’s share is high at 27 per cent of total export of cotton yarn. Decrease in India’s exports to China will put further pressure on domestic prices of cotton yarn, which is negative for the sector. Effectively, this will lead to lower margins of cotton yarn players.
Geojit report said, Demand is expected to be downward for the Metals sector due to lower global growth which may affect pricing power of metal stocks. Currently, imports from China are at around $5,500 million while exports are below $800 million, which signifies a huge opportunity for Indian players to cater to domestic demand. However, the virus spread along with Macro headwinds could affect domestic steel consumption and add volatility to steel prices.
Fall in international bond yields indicates high increase in global financial & economic risk, which could be the highest concern for Indian banks, though Other Income will spike for banks due to treasury gains. Apart from the increased systematic risk, PSU banks are currently undergoing structural change with the planned mergers, while stressed asset concerns persist for Banks and NBFCs. The recent Yes Bank issue has highlighted operational risk of small private banks. Considering the Gold prices, NBFCs with gold as collateral are much better placed than their peers.
Although there will be a marginal fall in general consumption and demand slowdown, the sharp decline in crude will benefit the industry with reduction in packaging and transportation costs. Companies have seen limited impact on account of supply chain disruptions because of inventory build-up ahead of season. However, prolonged disruption can have an impact and associated cost increases. “We can expect stable growth in business while high valuation will be a deterrent to perform in the short-term”, Geojit said in its report.
India imports 45 per cent completely built units (CBU) of consumer durables from China. In addition, India also imports bulk of consumer durables components from it. Players have already stocked inventory, so impact will be felt only towards the end of Q4 FY20. Product prices could rise in coming months (April-May 2020). The hike in GST rates from 12 per cent to 18 per cent recently will also increase prices of mobile handsets. India had a very high dependency on China in case imports of Electronics (including mobile handsets). It imported around 67 per cent of its requirements in FY’19. Though India progressed from assembling to manufacturing of low-end electronic components, import dependency remains high. Such high dependency on imports with some critical components being produced with China is expected to have significant impact, CRISIL said.
The overall demand outlook has weakened which will reduce consumption from Industries and Retail. The crude oil price correction has a mixed impact on oil & gas companies. Upstream companies will see revenues negatively impacted on account of lower oil prices while downstream companies will benefit from lower costs of refining and hence Gross Refining Margins (GRM) and marketing margins will improve, the Geojit report said.
India exports 34 per cent of its total petrochemicals output to China. Exports to China would be hit; finding new markets immediately is monitored. Indian petchem is unable to capitalise on COVID-19 effect, due to high utilisation. Petrochemicals prices and margins will be under further pressure due to the virus. In case of Plastics, India imports 44 per cent of its total plastics requirement from China. It is going to have positive impact on domestic Plastic industry as reduction in cheap Chinese imports will benefit domestic manufacturers, CRISIL report estimated.
Fear of the virus spread and restrictions placed will impact entire hospitality sector which includes movie box office collections, movie distribution income, advertisement income for movie houses and media companies and also impact sectors like amusement parks. Travel restrictions are likely to have material impact in near term due to flight cancelations leading to lower utilizations and other associated costs offsetting any gains in fuel input costs. The closure of borders and restrictions on travel will have an impact on tourism and its allied sectors.
Gem and Jewellery:
India is highly depended on China with respect to diamond, as it exports 36 per cent of its polished diamonds to China. Share of diamond exports to the region has been declining for some time due to reasons other than COVID-19. Nonetheless, rescheduling of the Hong Kong International Jewellery Show and aftershocks of COVID-19 will adversely impact exports and dampen the domestic industry in Q4 FY20, CRISIL said.
Shipping and Logistics:
Over 90 per cent of the global trade is via sea. China is key consumption centre for bulk drugs and containers. China accounts for 70-75 per cent of iron ore trade, 20-25 per cent of coal trade and 25-30 per cent for crude oil globally. The COVID-19 outbreak is expected to keep the demand and freight rates low in the short term for the sector, CRISIL report concluded.
The impact of recovery in Chinese Industrial sector on Indian Corporates is expected to be mixed and looking at the way efforts undertaken by Chinese authorities to take control of the COVID-19 situation and their high success rate, firms up the optimism that normalcy should return sooner than later, Geojit Financial Services said in its report.