Tire inventory | Paint Stocks: IT, Clear Metal Winners; paintings and most vulnerable tire stocks: GV Giri

“It’s not about gross sensitivity anymore. It is a direct vulnerability. Now crude appears to have settled at a level of $110-120, which is significantly above the third quarter average. It applies to paint companies as well as consumer electrical companies and tire companies. Their input costs are strongly tied to crude,” says GV GiriPresident and Director of Research, IIFL titles.

Crude went down. The FII began to organize a comeback. The stock market has reason to look forward, but the divergence in the bond markets signals that we should prepare for a recession?
I do not know. Are you talking about the US bond market or the Indian bond market?

US bond markets. We also saw what happened in Japan. Japan stepped in today to stop bonds of the kind of crash we’ve seen.
But several explanations are possible. For example, there’s a flight to safety going on and usually when that happens there’s a bit of buying into the long-term US Treasuries and so yields fall. So it might not signal a recession; that only a flat or trend to get inverted yield curve signals. So I don’t think recession is signaled by this yield curve and that’s the only interpretation.

US unemployment figures are quite low and the Fed needs to continue to tighten and the sanctions against Russia look set to stay. Recession may therefore be too much to expect at the moment, at least for the United States, since the United States is generally self-sufficient in the two big items, namely crude and gas. They would probably face fewer problems than importing countries like India. The problem is more ours than the American markets. That’s why I asked you if you were talking about the American market or the Indian markets.

For India, the high import bill poses many threats to the currency, growth as well as the current account deficit. Moreover, inflation does not seem to want to disappear. There will be an extended period of tightening by central banks. We may never see a recession for a long time. We’re supposed to have 7-7.5% growth and above, but that number could go down to a number below 7. I hope that’s not the number below 6 for the GDP growth of the exercise 23.

If we were to do an IIFL analysis, explain the recent upgrades in metals, upstream oil and gas, technology and also for Reliance Industries. Why the rise in heavyweight?
The IT sector is clearly a winner in the medium term for two or three reasons. First, there will be pressure on the rupiah if we have an inflated import bill. This helps IT companies with respect to growing their EPS. Second, as I said, the United States, because of its ability to export or produce commodities to self-sufficiency, makes it much less vulnerable to a commodity price shock and growth growth in the US economy is expected to continue without too much interruption compared to the growth of the Indian economy.

India will experience a bigger disruption than the United States and so, in relative order, the IT sector that depends on the United States should do better. When it comes to metals, there are many aspects where we can expect metal and metal prices to remain high, including near-term metal supply challenges to countries at war do not seem don’t want to disappear.

Second, in the medium term, more investment needs to be made in renewable energy which will also amplify the demand for metals and which is also a support for metals.

Third, China might decide that its flagging national economy needs help and if it revives the economy, demand for China’s metals will increase. We have seen that following the freezing of Russian central bank reserves by the United States, many central banks are starting to think about what the ideal reserve currency should be and if there is no currency, then you might as well stop piling up the raw materials and it will be a good way to park the excesses because the raw materials will always be exchangeable.

All of these factors could not only provide support, but could simply keep commodity prices uncomfortably high. Therefore, metals does not appear to be a sector that should experience downgrades. In fact, they should see some upgrades and this could also result in a small multiple expansion as the good strong cycle for the metals for the wrong reasons could extend further than we previously thought.

What about sensitive crudes like paints given that much of their RMC is crude oil derivatives. Are you downgrading paint companies?
It is fair to expect downgrades. In fact, we wrote two notes on it. In one, we just said let’s take the sensitivity of earnings to crude prices. In the second note, we said it’s not really sensitivity anymore, it’s direct vulnerability. This is what we expect as Crude now appears to have stabilized at a level between $110 and $120, which is significantly above the Q3 average. It applies to paint companies as well as consumer electrical companies and tire companies. Their input costs are significantly tied to crude.

Indeed, according to our analysts, tire manufacturers are 65% vulnerable and shares have hardly moved. Other vulnerable segments are consumer electricity and cement. All therefore have significant input cost issues and the torch bearer seems to be the paint and tire manufacturers.

In your last research note, you also talked about InterGlobe aviation as well as HPCL being on a slow lane. Why InterGlobe Aviation? Now, international air travel is resuming. Although ATF prices will increase, so will demand. Some of the local airports look like bus stations!
Yes, but at the same time prices cannot be raised completely based on high costs. It will be one too many, too soon, and there will also be some pushback from regulatory government oversight. If prices rise too soon, this will also impact demand. So we just take it all together and a composite picture seems to be that input cost inflation has been too sudden and too high and if it lasts for a few years earnings will be hit very hard at InterGlobe and HPCL.

Oil marketing companies will also have a problem if crude remains very high and they need to raise prices at the pump as this could be inflationary. Research from the RBI indicates that if every $10 increase in crude is fully passed through to prices at the pump, inflation increases overall by around 50 basis points. There’s a $30 to $40 increase in crude prices and that alone contributes 1.5 percentage points to CPI inflation and that might be something the government doesn’t allow and so there could be a price cap.

WTOs have moved away from commodity companies. These are commodity-consuming companies and they have a price cap. Moreover, they have no control over costs. Thus, their income should be the most vulnerable.

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