Consumption-Led Sectors Will Be Worst Hit By Government’s Currency Purge

The recent demonetisation of Rs 500 and Rs 1,000 currency notes will create headwinds for several sectors in the second half of financial year 2016-17 and negatively impact earnings, a number of brokerage houses said in recent reports.

In a move to fight black money, terrorism and counterfeiting, the government withdrew Rs 500 and RS 1,000 currency notes from circulation from the midnight of November 9. As of March 2016, RBI data indicates these denominations account for 86 percent in value of the currency in circulation - worth Rs 14.95 lakh crore. That amounts to approximately 10.5 percent of India’s gross domestic product (GDP).

The withdrawal of these currency notes has prompted a severe cash crunch and consumption slow down across the economy, till new notes replace old ones. Motilal Oswal Securities expects third quarter corporate earnings to be the worst hit, derailing an earnings recovery in the second half of financial year 2016-17. Sectors like auto, cement, consumer durables, non-banking finance companies (NBFC), fast-moving consumer goods (FMCG) and telecom may see earnings downgrades in the near term though the longer term implications of the move on various sectors and the economy are positive, the brokerage said.

Automobiles

The third quarter is typically a slow sales one for auto companies and the government’s currency curb could hit demand further.

The impact is expected to be less severe on the four-wheeler segment as most car sales are financed through bank loans. Two-wheelers sales however, are likely to see a bigger slowdown as almost 60 percent of purchases are made in cash, especially in rural areas, which contribute 45 percent of total sales.

According to Motilal Oswal Securities, 90 percent of tractor sales are financed through bank loans and hence tractor sales would also remain healthy, especially on account of good monsoons.

Paints

Amid the severe cash crunch, Kotak Securities expects consumers to defer or cancel their discretionary spends. A slowdown in the real estate sector, which has traditionally seen a high proportion of cash or even black money transactions, will lead to lower volumes and realisations in the near term for paint companies like Asian Paints, Berger and Kansai Nerolac, the brokerage said.

Building Materials

This sector will experience near-term demand issues as it is linked with real estate. A significant portion of the supply comes from unorganised players and is likely to be impacted due to their reliance on cash transactions.

There will be little impact on the organised players as primary sales to dealers are done through cheques but 30-40 percent of secondary sales are cash transactions and that will in turn impact near to medium term sales. Stocks in this sector slipped between 15 to 25 percent since demonetisation came into effect.

Cement

Cement demand is likely to be adversely impacted over the next few months. Companies in this sector are already running at 50-60 percent capacity utilisation, both Kotak Securities and Motilal Oswal Securities pointed out. Nearly 60 percent of cement demand comes from real estate and the since the absence of cash will impact real estate sales and construction supplies, cement will be impacted too.

Lower-than-expected demand is also likely to put pressure on cement prices in the near term. However, over the longer term, cement demand is expected to grow, led by the government’s emphasis on infrastructure spending and a revival in rural demand after healthy monsoons. The top five cement stocks slipped between 15 percent to 25 percent since the currency curb was imposed.

Consumer Durables

Demand for appliances is expected to slow down as cash transactions account for 70-75 percent of the overall sales of consumer durables. In tier one cities, 30-40 percent of sales are cash transactions while the remaining are financed by bank loans. Purchases in smaller cities are predominantly done through cash.

Like the auto sector, sales of consumer durables typically see a lean patch following Diwali, and with the ongoing cash crunch, demand is expected to fall further. Products like air conditioners, front-loading washing machines, high-end television sets and refrigerators may take longer to recover due to the restricted flow of cash and the demonetisation impact on black money.

Fast Moving Consumer Goods

The negative impact on this sector is likely to last for the entire second half of financial year 2016-17. Rural demand will be hit more than urban. However, companies are likely to provide longer credit periods which may blunt the impact to an extent. Channel-wise feedback cited by Motilal Oswal Securities shows sales have fallen 40 to 50 percent.

Media

The bulk of television advertisements come from the FMCG sector and a slowdown in that space is likely to have a negative impact on ad spends, in turn hitting media companies. In addition, print media is likely to see a pullback in real estate advertising. Overall, advertising revenues of print media companies are likely to see a bigger hit than television. Subscription or circulation revenues could see some weakness through the second half of financial year 2016-17.

The benchmark index, Nifty 50, has fallen 5 percent since the demonetisation announcement. Kotak Securities expects the move to significantly reduce the circulation of black money and make the creation of new black money tougher. On the economic front, demonetisation will bring in additional liquidity to the formal economy and support growth in the longer term, while also leading to lower inflation and interest rates, the Kotak report said.