FY16 expected to see muted rural show

Investors should avoid companies with a substantial part of their portfolio here, say analysts

Factors such as unseasonal rainfall, lower construction/mining activity and weakening agricultural and non-agricultural incomes will impact companies heavily dependent on rural economies in FY16, believe analysts.

Thus, Mahindra & Mahindra, M&M Financial Services, Shriram Transport, Hero MotoCorp, Hindustan Unilever and Maruti, among others, could see subdued growth. The key short-term monitorable are the monsoons, as it plays a key role in cash flows and the purchasing power of farmers. Bad news on this front could worsen the situation.

“We see little chances of a positive earnings surprise in FY16 for stocks levered to the rural economy. In the near term, one should be underweight the (basic) rural plays, given that erratic rainfall has damaged two crops in succession, low levels of activity (construction, mining) and rationalisation of subsidies have impacted non-farm incomes, and land price increases have moderated and fallen in a few places,” says Suhas Harinarayanan, head of research, JM Financial Institutional Securities.

Notably, key statistics such as tractor/automobile sales, consumer durables sales, and rural inflation and wage growth indicate a softening of that economy. Analysts believe this trend will improve only at a gradual pace, leading to muted near-term performance by companies having a high exposure to this economy. Sectors such as agri chemicals, consumer goods, automobiles and banks/financial institutions will be more vulnerable to a weakening rural economy.

Rakesh Arora, head of research at Macquarie Capital, says: “We are underweight on staples and positioned for a consumption slowdown in the rural economy. We believe slowing rural incomes will affect demand for building materials, two-wheelers and tractors. In this backdrop, we believe M&M and Hero MotoCorp will be more impacted.”

About 67 per cent of M&M's passenger vehicle sales and its entire tractor sales come from the rural segment. For two-wheeler companies, the rural economy contributes 40-50 per cent of sales volumes. In the consumer sector, HUL and Dabur derive about half their revenue from rural areas; this metric is about 45 per cent for Britannia. Thus, these companies will witness higher sales pressure than peers as the rural economy slows down. Interestingly, most consumer companies have invested in increasing their reach and revenues in rural areas over the past few years. This has led to higher sales contribution from these areas.

The volume growth estimates for FY16 can be misleading, given the low base of the preceding two years. Bajaj Auto and M&M’s utility vehicle portfolio saw volume contraction in FY14 and FY15. M&M tractor sales volumes also fell in FY15.

“We maintain our underweight-rural and preference for urban themes. Declining cash flows for the sector will have significant impact on rural themes, including consumer goods, automobiles, agri inputs and public sector banks,” says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.

Agro chemicals and complex fertilisers will be hit the most by rural slowdown, though the impact on their financials will come in only with a lag effect. Falling commodity prices, though, provide some relief at the margin for these companies. “Our preference remains for companies with asset-light and flexible business models such as Sharda Cropchem and Dhanuka Agritech or for companies with export exposure like UPL and PI Industries,” adds Sinha of Emkay.

As a large part of M&M Financial and Shriram Transport's branches are in rural areas, these lenders will see impact on asset quality and credit offtake. Most banks will witness increased stress on their agricultural loans and will need to keep an eye on their asset quality. The possibility of debt waivers on agri loans could further impact this sector.