WILL THE RAIN GOD KEEP SMILING?

With so many ifs and buts, at last the crucial southwest monsoon has gathered momentum in the month of June, giving much needed respite to the already restrained Indian economy. As per the Indian Meteorological Department’s (IMD) data, the Indian landscape has received normal rains in the month of June and till June 18, rains are more than 11 per cent above average. Most encouraging is that the monsoon is continuously gathering pace, leading to boosting of kharif sowing across the country. Also due to adequate rains in June, water storage across 91 crucial reservoirs of the country has improved and with 39.05 BCM of storage, it has reached 103 per cent of storage compared to the corresponding period last year and 139 per cent of the last 10 years’ average.

This situation has really boosted the fortunes of Indian economy, which is reeling under the pressure of low demand, lukewarm consumption cycle, higher interest rates and potential inflationary threat. Agriculture for Indian economy is so crucial that any derailment of the monsoon can play havoc for the economy as a whole. Though it only contributes around 15 per cent of Indian GDP, it actually employees 60 per cent of the Indian population and any impact on the income generation of this agrarian class would send the whole consumption cycle haywire, especially the products that directly relate to rural economy. This includes sales of automobiles, tractors, FMCG products, -pesticides, fertilizers, gold, etc.

Considering this, having normal monsoon in a country like India is no less than a state of bliss. At the same time, if concerns hover over the quantity of rainfall in the most crucial month of kharif season i.e. July, it is most sensible to take into account this crucial factor while making your investment strategy, particularly into stocks related to the agriculture-based economy. The importance of monsoon can be gauged from the fact that even Finance Minister Arun Jaitley wasted no time in inviting international investors’ in the US as the monsoon prediction improved in June. “With it (monsoon) prospects of the agriculture sector doing better, this will put the economic growth prospects on an even better footing,” remarked Jaitley in California.

July Holds the Key

If we talk about the impact of the southwest monsoon on the Indian panorama, then the period of June-September is most crucial for the agriculture sector. Indian agriculture production is basically divided into two seasons: kharif and rabi. The former relates to the June-September period while the latter relates to November-February. As per the production data released by the Ministry of Agriculture, the kharif season is much more important for the Indian economy as around 53 per cent of agri produce comes from the kharif crop, whereas the rest is contributed by rabi. At the same time the kharif crop is majorly dependent upon monsoon as around 65 per cent of the agriculture area is rainfed, without any other irrigation facility.
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Another crucial impact of the monsoon is that India receives more that 75 per cent of its rain via this season in just four months and it is vital for the groundwater reservoirs of the country to fill up, which are used throughout the year for water needs, including rabi crop irrigation. Considering all these factors, when DSIJ investigated deep into the present state of the southwest monsoon then the current situation seems okay but the IMD still has concerns over the next three months. Though of late the June rainfall has gathered momentum, IMD has predicted weakening of southwest monsoon rainfall in July. In the crucial month of July the monsoon is expected to be 92 per cent of the long period average (LPA) and 90 per cent of LPA in August. If this prediction proves correct then it can potentially hamper the pace of sowing and growth of the kharif crop.

Also, the IMD has predicted that the probability of normal rainfall during the current year is just 7 per cent, clearly showing that the threat of below normal monsoon is looming large over Indian economy and if this happens then it will be the second year in row when monsoon would remain deficient for the country, seriously impacting food grain production. IMD has also predicted 2015 to be affected by El Nino, which further raises the concern. Importantly food grain production was at 265 MT during FY14, the highest ever level since Independence whereas it is expected to decline to 251 MT during FY15 due to below the normal rain during the last fiscal.

Though during the current fiscal the IMD forecasted 88 per cent monsoon rains, June rains remained quite normal, due to which sowing activity across the country has picked up. As per the agriculture ministry’s data, till June 19 the total sown area across the country was 91.61 lakh hectare as compared to 98.88 lakh hectare at this time last year, indicating a drop of 7.9 per cent. On the other hand, the crop-wise area that was reported by states represented the acreage of  paddy at 8.33 lakh hectares, pulses in 4.51 lakh hectares, sugarcane in 41.58 lakh hectares and cotton in 19.66 lakh hectares, which is showing a decline. But if the rains remain robust, sowing will gather momentum.

Government Spikes Inflationary Threat

At a time when the threat of below normal monsoon is looming large for the second consecutive year in a row, the “relatively seasoned” NDA government is playing the ball wisely. The government has already taken steps to neutralize the threat of inflation. As per the first effort, the government has marginally increased the minimum support price (MSP) of paddy by less than 5 per cent. The Cabinet Committee of Economic Affairs (CCEA) recently increased the MSP of paddy by Rs 50 to Rs 1,360 per quintal, whereas the MSP of pulses has been jacked up by Rs 100 per quintal.

Agriculture experts are of the opinion that in the matter of deficient rain, this marginal increase in MSP won’t impact the inflationary pressure, though it will act as an encouragement to the farmers to cultivate more paddy and food grains. On the other hand, the government is also taking steps to control inflation, especially food inflation. In the matter of cotton, arhar and urad pulses and sunflower the rise in MSP is just Rs 50 per quintal each, thereby dousing any possibility of increase in prices.
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Actually this step of the government is quite strategic in the sense that the finance ministry and RBI are taking all the required efforts to put the growth engine back on track through greater infrastructure spending and consecutive rate cuts. The RBI has slashed the rate of interest thrice during 2015 to give the desired booster to the economy and also indicated that this rate cut will continue during the current year. The only threat to this strategy is rising inflation. If the monsoon remains deficient, then it would be double whammy for the government as it will impact the production of food grain on one hand, thereby fuelling their prices and on the other hand if the MSP is raised the prices would go further northward.

At the same time, just to boost the acreage, for sugarcane production the government has approved an interest-free loan of Rs 6,000 crore to sugar mills so that they can pay arrears to farmers. “The money will go directly to farmers through their Jan Dhan accounts,” Transport Minister Nitin Gadkari said, while announcing the decision. This is quite important for the fact that sugarcane production doesn’t depend much on monsoon and it is quite evident from the past years that sugarcane production increased during years when rainfall was less, especially in UP and Maharashtra.

Right Investment Strategy

Clearly the progress of the southwest monsoon is difficult to predict and in the last 11 years the IMD was able to predict monsoon activity correctly in just five years. For an investor, to focus on various crucial parameters and choosing the right stock is quite important. As per a recent Edelweiss’ agri research report, investors should take into account each and every scenario and then take investment decisions accordingly.

In of a normal monsoon, there will be robust production of pulses, soybean, maize and groundnut. All of these have fetched excellent prices over the year which will prompt farmers to devote higher acreage to these crops. On the contrary, acreage under paddy, bajra and castor are likely to shrink this year. On the other hand, in case of below normal monsoon, the report indicates downsizing of the production prospects of various crops. It opines, “In such a scenario we would see acreage under cotton, sugar and urad to remain higher. Cotton has an advantage of the longest sowing window, sugar is hardly rain-dependant as most of it is grown in irrigated regions and urad will do well in terms of yields with lower rains. However, crops like paddy, maize, groundnut, guar, castor, tur, moong and bajra would suffer due to lower yields.” Brokers have predicted a range-bound movement for sugar as sugarcane production remains unaffected by even deficient rain or El Nino.

As far as Basmati and non-Basmati production is concerned, the report has predicted a range-bound movement of prices as production remains normal even in deficient rain, unless El Nino comes into play in a big way. At the same time, pulse production will be majorly dependent upon monsoon rainfall and so inflationary pressure would continue to play a major role in the prices of pulses, especially tur and moong, whereas urad prices would be under pressure due to the fact that it remains unaffected by rainfall.
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Follow Stock-Specific Strategy

Considering the complex state of the monsoon, it would be sensible for investors to take into account both the scenario of normal as well as deficient rainfall. DSIJ tried to decipher the impact of monsoon on specific stocks and pulled up a few stocks which would be negatively and positively impacted by the deficient rainfall. Investors’ can follow this strategy to gain at the bourses.

Stocks to Avoid for Below Average Monsoon

If the monsoon turns out to be below average, we expect price correction in the below mentioned stocks which may not see any further upside from their current level in FY16.

NHPC | BSE Code: 533098 | Face Value: Rs 10 | CMP: Rs 19.75

One concern regarding the lower monsoon is that probably the hydro power plants get impacted. Hydro power companies do not have a back-up plan for deficient rainfall and the plants dependent on reservoirs fed by rainfall will produce less in the event of a weak monsoon. State-owned NHPC is the country’s largest hydro power producer with an installed capacity of 6.5 GW (including 1.5 GW through JV), which contributes around 16 per cent of India’s total hydro capacity and 17 per cent of total hydro generation (25.7 BUs in FY15). NHPC’s historical growth has also been hit by sectoral woes leading to delayed project execution and cost overruns. The company also added muted capacity of 130 MW in FY15 and similar capacity is expected to be added in FY16.

ESCORTS | BSE Code: 500495 | Face Value: Rs 10 | CMP: Rs 120

Last year, poor monsoons had a lagged impact on tractor manufacturing companies like Escorts. The total tractor sales in the country were down in FY15 to 5.50 lakh units from 6.14 lakh units in the previous year. This year too the sales are likely to be down to 5 to 5.2 lakh units in case the monsoon becomes deficient. Escorts’s tractor segment constitutes around 80 per cent of the total revenue and it is the fourth-largest tractor manufacturer with a market share of 10.4 per cent in FY15. The company does not have a strong presence at pan-India level and has a lower presence in south and west India. Even the company’s tractor sales declined by 22.6 per cent in the first two months of Q1 FY16 from 11,160 tractors units in April-May 2014 as compared to 8,637 tractors units in April-May 2015. Overall, the first half of FY16 can remain unexciting for Escorts.

Hero MotoCorp | BSE Code: 500182 | Face Value: Rs 2 | CMP: Rs 2520

In FY15 the crashing prices of crops, low wages and erratic rainfall have put pressure on the sales of motorcycles in rural markets. Hero MotoCorp is continuously losing its market share in the motorcycle segment from 56 per cent in FY12 to 53 per cent in FY15. Further, amidst a slowdown in rural demand which accounts for about 50 per cent of sales, the overall industry would also face a tough time for growth. The company sold a record 6.63 million units of two-wheelers in FY15, which are its highest-ever annual sales. However, in the first two months of Q1 FY16 its sales declined by around 6 per cent from 11,73,535 units in April-May 2014 as compared to 11,73,535 units in April-May 2015. 

Hindustan Unilever | BSE Code: 500696 | Face Value: Rs 1 | CMP: Rs 895

About 40 per cent of the FMCG sector’s demand comes from rural regions. If the monsoon is below average then it will drive up prices of the raw material, which will hurt the profitability of companies like HUL that don’t pass on increased costs to consumers. HUL’s volume growth has declined from around 13 per cent in FY11 to around 4 per cent in FY14 and 5 per cent in FY15. The slowdown was largely on the back of a slowdown in urban discretionary demand with rural growth remaining moderate. The company’s revenue indirectly depends around 40-45 per cent from rural markets and directly it will be around 35 per cent. The company is currently trading at high valuations of around 44x PE on FY15 earnings of Rs 20.2 per share. A below average monsoon will definitely impact HUL’s business and the stock price may correct or may not move up from the current level.
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Stocks to Invest in Case of Normal Monsoon

The following stocks will be positively impacted by normal monsoon and we expect further upside from the current level in FY16.

Insecticides (India) | BSE Code: 532851 | Face Value: Rs 10 | CMP: Rs 574

Despite the inconsistent monsoon over the past five years, Insecticides (India) has managed to buck the trend and deliver robust performance. It is amongst the top 10 Indian agro-chemical companies with almost 7 per cent market share of the Indian agro-chemical market. Around 95 per cent of its revenue comes through domestic market. The company is still trading at around 13 times its FY15 earnings per share of Rs 43.3, which is at a substantial discount to established peers which are trading above 20x PE in the domestic agro-chemicals industry. With the Dahej facility scaling up, we anticipate operating profit margins to expand by around 100 bps to 12.5 per cent in FY16 as against 11.5 per cent in FY15. Further, with no major capex planned, we expect free cash flow generation going ahead. Debt to equity is likely to improve from 1 in FY15 to 0.6 in FY17.

Dhanuka Agritech | BSE Code: 507717 | Face Value: Rs 2 | CMP: Rs 632

Being in the agro-chemical space, the monsoon plays a vital role in driving demand for the sector. Dhanuka Agritech is amongst the top 10 Indian agro-chemical companies, with almost 6 per cent market share of the Indian market. If the monsoon is better, the company expects growth upto 30 per cent in FY16; even in deficit monsoon it expects 10 per cent growth in the current fiscal year. The company is in the midst of setting up a formulation plant in Rajasthan at capex of Rs 50 crore, and the plant is expected to go on‐stream by the beginning of Q3 FY16. The company will focus on new molecules and technology to cover agri protection chemicals. The company has a target of Rs 2,000 crore topline by 2020, growing at 15-16 per cent CAGR from its current turnover of Rs 785 crore in FY15.

Shriram Transport Finance | BSE Code: 511218 | Face Value: Rs 10 | CMP: Rs 891

The Reserve Bank of India (RBI) lowered interest rates three times (25 bps each) in this calendar year to spur growth. In its last monetary policy announcement on June 2, 2015, RBI Governor Raghuram Rajan had stated that any further cuts would depend on data, among the most crucial of these being the monsoon. The monsoon has progressed better than the forecast, which has led to hopes that the RBI might cut rates further in the near future. In this scenario, Shriram Transport Finance can benefit, being engaged exclusively in the financing of commercial vehicles (CV), both new as well as old. The company expects significant growth from rural areas over the next 2-3 years as it has opened new centres in these areas. Furthermore, lower fuel costs and reduced interest rates would assist demand for CV in FY16 which will benefit CV finance lending companies like Shriram Transport Finance.

Rallis India | BSE Code: 500355 | Face Value: Rs 1 | CMP: Rs 247

Rallis India over the years has diversified from a plain vanilla domestic crop protection company to lucrative segments like seeds, plant growth nutrients (PGN) and exports. Rallis India has a market share of around 8 per cent in the crop protection business at around Rs 900 crore in FY15. It’s a safe bet to play upon in the agri input segment with presence across the value chain. Rallis has launched six products in FY15 and has a slew of product launches lined up for FY16. Tie-ups with international companies such as Dow Agro Sciences, Syngenta and Nihon Nohyaku has led Rallis to introduce internationally proven products into the Indian market at regular intervals. It also has a healthy balance-sheet with debt to equity standing at around 0.14x as of FY15. Rallis enjoys strong return ratios (ROE at around 20 per cent) due to low asset base and high margin pesticide business.