Industrial Production Something amiss ::EMKAY

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Industrial Production

Something amiss

Strong growth contradicts leading indicators

IIP growth (base year 2004-05) for Nov-11 at 5.9% yoy was a positive surprise against consensus expectations of just 1.6% Strong growth came in even as no leading indicators were suggestive of such growth. For e.g. the exports growth for Nov-11 was at just 3.8% (vs 46% till Oct-11) and the govt revenue expenditure has declined by 5.2% yoy and the additions in the projects under implementation as per CMIE data has declined by more than 50% yoy for Q3FY12.

IIP SA suggests steeply high utilization levels…

On seasonally adjusted (SA) basis, the IIP level is closer to Mar-11 (recent peak) implying that in just one month the industrial activity has reversed the deceleration seen over past seven months. This would also imply a rise in the capacity utilisation and significant bounce back in demand and pricing power which again is not reflected in the WPI data. This can happen only if there is big positive policy shock.

… But contradicted by WPI data and corporate profitability

The pass-through coefficient (12 month elasticity of core inflation ex-food, gold & silver w.r.t. primary non-food inflation) increased marginally to -0.01 in Nov 2011 vs -0.03 in Oct 2011 and -0.08 in Aug-Sep. While the improvement is indicative for receding margin pressures for the manufacturing sector we believe the pricing power is still very weak as the coefficient is far lower than 2008 levels (peaks 0.45 in Aug 2009 and 0.36 in Aug 2010).

In fact for companies under our coverage, we expect the EBIDTA margins to decline sharply by 102bps for Q3FY12. Hence, despite a price led 18.6% yoy growth in revenues, we believe cost pressure would reduce the APAT growth to mere 5.2%. (See Q3FY12 Results Preview: A quarter of mellowed expectations dated Jan 3, 2011)

Growth still remains narrow-based

Decomposition of the manufacturing sector shows that 11 out of 22 sectors (46% weight in manufacturing index) decelerated of which 7 (45% weight) grew by less than 5% yoy.

Capital and consumer goods remain volatile

The consumer goods growth for Nov-11 stood at 13.1% which was a contradiction to declining trend of previous ten months. In fact, within manufacturing sector ~2.5% growth (out of 6.6% yoy) was contributed only by food (2.1%) and tobacco products (0.4%), Edible oils are key seasonal contributors to the Nov food products index. However, despite the acreage remaining flat at 25.6mn hectares for oilseeds during FY12 (Rabi+Kharif), the food products index has grown 29.5% yoy and 38% m-o-m. “Publishing, printing & reproduction of recorded media” added another 70bps of growth to the manufacturing sector.

Capital goods segment was equally volatile as the production declined by 4.6% yoy, a third consecutive decline. However, within capital goods transportation equipment witnessed a strong growth of 25% yoy driven by commercial vehicles production (37% yoy).

Outlook

Overall sense emerging from the IIP data suggests that the underlying growth, excluding volatile components, is not more than 5.7% in Nov-11. Also in the backdrop of higher cost of raw materials, slowing credit growth and stretched liquidity conditions, the IIP data for current month looks very surprising vs the trend seen in first 10 months of FY12. We believe that with conditions mentioned above still prevailing, the IIP growth will trend to be more towards 2.5-3% over Dec-Mar period.