The One Big Theme I'm Most Bullish on Right Now

Last week, I wrote to you about the capex revival in the country...rather its non-revival.

I'd asked a couple of questions:

• When will the capex cycle revive exactly?
• What will be the key trigger that will bring back it back?

I've received several comments and feedback. Thank you.

I look forward to reading your views. It gives me an opportunity to reply to any concerns you may have. So keep them coming.

A common reply was: A consumption-led revival.

Yes, I agree...to an extent.

But I've done my research on this important issue over the last few weeks.

And I've noticed one specific theme that's emerging.

I looked at one of the important indicators of a capex revival - gross fixed capital formation (GFCF).

In simple words, GFCF measures the net increase in fixed capital.

It's the investments made each year in the country as a percentage of the total GDP.

Normally, GFCF revives first, driven mostly by government spending. Private corporate spending usually follows...

However, GFCF has fallen continuously from FY12.

GFCF on a Downward Trajectory

GFCF was 34.3% in FY12. It fell to 27.2% in FY17. This clearly shows us the slowdown in investment that's been prevalent since FY13.

Nevertheless, as per the latest data (the December 2017 quarter), there has been some improvement. It's expected to increase considerably to 28.5% of GDP for the full year FY18.

This are early signs of a capex revival.

However, it will not happen suddenly. It's likely to be scattered....and spread out over many quarters.

Also, the revival will start in select pockets before spreading to the entire economy.

Some of the capital-intensive sectors - power, telecom, construction, textiles - will continue to languish for a while.

So where do I see the first signs of a revival?

I'm positive about the rural-led recovery.

The rural economy, represents about 69% of India's population and contributes about 45% to India's GDP.

Over the last few years, Indian farmers have suffered from insufficient rainfall. Demonetisation in 2016 (after a good monsoon) caused crop prices to crash. This triggered a wave of farmer protests across India.

This, in turn, pushed the government to shift policy from keeping food costs low for consumers to offering farmers higher prices for their produce.

The government has launched various initiatives recently.

• Target of doubling farmer's income by 2022 - MSP to be 1.5x of the cost of production.
• Creation of national farm market (eNAM) and agri-market infrastructure-with Rs 20 billion corpus.
• Special focus on irrigation with sufficient budget, with the aim of 'Per Drop More Crop'.
• Promotion of ancillary activities like poultry, beekeeping, and aquaculture by creating a separate fund with a corpus of Rs 100 billion

These policy initiatives are creating positive traction.

Here's what Dr Pawan Goenka of Mahindra & Mahindra said during a recent conference call:

• Clearly, the agriculture and rural development thrust that the Government of India has put, speaks well, directly for tractor business, and also positive impact on the automotive business.

In fact, the initial signs of the recovery in rural demand are already visible.

Whether it is the steady growth in tractor sales, commercial vehicles, or volume growth for FMCG companies.

Rural demand is outpacing urban demand after about three years.

Companies like Maruti Suzuki are also hinting at a rural recovery. Here's what the management said recently:

• Rural growth so far has been quite robust, and we are at 19% growth YoY for rural markets. If we talk about our overall growth it is at about 15%, so rural growth is ahead of urban growth. We think the momentum is going to continue.

Along with the government's increased focus, good rainfall (I'm hoping for a good monsoon in 2018) will lead to higher output.

This combined with higher MSPs is likely to accelerate the gradual recovery witnessed in rural demand.

Last week, Kunal wrote about three themes that India's super investors are bullish on. One of them was the rural economy.

In fact, the Smart Money Secrets team has already recommended a stock which is all set to benefit from the government's focus on agriculture and farm mechanisation.

With the recent correction in the market, the stock has fallen and looks very attractive now.

To conclude, I think capex is like oxygen for companies. It is what brings back much-needed earnings growth.

And ultimately, it's earnings growth, that drives stock prices.

Regards,

Sarvajeet Bodas
(Research Analyst)

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