A few bright spots

Higher input costs, rising interest rates and subdued other income? all point to the lowest quarterly profit growth in the last ten quarters. From the hunky-dory days just a couple of quarters back, times have changed for the worse for India Inc. Not so long ago, strong demand and expansion in margins led to robust sales and profit growth for companies. The same however, is not true anymore. On a broader level, while factors like high crude oil and commodity prices (including steel), and the rupee's depreciation has inflated topline growth, they have also led to increase in costs for companies. A few sectors are also expected to report a slowdown in revenue growth due to slackening demand. Importantly, the inability of most companies to completely pass on the increase in costs due to various reasons (including the government restraining companies to increase prices), mean that their EBIDTA (earnings before interest, depreciation, tax and amortisation) margins will slip further. Additionally, the consistently rising interest rates would mean higher expenses on loans taken by companies. And, the trend of high growth in other income (to an extent led by forex gains) seen in some cases in the earlier quarters is unlikely to persist. The rupee has depreciated by about seven per cent in the quarter as against a six per cent increase in Q1 last year, which is expected to have a significant impact on financials. All these factors put together, indicate that India Inc's profit growth will decelerate sharply to the lowest rate seen in the last 8-10 quarters. Various estimates peg the aggregate net profit growth between 9-15 per cent for the quarter ended June 2008 (Q1FY09) as compared to about 25 per cent for the quarter ended March 2008. Among the worst hit sectors are expected to be cement, auto, aviation and oil marketing companies. But, its not doom for all. There are certain sectors and companies that are expected to put up a decent performance, which includes telecom (wireless), steel (mainly integrated players like Tata Steel and SAIL), retailing, FMCG and capital goods. To know more, read on.

Auto
Higher input costs and waning demand due to higher interest cost have dealt a double blow to the auto sector with the worst performers being the heavy commercial vehicles and to a lesser extent the two wheeler segment. Passenger vehicles and light commercial vehicles however have been showing robust volumes aided by new product launches. Cost reduction programmes and productivity improvements coupled with setting up of manufacturing centres in tax free zones have helped offset rising costs. The outlook going forward has worsened as the RBI looks to continue with its monetary tightening policy resulting in a 50-100 bps rise in interest rates for auto loans. Despite a hike in fuel prices and increase in product prices, June figures indicate a 9.2 per cent increase in auto volumes and a growth for all sectors except three wheelers. While passenger vehicles grew nearly 20 per cent YoY, commercial vehicles and two wheelers put up a robust show with sales numbers registering growth of 7.1 and 8.1 per cent, respectively. While FY09 forward P/E at sub-15 for most auto stocks are quite attractive considering strong growth potential, investors should wait for the interest rates scenario to settle before making investments in the sector.

Banking & Financial services
The Banking sector has seen tough times in the recent past with the Reserve Bank of India (RBI) raising the repo rate by 75 basis points (BPS) to 8.5 per cent and the cash reserve ratio by 125 BPS (of this, 50 BPS is effective July 2008) to 8.75 per cent. That apart, the turmoil in capital markets and rising bond yields has only added to their woes. The RBI's moves have led to increased costs of borrowings for banks. High interest rates also make it attractive for customers to keep money in term-deposits than in current or savings account (CASA); the Zlatter offer low interest rates (0 to 3.5 per cent per annum), thus adding further pressure. Hence, banks with higher CASA are better placed. Although banks have hiked lending rates to offset the pressure, credit off-take has been healthy. However, with the overall economic outlook not very favourable, analysts also expect some increase in non-performing assets (NPA) and hence, increased provisioning for the same. Some private banks are also expected to see a slower growth in other (fee-based) income. Says Ashutosh Datar of India Infoline Institutional Research, "Non-interest income growth is expected to slowdown for new private sector banks and IDFC, on account of adverse capital markets. We forecast a 10 per cent YoY non-interest income growth for new private sector banks, as compared to 55 per cent YoY growth in 1QFY08." For public sector banks that have a high percentage of their non-SLR bond portfolio held under AFS, they may have to increase provisioning for mark-to-market losses thanks to the increase in bond yields. Says Ashutosh, ?-year bond yields hardened by 76 BPS to 8.7 per cent in 1QFY09 leading to rising MTM losses on bond portfolios." While banks are expected to report a healthy performance at the operating level, the lower growth in other income and impact of provisioning on bond portfolio and loans is expected to lead to a slower growth in profits.

Capital Goods & Engineering
Strong order books and favourable demand outlook has helped companies experience an upward trend in margins for the last few years. It is only lately that the market has started to doubt whether this trend will continue, thanks to lower margins reported by companies like BHEL, L&T and some others in the March 2008 quarter, as well as the dip in IIP in the last two months. With the price of steel up by over 50 per cent in the last few quarters, it will be interesting to see if companies are able to sustain margins. Their ability to do so, will also hinge on factors like long-term arrangements with suppliers, price escalation clause with customers and so on. Nevertheless, the broad consensus is that companies may see a marginal dip in margins ranging between 8-66 basis points, which is not a major concern. Among other factors to watch is the timely execution of projects/orders and ability to attract skilled manpower. Analysts expect BHEL, L&T and ABB to report robust growth in revenues as well as profits. For BHEL, contribution from new capacities should help boost revenues. For L&T, excluding the one-time exceptional gain reported in Q1 last year, profit and revenue growth should be in excess of 30 per cent.

Q1 EARNINGS ESTIMATES
Rs crore	Q1 FY09 Net Sales	% chg yoy	Q1 FY09 EBIDTA	% chg yoy	Q1 FY09 Net Profit	% change YOY
AUTO
Amtek Auto	1,328	26	233	26.6	106	7.7
Ashok Leyland	1,725	6.4	141	-4.5	62	-8.6
Bajaj Auto*	2,310	9.6	266	-5.5	175	-4
Bharat Forge	1,104	4	162	10.6	62	-22.6
Hero Honda	2,830	15.6	363	38	315	38.2
Mahindra & Mahindra	3,204	22.6	340	22.7	224	16.5
Maruti Suzuki	4,695	19.5	594	-1.8	432	-13.5
Tata Motors	6,665	10.1	569	4.2	267	-10.5
CAPITAL GOODS & ENGG
BHEL	4,135	27.9	390	25.4	345	25.2
Larsen & Toubro	6,005	33.3	594	32.2	380	30.6
Suzlon Energy	2,216	14	153	6.9	1	-94.5
ABB	1,768	26.2	209	27.6	140	29.6
Voltas Limited	1,011	22.9	81	13.5	59	17.7
CEMENT
Ambuja Cements	1,550	5.9	463	-15	302	-24.8
ACC	1,832	-1.2	458	-15.9	307	-12.6
Grasim Industries	2,726	11.5	685	-13.6	444	-13.3
UltraTech Cemco	1,471	7.8	430	-0.8	246	-5
CONSTRUCTION
HCC	900	23.4	101	27.9	23	58.4
IVRCL	926	36.8	83	39	39	5.2
Jaiprakash Associates	1,150	24	326	36.5	165	17.8
Nagarjuna Construction	1,013	33	103	28.9	170	22.3
FMCG
Colgate-Palmolive India	399	13.6	69	1.9	64	4.7
Dabur India	623	15.3	89	11.9	70	13.4
Godrej Consumer	357	24.8	64	24.7	50	30.3
Hindustan Unilever	4,075	17	623	16.3	540	14.5
ITC Ltd.	3,626	9.1	1,192	5.7	839	7.2
Marico Limited	554	18.2	74	11.6	47	16.4
Tata Tea	1,085	6.5	187	12.1	103	135.4
METALS
Hindalco	5,600	19.7	944	6.8	604	0.2
Hindustan Zinc	1,830	-7.1	1,123	-21.7	872	-26.3
JSW Steel	4,164	85.6	853	10.5	313	-25.4
SAIL	10,019	24.6	3,072	29.3	2,092	36
Sterlite Industries	6,342	3.3	1,846	-14.5	999	-11.3
Tata Steel	6,001	43	2,546	49	1,400	54
OIL, GAS & PETROCHEM
Reliance Industries	41,616	41	6,289	10.9	4,080	12.4
GAIL (India)	5,304	24.9	1,123	8.1	737	7.5
ONGC	16,698	26	9,368	18.2	5,343	15.9
PHARMACEUTICALS
Cipla	1,046	18.1	191	24.1	154	25.5
Dr Reddy's	1,368	14.2	205	-2.3	144	-21.7
Ranbaxy	1,900	16.6	251	10.8	41	-70.8
Sun Pharma	1,006	62.6	492	129.1	473	107.9
POWER UTILITIES
Reliance Infrastructure	5,971	26.8	572	25	375	24.7
Tata Power Co	1,811	19.8	314	13	177	-3.3
NTPC	10,210	13.8	2,672	-0.8	1,738	-1.5
REALTY
DLF	4,058	32	2,685	21.1	2,011	32.3
HDIL	567	28	324	36.3	247	21.7
Unitech	1,266	46.4	616	20.9	400	9.4
RETAIL
Pantaloon	1,624	59.3	116	104.7	34	84.5
Shoppers' Stop	322	43.4	19	38.6	2	11.1
Titan	881	34.1	47	25.6	21	50.4
SOFTWARE **
Infosys*	4,854	6.8	1,479	0.1	1,302	4.2
Satyam	2,636	9.1	629	14.4	505	8.3
Tata	6,326	3.8	1,565	0.8	1,230	-2
Wipro	5,922	3.8	1,232	19.9	931	6
TELECOM
Bharti	8,396	42.2	3,519	43.9	1,958	29.6
Idea Cellular	2,165	46.5	717	39.9	282	-8.4
Reliance Comm	5,699	33.1	2,483	37.8	1,470	20.5
BANKING & FIN SERVICES
	Total Income	% chg			Net profit	% chg
ICICI Bank	4,119	20.1	-	-	835	7.8
HDFC Bank	2,230	43.1	-	-	414	29
AXIS Bank	1,131	44.5	-	-	239	36.4
State Bank of India	6,039	13.1	-	-	1,347	-5.5
Bank of India	1,513	13.9	-	-	382	21.2
Punjab National Bank	1,924	6.3	-	-	489	15.1
HDFC	750	28.4	-	-	495	32.8
IDFC	339	13.4	-	-	200	10.5
*Actuals, **Change in net sales, EBIDTA and Net profit over previous period pertains to the March 2008 quarter; Numbers based on estimates of Motilal Oswal, Religare, Angel, Prabhudas Liladher, Emkay, Kotak Securities, India Infoline and IDFC-SSKI

Cement
Nearly all cement companies are expected to report a decline in EBIDTA margins on account of rising input costs (especially coal) and higher freight expenses. While the volume growth of the top four cement producers is not exciting (between negative 5 per cent and 3 per cent), some of the regional players like Madras Cement, India Cement and Shree Cement have done well. The temporary ban (for 45 days) on cement exports, too, impacted sales volume for the industry. On an average, cement realisation was higher YoY by 5-7 per cent. This along with higher volumes, analysts say, will lead to an increase in topline for most companies. However, the same is not sufficient to cover up for the cost increases. Within individual stocks, Ambuja Cement is expected to witness the steepest fall in EBIDTA margins (down by 7.34 percentage points) as prices of coal has shot up; it imports a large part of its coal requirements. For Grasim, apart from cement (49.2 per cent of revenues), the cost pressure in its VSF business (25.9 per cent of revenues) will together have a toll on its margins. Going forward, companies that have recently commissioned capacities and those expected to do so, should see their interest and depreciation costs rise. While most cement stocks have under performed the market since April 1, 2008, the silver lining is that valuations of quite a few have turned reasonable at below their replacement cost.

Construction
With a robust order book backlog, companies in this sector are expected to register y-o-y topline growth rates in the region of 25-40 per cent. This could be down sequentially as infrastructure companies tend to bring in higher revenues in the third and fourth quarters. Operating margins could be impacted by higher commodity prices, staff costs and fixed price contracts, which form 5-20 per cent of the order book. Players such as IVRCL, which have a higher share of its orders with price escalation clause, are better placed to ride out margin pressure concerns. Higher interest rates, which compound the liquidity crunch and a volatile stock market, are negatives for the sector as it could delay public-private partnership projects.

FMCG
The FMCG sector is no exception to rising cost pressures with prices of inputs like palm oil, wheat, milk, lab, soda ash and packaging materials have remained firm with an upward bias; the exception is sugar. Higher transportation costs have only added to the woes. However, FMCG companies have been able to pass on a large part of this cost increase either through price hikes or reduction in weight of packs. Apart from the price hikes undertaken in 2007, the effective product prices have been raised further by 2-15 per cent in the last few months. The favourable macro environment, with rising income levels (urban as well as rural) and expanding middle class, has led to higher purchasing power of consumers translating into robust growth in sales volume. Not surprisingly, most FMCG companies are expected to report double-digit (13-25 per cent) growth in topline, with a marginal fall in EBIDTA margins (up to one percentage point or 100 basis points) in most cases. Notably, many companies are expected to report a faster growth in bottomline, and for various reasons including higher production from factories in tax-incentive zones and higher interest income (incase of Tata Tea) among others. Among negative surprises, analysts point towards ITC, which has reportedly discontinued production of non-filter cigarettes in Q1 after a sharp increase in excise duty on the same. That apart, the non-cigarette FMCG business may also report slightly higher losses due to new launches and increased competition. Going forward, analysts expect volume growth to remain healthy, while raising concerns over the ability of companies to hike prices further (if input prices rise). They fear that it may lead to some down-trading (shift to lower priced brands) by consumers in the lower-income category.

Software
The rupee depreciation of about seven per cent is a positive trigger for the sector as a percentage point change improves operating margins by about 50 bps. Firms which have lower forex hedges (Infosys and Satyam) are expected to benefit the most from the depreciation. With the key US market slowing down, IT spending could be lower thus, impacting the revenues of key IT players. Results of Infosys indicate that revenue growth on a sequential basis (q-o-q; compared to March 2008 quarter) for leading IT companies will be in the region of 1-5 per cent. Operating margins are likely to be hit due to hikes in wages and visa costs (Infosys reported a sub 1 per cent OPM growth q-o-q). Delays in decision making on projects and calls for a cut in prices by customers, especially from banking and financial services and retail customers, points to difficult times for the Indian IT sector. The lack of improvement in the business environment means that revenue and earnings growth is likely to come from the fall of the rupee against the dollar. The challenging macroeconomic environment and Infosys guidance saw the IT sectoral indices slip by 7 per cent on Friday.

Metals
Despite doubling over the last five months, global prices of steel products continue to rise on account of raw materials shortage (coking coal and steel scrap). Flat product prices are up by 31 per cent and long product prices have increased by half in the same period in the domestic market. Domestic prices of hot rolled coil (HRC) are expected to catch up with international prices of $1,200. Robust demand, high prices and removal of export duty on steel products should help the sector with toplines of integrated steel players registering good growth rates. In non-ferrous metals, prices have been on the upswing increasing by about 10 per cent in the last quarter for copper and aluminium. While strong aluminium prices should aid Nalco and Hindalco in boosting their toplines, rising input costs could dent profitability.

Oil & Gas, Petrochemicals
Except for fuel marketing companies (OMCs) like HPCL, BPCL and Indian Oil, the other bigwigs are expected to report decent performance. Based on the subsidy sharing announced recently, analysts expect ONGC to report strong growth in sales, led by higher realisations. Some though believe that ONGC may have to bear a higher than estimated burden, and thus expect a lower growth in profits. On a consolidated basis, contribution from ONGC Videsh should boost revenue and profit growth led by high crude oil prices. For GAIL, increased gas transmission volumes and higher gas price should boost revenue growth. The enhanced petrochemicals capacity (up 33 per cent since January 2008) will also contribute to growth in Q1. However, a higher than estimated subsidy burden may tame profit growth. For Reliance Industries, higher crude oil prices are expected to drive revenue growth, which along with improved gross refining margins (GRMs) of $16.5-18.5 per barrel ($15.5 in Q1FY08) will drive profitability. However, weak margins in the petrochemicals business is expected to offset a part of these gains. Lastly, for OMCs, despite improved GRMs and potential inventory gains, a majority of analysts expect them to report losses due to higher share of subsidies and lower support in the form of oil bonds from the government.

Pharmaceuticals
The seven per cent depreciation of the rupee will boost the numbers of major pharmaceutical companies which derive a major chunk of their revenues from overseas locations. Costs, however, could go up on the raw material front as most active pharmaceutical ingredients and intermediates are imported from China. While pricing pressures remain in the regulated markets, settling patent suits with innovator companies and increased ANDA approvals (45 in June quarter v/s 36 in March quarter) will help keep export revenues and growth robust for top generic players. The recent acquisition of Ranbaxy by a Japanese innovator company could lead to more consolidation and acquisitions not just by innovators but also by generics players such as Israel's Teva. The domestic market is expected to record a 15 per cent growth for the June quarter aided by new product launches and increase in sale of drugs in the lifestyle category. The dampener for the sector could be the proposed new pharmaceutical policy, which is likely to bring 354 drugs under price control.

Power utilities
Except for Reliance Infrastructure (earlier Reliance Energy), the other two utilities don't seem to be heading for an exciting show in Q1. However, adjusting for the exceptional items pertaining to profit on sale of investments and forex gain (about Rs 43 crore) that Tata Power earned in Q1FY08, its standalone performance should be reasonably good with adjusted net profit likely to rise by 21 per cent. The commissioning of 90 MW of new capacity and higher fuel costs (which are pass through) will drive topline growth for the company. With coal prices ruling high, its stake in Bumi Coal mines should also lead to higher consolidated profits. For NTPC, analysts expect muted bottomline growth even as the company operates on a higher capacity base of 29,300 MW as against 27,400 MW as on April 2007. They however, expect a lower plant load factor at its coal and gas based plants. For Reliance Infrastructure, growth rates are expected to be the highest, which analysts indicate is on account of higher tariff and increased income from its EPC business.

Realty
A slowdown in property registrations in key cities due to hike in property prices is likely to dent sales numbers of realty players. On the operational front, higher borrowing costs due to monetary tightening and increase in construction costs due to 20 per cent spike in commodity inputs has led to delays in project completion. The hike in interest rates has also dented the consumer appetite for homes due to higher EMIs and difficulty in getting loans as banks cut their exposure to the sector. The dismal outlook is likely to continue for the current fiscal due to higher supply and muted demand. While the commercial segment has not been hit as badly, the outlook will be the worst for developers in the NCR region where the prices had gone up the highest and consequently come down the most. The realty index, which has lost more than half its value since the January highs, is expected to underperform the Sensex for a few quarters with fortunes turning around only on the back of positive macroeconomic changes.

Telecom
With over 8 million customers being added every month---about 25 million subscribers added in Q1--- and subscriber base crossing the 300 million mark, growth isn't a problem for the wireless telephony service providers. The worry for the players is falling operational metrics--- revenues on a per subscriber and on a per minute basis. Nonetheless, the top companies are expected to maintain EBIDTA margins in Q1 on the back of economies of scale. However, higher interest outgo and lower growth in other income is expected to shave-off a few percentage points of growth at the net profit level. Going forward, operational metrics may continue to slip as companies penetrate the Tier2 and Tier3 cities and towns. Also, while consolidation in the sector does provide some respite, rollout of services by new players and the imminent 3G launch will keep costs high and margins static or lower. Increased sharing of infrastructure should however, provide some relief at the cost front. Companies with tower portfolios either through joint ventures or standalone such as Bharti Airtel (Bharti Infratel), Idea (Indus) and RCOM (Reliance Infratel) could list unlocking value for shareholders. While RCOM deal with the largest African telco could give it a large footprint in the emerging market space, Idea's acquisition of Spice Communications and subsequent TMI investment will make it debt free and will help it to expand into new circles.

Business Standard dt. 14 7 2008