Q2 Results Bloom in the Gloom

The September quarter results are out and the corporate India has presented its performance report card to the investors at large. However, is the investors’ mood upbeat for the results this time around? We believe not.

Considering the factors such as the global market turmoil, where economies are feeling the heat, liquidity drying up, hardening interest rates, inflation touching 16-year high and slowing demand, nobody could have expected India Inc to come out with even good set of numbers this quarter. And are the investors right when we see India Inc posting a topline growth of 31.38 per cent, while the bottomline declining by more than 27 per cent for 1554 results that have been captured by Dalal Street Investment Journal so far?

At the first glance many would immediately paint a dark picture for corporate India while raising questions whether this ends the positive streak of India Inc seen over the last 13 quarters?

Before reaching to any abrupt conclusion the caveat here is that these numbers could be misleading and hence investors or readers at large have to go beyond these obvious numbers to gain a better perspective on India Inc. To probe on this we dissected the bottomline numbers further and found that it was the refinery companies that have spoiled the party for India Inc even in this quarter. The refineries collectively posted losses of Rs 12,936.55 crore in Q2FY09 compared to profits of Rs 6412.97 crore during the same period last year. These losses are due to under-recovery on account of non-realisation of market related prices for its petro products, thus dragging India Inc’s profit growth in negative zone for the first time in more than 3 years.

On the other hand, it should also be noted that these refineries have grown by more than 53 per cent in the topline during Q2FY09. Thus at one end it has pushed the overall topline growth for India Inc, at the other end it has also eaten in to the profits. On adjusting this aberration and deducting refinery numbers from the overall results, India Inc’s sales has actually grown at 25.11 per cent on y-o-y basis which is a very decent growth considering hostile international scenario, while the bottomline jumps in to the green at 1.39 per cent, which is a commendable.

In fact, while many might even question this bottomline growth, it should be noted that things have changed drastically over the last one year. Factors such as hardened interest rates, inflation and the fluctuating rupee all, which were spoken at length during last fiscal, have taken its toll on India Inc in this fiscal. Besides, one should not also forget the Index of Industrial Production (IIP) numbers, which have changed from good to bad and bad to worse as the August IIP showed a paltry growth of 1.3 per cent compared to double digit growth of 10.9 per cent in the same month last year. Despite all these negative factors India Inc still showed the resilience and has performed. In fact on a q-o-q basis India Inc less the refinery companies showed sales growth of 8.94 per cent, while bottomline grew at a stronger 3.91 per cent. What else could one ask for?[PAGE BREAK]

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What is also heartening is that the growth has been well spread of India Inc. Out of the results of 1116 companies tracked by Dalal Street Investment Journal, 1212 companies (77 per cent of India Inc) have reported growth in sales, while 442 companies reported decline in sales. On net profit front, 614 companies (50 per cent of India Inc) reported growth in profits, while 598 companies reported drop in their profits. One should keep in mind  that India Inc reported extra-ordinary losses of Rs 1806.22 crore (net) in September 08 quarter against extra-ordinary gain of Rs 1413 crore in September 07. Also the other income took a sharp beating and stood at mere Rs 22199 crore against Rs 24612 crore in the same period last year. Keeping this fact in mind the numbers are quite encouraging.

That apart in Group A, after adjusting for refinery companies, the sales growth is still healthy at 24.33 per cent, while bottomline growth is 4.40 per cent on y-o-y basis. Even on q-o-q basis also the sales grew 1.08 per cent, while bottomline growth is 2.50 per cent. Thus the front runners or the bigger companies continue to do well even in these adverse conditions. Besides, stronger sales growth by India Inc is also comforting factor as it also indicates that despite slowing demand India Inc has managed to drive its growth through higher volumes, which is quite commendable. But there are concerns too as Indian Inc hasn’t been able to pass on the cost fully to the end customers as its raw material costs has seen jump of 49 per cent. This, coupled with the higher power cost, the operating margins have taken a hit by 712 basis points. The net margins too have seen a dip of 513 basis points on account of higher interest cost (excluding banks and financial institutions). This cost has shot up by a whooping 97.28 per cent or Rs 6603.31 crore indicating that companies have not only raised fresh funds at higher rates, but costs of their existing debts have also gone up. That apart the tax outgo of India Inc has declined by 10 per cent this quarter, which is a concern as it indicates uncertainty of sustaining profitability in the coming quarters.

But despite these concerns we expect things to improve for India Inc. Interest rates, inflation and crude, which were major threats to the growth of India Inc, seem to be slowly fading away as RBI is trying to fuel growth. And new RBI Governor D Subbarao is already releasing liquidity into the system. RBI started with 150 basis points cut, thereby reducing CRR from peak of 9 per cent to 7.50 per cent. It again cut the CRR twice by 100 basis points each to bring the CRR to 5.5 per cent, thus releasing liquidity to the tune of Rs 140000 crore in to the system. In fact RBI has also reduced the repo rate by 150 basis points to 7.5 per cent and reduced the SLR by 100 basis points to 24 per cent. All these moves are aimed towards benign interest rate regime and enabling banks to lend more to stimulate growth. Even FM has asked banks to reduce their lending costs. By next one month we are expecting the borrowing costs to come down as banks would start reducing their PLR.[PAGE BREAK]

That apart, inflation, which hit a 16-year high at 12.91 per cent during September quarter, has also softened and dropped to current level at 10.72 per cent and the possibility cannot be ruled out that the rate would drop further. Besides crude, which touched an all-time high of $147 per barrel, has corrected by 55 per cent to $66 per barrel amidst the global turmoil. This too augurs well for oil marketing companies, who have been suffering huge losses due to higher prices. With this kind of fall, possibility is not ruled out that price of petrol and diesel being reduced easing inflation rate.

Though India Inc’s bottomline growth is impacted, the topline growth still looks intact as it has been successful in posting good growth quarter after quarter, which is a comforting sign. We expect things to improve by last quarter of FY09 and India Inc would successfully tide over this patch as well. Our sense says that the December quarter would be comparatively stronger as the effect of festive season would be built in it. Hence one can watch out for the December numbers. On the stock market front, Sensex correction has been quite sharp due to weaker global sentiments and it would take some time before markets stabilise. But Sensex at 10338 levels and FY09 projected EPS of Rs 950 it is available at just 10.8x, which is quite low from historical levels. Besides, though the Sensex is at 10338 levels, the other than Sensex companies are available at prices when the Sensex was at 4500-5000 levels. Thus for the long-term investors it makes sense to invest in a staggered manner for better returns in coming period.

AUTO: Concerns Still Dogging The Sector
The victim of the hardened interest rates and the inflation, the auto sector has a huge task cut out for itself. At one end, where managing costs have become the need of the hour, staying afloat in the intense competitive business has become a necessity too. And this is taking its toll on the sector which posted dismal topline growth of 0.12 per cent, while bottomline has actually declined by 20 per cent. The numbers aren’t exciting at all and the profits of all auto majors, except one, have declined in Q2FY09.

Maruti Suzuki (MSL) has seen a tough time this quarter where its bread and butter, the A2 segment’s sales numbers declined by 3.75 per cent. Infact the October numbers for A2 have also declined by 7.7 per cent thus raising concerns over the December results. Even Tata Motors sales numbers have been affected due to the slowdown in the industrial activity. Though its LCVs have done well in this quarter, it’s Medium & Heavy Commercial Vehicle (M&HCV) sales numbers has declined 8.72 per cent. Infact on adjusting for one time profit on sale of investments of Rs 358.8 crore from the net profit, Tata Motors actually has posted loss of Rs 11.89 crore. Besides, with the October month numbers for M&HCV dropping 47.63 per cent the outlook for December quarter looks weak.

But the surprise package has been the two wheelers in this quarter, especially Hero Honda who has really come to the party this time. Hero Honda’s (HHML) sales numbers increased 28.5 per cent during the same period leading to 50 per cent jump in its net profits. However, Bajaj Auto’s sales numbers were more subdued and grew by 4.80 per cent for Q2FY09. Though there is an expectation that the market might remain subdued after festive season, we still feel HHML would do well, while it would be better to stay away from the rest of the auto pack.[PAGE BREAK]

TELECOM: Invest With Caution
It is indeed a milestone for the Indian telecom sector as teledensity crossed 30 per cent mark for the first time ever in the month of September this fiscal. Wireless connections continue to grow thick and fast with 28.45 million customers added during this September quarter taking overall wireless connections to 315.31 million customers. Bharti Airtel added the largest customers in Q2FY09 with 8.10 million customers, followed by Reliance Communications (RCOM) at 5.27 million customers and Idea at 3.19 million customers.

In Q1FY09, telecom grew at 49.80 per cent and 44.28 per cent on y-o-y basis in the topline and bottomline, while in Q2FY09 the same grew at just 23.55 per cent and 7.48 per cent respectively. Thus growth rate has come down this quarter. In fact on q-o-q basis, Bharti Airtel (BAL) has just grown 6 per cent, while the bottomline increased a mere 1 per cent despite its record additions. Even RCOM too grew at 9.2 per cent in the revenues and just 1.2 per cent in the bottomline. Overall EBIDTA margin has contracted for BAL and RCOM, BAL’s mobile segment’s EBDITA margin continued to drop even in Q2FY09 by 1080 basis points. The ARPUs too fell for BAL and RCOM by more than 5 per cent and 3 per cent respectively.

The telecom sector is undergoing a change as previously the ARPUs too grew with the increase in user base, thus the scrip commanding higher valuations. But with the customer base growing at brisk rate and the ARPUs falling, we don’t expect telecom sector to command the valuations they used to. Hence the probability of sector to stabilize at a comparatively lower valuation band is quite higher. Besides, with competition slated to increase in telecom space tariffs would come down further hitting the ARPUs further. Hence caution is advised while investing in telecom stocks.

STEEL: Situation In Steel Gloomy
Steel becomes first casualty of any slow down in economy and this can be gauged from the latest quarter results. For second quarter FY09, though the sales has increased by 46 per cent y-o-y and 18 per cent q-o-q basis, this increase was primarily due to increase in realization of steel. Average realization in this quarter was around 26 per cent to 41 per cent better than last quarter same year.

Steel prices were on the rise for the first seven months of this calendar year. After that it started moderating. Steel prices, which were hovering below $700 per MT in Q2FY08, were quoting on average $1150 per MT last quarter. Same level of price increment was not witnessed in the domestic market due to government’s effort to rein the price rise. Going forward steel prices are further going to slide due to weak demand from infrastructure and automobile sector.[PAGE BREAK]

When we see the net profit figure it increased by 12 per cent from last quarter and decreased by 9 per cent sequentially. Net profit figure could not catch with sales figure because of two reasons. First due to unprecedented movement of rupee against dollar forced major companies like Tata Steel and JSW Steel to book notional losses to the tune of Rs 345.6 and Rs 268 crore respectively on account of MTM (mark to mark). Second the prices of key raw material, though decreased, steel companies has signed long-term contract and drop in the price has not been re-negotiated. Therefore, cost of raw material prices as percentage of sales has increased from 37 per cent to 43 per cent. We expect that company will negotiate the prices in third quarter and it (raw material prices) will fall from current level. This (Raw Material) factor has even    led to depressing of EBITDA margins by 100 basis points in this quarter.

Though the recent demand fall has even impacted the capital expenditure plan of the sector, no new capacity was added last quarter and at least three steel companies including JSW Steel, has postponed its capacity addition for six to nine months. This is reflected in its depreciation cost which increased by 10 per cent from last quarter same year and 2 per cent from last quarter. Taxes have increased by 18 per cent from last quarter same period and only two per cent quarter on quarter basis. It signifies the likely slowdown in sales growth. Recently the government has scraped export duty on steel and replaced 15 per cent ad volerem duty on iron ore fines to make Indian steel more competitive in international market and contain the price decrease of iron ore. (Iron prices have fallen by 43 per cent from April 08.) Overall situation for the steel sector seems gloomy for next few quarters because of slackness in demand and failing prices.

PHARMACEUTICAL: All Set To Grab Opportunities
Pharmaceutical sector was among few sectors which were holding its ground to all the financial turmoil and one of the best performing sectors in last quarter. Now it is the latest to lose grounds to financial turmoil. Healthcare which has been largely considered as immune to recession has underperformed the broader market last quarter. Last quarter (July- September) when the broader market index Sensex has fallen by less than one per cent pharmaceutical sector has taken a beating of ten per cent.

Of 86 companies that have been analyzed, the topline has remained largely intact due to steady growth in domestic market, a strong growth in con-tract research and manufacturing services (CRAMS), new product launches in regulated market and consolidation of acquisition done in last year. But the increase in sales has not translated into increase in net profit.

Net profit has been hammered out of shape and is 39 per cent lower than previous year same quarter and 24 per cent down sequentially. Seven out of top ten companies have seen their profit decline. The primary reason for this sharp drop in profit was drastic fall in other income. It fell by 61 per cent from last year same time period.

Other major concern which is staring this sector is interest cost. It has almost doubled compared to last year. Though exports accounts for almost half the sales, depreciating rupee should have helped them but actually it worked against them in two ways. First, some of the top companies like Ranbaxy and Orchid have foreign debt and any depreciation of rupee forces them to book mark-to-mark losses. Secondly, other than Sun Pharmaceutical most of the companies have hedged there position below Rs 45 and rupee currently at Rs 48-49 per dollar is hurting their hedges. Even EBITDA margins for the sector saw the erosion. It shrank from 26 per cent in Q2FY08 to 18 per cent Q2FY09.[PAGE BREAK]

Coming quarters will definitely throw challenging time to this sector but as and when this uncertainty subsides, Indian pharmaceutical sector will perform well by grabbing opportunities at less regulated market and consolidating there position in developed market.

IT: Loses Its Shine
Since the onset of FY09 the fortunes of the most adored sector have changed and with the US sub-prime crisis reaching its peak, the valuations of the IT pack have reached the bottom. Despite immense efforts put in by the IT companies, the growth factor has somehow been caught in a downward spiral. For Q2FY09 the IT companies posted topline and bottomline growth of 25 per cent and 14 per cent respectively. These are more or less similar to Q1FY09 results. And it is only the group of the big four that has been pushing this growth. If one were to discount the results posted by these companies, the growth figures drop down to 19 per cent topline and 7 per cent bottomline. And despite such a damaged scenario the big four continue to post incremental growth quarter after quarter. But this is not to say that they have not been reeling under the heat.

While the IT companies might tide over the next quarter as well, what we are concerned about is the next year which, as of now, indicates no clarity on the business front. With a huge shake-up of leadership in the BFSI industry in the US, investments and funds would flow to only core areas, and though IT infrastructure is one of them, the budget finalisation could get longer while some clients might cut down on this spend on account of cost-cutting measures.

Already, US IT majors are expecting a $170 billion hit on sales as also cut-back on IT spends and if that is the case, Indian IT companies would face a hard time. The IT big four are already cautious as apart from Infosys, whose net hiring increased 31 per cent, that of TCS, Wipro and Satyam declined 74 per cent, 69 per cent and 40 per cent respectively in Q2FY09. Besides, Infosys has reduced its full year dollar revenue guidance to 13.1-15.2 per cent (19-20 per cent), while TCS’s active clients declined 8 per cent to 814 (885) in Q2FY09 on a sequential basis. It does indicate tough times ahead for the IT sector.

BANKING: RBI Steps To Start Showing Results Soon
Recent meltdown in financial sector has muted all the proponents of decoupling theory, who argued India is insulated from the events unfolding in US and other parts of the globe.  Credit crunch in the US and Europe had its effect in India too. Desperate measures taken by the RBI to ease the liquidity situation by changing key policy rates twice in a fortnight is testimony to the severity of the situation. This comes at a time when the credit deposit ratio of the scheduled commercial bank is at 75.16, highest in last thirty years. This increase in CDR has led to the topline growth of Indian banks in Q2FY09 by 29 per cent y-o-y basis. But despite this why is there credit crisis? The answer lies in drying up of funds that India Inc. use to rise from outside India either through external commercial borrowings or FCCBs or by hitting capital market.[PAGE BREAK]

In Q1FY08 corporate India has raised $ 7 billion dollar against just $1.6 billion dollar it could rise this year in the same time. Even funds mobilized through ADR/GDRs has taken a beating -- it was $2.8 billion in first half of FY08 compared to $1.1 billion in H1FY09.

Adding to the problem is huge selling of portfolios by FII’s, which sucks the liquidity from the market. It is estimated that in CY08, FII’s have sold more than $ 11 billion worth of portfolio. Increase in credit has other pitfalls, it increases the delinquency level. Most of the banks have seen their gross and net NPAs rising q-o-q basis. Even the provisions have increased. SBI has increased its provision by more than seven times, whereas Axis Bank has increased by more than hundred per cent. Net Interest Margin (NIM) has shown improvement in almost all banks. This was mainly due to increase in lending and withdrawing of money from low-yielding assets of government bonds. Investment Deposit Ratio (IDR) of 28.27 for schedule commercial bank at the end of the quarter was multi-year low. All the banks are adequately capitalized maintaining Capital Adequacy Ratio above RBI norms, though decreased marginally from last quarter. Other incomes also saw decent increase. It increased 10 per cent y-o-y basis and 6 per cent q-o-q basis. Net profit for the banks increased by 23 per y-o-y basis and 49 per cent sequentially. We feel that most of the trouble in the banking sector is over and the steps taken by the central bank will start showing results in the coming quarters.

TEXTILE INDUSTRY: In Troubled Waters
Despite several revival efforts the textile sector finds itself in troubled waters every quarter. This time it is US slowdown that is impacting the textile exports from India badly. US imports for the period January-August 2008 have declined 3.68 per cent, while from India specific imports have declined 1.56 per cent to $ 3.54bn ($3.60bn) during the same period. What is making matters worst is that the orders from US retailers have dropped 25 per cent as many of them are either scaling down operations or shutting down non-performing outlets. Couple of big retailers in the US have already filed for bankruptcy protection under Chapter 11 and the matter could get even worse going forward. Almost half of India’s textile produce is exported, while US itself accounts for 35 per cent of the total Indian textile exports. The cascading effect is already seen as to stay afloat the domestic players have already started to cut cost by laying off workers or even shutting units.

Besides, while the cotton prices have stabilized after they had shot up 40 per cent in the first quarter, the government in a shocking move has increased minimum support price (MSP) for cotton by 46 per cent.

Indian cotton prices are already 15 per cent higher than international prices and increasing the MSP would increase the raw material cost for textile players thereby eating in to their margins further. While the industry is pleading government to revive consider factors such as controlling interest rates, two years moratorium on repayment of loans, refund of all duties and additional fund allocation through TUFS scheme to revive the industry, the current scenario will only push the sector closer towards stagnation. Hence it would be better to stay off the textile sector for good despite rupee has depreciated by 25 per cent.[PAGE BREAK]

REAL ESTATE: Yet To Come Out Of Woods
Although real estate companies were already battered down at the time we analyzed the Q1FY09 results, we clearly mentioned that the real estate sector has not yet come out of the woods and the pain is expected to remain there.

With real estate index taking a further beating, we have been proved right. And if we analyse the situation at the current levels, we are of the opinion that, although RBI has taken drastic steps to infuse liquidity by cutting Repo rate, CRR and even SLR, we expect the pain to remain for some time ( at least in the short term). The concerns like we mentioned in our previous analysis like demand slow down in commercial as well as housing projects, lower pre-sales and most importantly correction in prices are still impacting the real estate players. The capital requirements are on higher side and with lower pre-sales, inability to raise funds through ECB and even PE funding not available, many real estate players are facing problems. The companies are borrowing at higher cost and with rising capital cost the interest payout has also increased in the quarter. Regarding the declining prices Pujit Aggarwal (MD, Orbit Corp) said,  “The next 8 to 10 quarters will see significant rise in the transactions at price discounts up to 20 to 25 per cent from the top”.

Regarding the infrastructure companies, although most of the companies have managed to post a good growth in Q2FY09, we are of the opinion that, it is not the quarterly results which are important, but it is the order flow for the quarters which makes the difference.  We feel the lowered GDP estimates for next two years and rising project cost are going to be the major drawbacks for the infrastructure sector. If we take a look at the order flow for the first two quarters of FY09, it is clearly seen that, although marginally, order flow has declined. Now another important factor is given the deteriorating environment for raising funds many projects are facing equity-funding gap.

The project costs have increased with around 200 bps rise in interest rates and some increase in capital costs. Now some larger players like L&T, IVRCL, Reliance Infrastructure and Nagarjuna Construction are cash-rich and are adequately geared for funding the medium term requirements. With RBI taking drastic steps the liquidity may ease up. But that will take some time and till then it will be difficult time for the smaller players.