June Quarter Results

Fiscal 2009 was tough, but the year drew to a close with some indications of recovery. So the investors were all ears for the first quarterly results of the fiscal 2010. While most of the companies have done well this quarter, some of them have actually managed to outperform street expectations, which has only increased investors’ curiosity even more. While everybody had a general idea of the June quarter results being better than the March quarter, what investors want to know now is how good and sustainable these results really are, which can help them get some cues on the way forward. We at Dalal Street Investment Journal analysed the June quarter results in depth to decipher emerging trend in India Inc.’s performance. To summarize, the Q1FY10 results are more about bottomline growth and operational efficiencies rather than topline growth. This is the outcome of cost management initiatives of India Inc and the change in the accounting standards 11 and also lower commodity prices.
 
With the 2136 results available with us so far, India Inc’s topline dipped by 6 per cent for Q1FY10. The bottomline, however, increased by 17.62 per cent during the same period. This is the second quarter in a row in the recent past that India Inc has actually posted profit growth, which is commendable. Though a dented topline might present a different picture to the investors, one should note the weaker sales numbers of the refinery companies have played a major spoilsport. It should be noted that the sales of refinery companies have dipped by 30 per cent on account of reduction in the petroleum product prices and this has impacted the overall sales growth of India Inc. If we adjust for these numbers, then topline of India Inc increases by 2.35 per cent. To get a further clearer picture of India Inc numbers, we also adjusted the refinery numbers and the extraordinary numbers from the total profits and found that the net profits still grew by 5.13 per cent. Thus, on adjusting the aberrations, India Inc has actually posted decent results for Q1FY10. In fact, out of 2136 companies, sales of 1044 companies’ have[PAGE BREAK] grown, 107 companies’ sales have not grown and 985 companies’ sales have declined Out of 2136 companies, profits of 1,111 companies’ have grown, 55 companies’ profits have not grown and 970 companies’ profits have declined. If we analyze the adjusted performance on sequential basis, we find that though the topline has declined marginally by 2.59 per cent, the profits growth actually increases by 15 per cent. What this indicates is that India Inc has not only performed well on a year-on-year basis, but also on sequential basis as well, which we believe is quite commendable.

But if we ignore profits and just focus on the sales part, the sales adjusted for refinery numbers would still raise some eyebrows as it still shows a growth of just 2.35 per cent on y-o-y basis. But before reaching any conclusion, one should know that sales growth is a function of both price and volumes. Prices have been falling consistently over the last two quarters as inflation rates were negative. Thus realisations have remained capped. Besides, the demand too has not picked up as expected, barring a couple of industries. Thus, volume growth too has not materialised, impacting the overall sales growth. We expect it would be couple of quarters before the realizations and volumes bounce back.

However, despite this, India Inc’s profit growth has not only remained strong, but it also managed to expand its margins. This has happened on account of lower raw material and other input costs. It should be noted that though the commodities price are up from Q4FY09 levels they are still below their peaks last year. Hence, the raw material cost has remained low and has fallen by 18 per cent in Q1FY10. Besides, with downsizing of manpower resources, India Inc has been able to manage the employee costs well, which has increased by only 7 per cent. All this has worked well for India Inc as it has helped it register growth in its operating margin by a whopping 561 basis points despite flat sales. Besides, with interest cost, excluding banks and financial institutions, increasing by a mere Rs 91 crore or 0.72 per cent, it indicates that cost of debt has come down for India Inc. The other factor that is keeping the bottomline buoyant is the change in the Accounting Standard 11, which gives relief to companies for adjusting forex losses or gains to balance sheet rather than to profit and loss account. The growth could hit the wall if monsoon plays spoilsport. Apparently, this has been on the minds of the investors, whose smiles have faded with the end of the June quarter results. The monsoon usually plays havoc every year, but this year it has been playing truant. The cumulative seasonal rainfall for the country from[PAGE BREAK]June 1- August 9, 2009 has been 28 per cent below the Long Period Average (LPA) and being said as the scantiest since Independence. Already 164 districts have been declared drought prone regions and if the rain-fall situation does not improve, then this number will only increase further. In fact, the worst part is that it would hurt agricultural contribution to Indian GDP this fiscal and it would be now up to the manufacturing and the services sectors to make up for the shortfall. But deficient rains could also have cascading effect on industries as well, and this could hurt the GDP estimate for FY10, which is expected at 6 per cent. This raises our concern even further. As for September quarter results, we may witness decline in profits on account of deficient rains.

Racing Ahead - AUTOMOBILE
Automobile companies delivered the greatest earning surprise in Q1FY10, so much so that they posted a double push to bottomline performance. While the realisations were better than expected, saving on the material cost helped the companies put in strong bottomline growth. A noteworthy factor is that the auto companies have not only showed growth on a YoY basis but have also posted growth on a QoQ basis. While the YoY topline growth is 4.41 per cent, its bottomline growth is 25 per cent. Similarly on a QoQ basis its topline growth is 3 per cent and bottomline growth is 29 per cent.

The reason behind this single digit revenue growth is low volumes. Except Maruti Suzuki and Hero Honda Motors other companies have failed to show significant volume growth. The revenues for the quarter indicated a strong performance across the two-wheeler and four-wheeler segments. Easing liquidity constraints combined with the positive effect of the recent government measures to boost the economy had a positive impact on the sector. The excise duty cut in stimulus packages combined with the slew of new launches by the auto makers and a strong rural focus helped the automobile companies.[PAGE BREAK]

As mentioned earlier, on the margin front, the benefits of decline in commodity prices and the cost efficiencies undertaken by the companies played an extensive role in expanding the margins during the quarter. The operating mar-gins for Q1FY10 have gone up to 12.50 per cent from 7.50 per cent in Q1FY09. Meanwhile, the net margins in Q1FY10 have improved to 8.70 per cent from 5.70 per cent in Q1FY09. The outlook for the sector remains positive as the July 2009 sales figures have also been good, but there are some ‘ifs’ added to our outlook. As mentioned earlier, the volume growth showed by some companies was on account of rural growth. But the deficient monsoon is expected to cast its shadow on this sector. While Maruti Suzuki gets 9 per cent of its revenue from rural markets (up from just 3 per cent last year) and Hero Honda has been expecting 55 per cent of its volume to come from rural areas in the next two years, it now needs to be seen how the automobile companies will perform if this rural growth gets impacted.

Neither Bright Nor Dim - POWER
The power sector was in the news and would remain in the news due to many companies from the sector tapping the primary market. But when one looks at the leading power companies’ performance on the bourses it’s not very exciting. India’s largest power generating company NTPC’s market cap grew by only 14 per cent in the last six months against a Sensex surge of 72 per cent. Even Reliance Power under-performed with a mere growth of 3 per cent, lesser than the bank’s fixed deposit. So one really wonders why so many IPOs are tapping the market when the sector is still under the weather. The reason could be in the potential that the sector offers. India has very low per capita consumption of electricity with a figure of only 704 KWH against the world average of 2,701 KWH and of China’s 1,684 KWH. As regards the June quarterly performance, sales for the sector grew by 18.5 per cent in topline while the bottomline surged by 33.3 per cent. The reason for a better bottomline is due to the new CERC tariff which helped companies to report better margins.[PAGE BREAK] NTPC accounts for 50 per cent of the sector’s topline as well as bottomline and reported better numbers with sales surging forward by 31 per cent and net profit by 27 per cent. What is heartening to note is that almost all the players in the industry are on an expansion mode due to the huge demand supply gap, meaning that growth would be there for companies in the coming years. For the September numbers we feel that the topline as well as the bottomline would grow in single digits. Even though the sector may not offer great capital appreciation it can offer lot of cushioning support to the portfolio when times are uncertain. NTPC continues to remain one of the best picks from the sector.

Getting Sweeter - SUGAR
In Q1FY10, sugar tasted sweeter to the sugar mill owners due to the ‘up’ cycle in the industry. However, lower domestic sugarcane production in the current season has led to a decrease in sugar production. Such a domestic supply shock has pushed up the sugar prices and consequently the realisations of the sugar manufacturer to touch record highs. Such high realisations helped sugar manufacturers to post robust growth in their financials in Q3FY09. The financial year for sugar companies ends in September.

The gamut of 24 companies analysed has displayed a growth in their topline by 24.57 per cent. Such growth was on account of higher realisations in the quarter and despite the massive fall in the volume-wise sugar sales during the quarter. The lower sugarcane availability in the current season had lead to lower crushing and thereby lower availability of molasses. This resulted in de-growth in revenues for most of the integrated players from the cash cow businesses that include co-generation (power) and distillery. For Bajaj Hindusthan, the revenues from the power and distillery business drastically reduced by 53.77 and 84.53 per cent respectively.

In spite of such a situation, higher realisations from the sugar business helped these sugar companies to record a mammoth YoY growth of 1,030.88 per cent in its bottomline. However, one has to note that sugar manufacturing is a cyclical business and such profits are a result of the current ‘up’ cycle in the sugar industry.[PAGE BREAK] Going forward, we expect the cycle to become stronger in the next season owing to the lower closing inventory in the current season doubled with the low global sugar inventory.

As per the Indian Sugar Mills Association, even after import of 2 metric tonnes (MT) of raw sugar in the current season, the closing stock stands at 2.3 MT, thus resulting in low stock-to-use ratio (closing stock/domestic demand) of 10.2 per cent, which is at all time low in the last seven years. Moreover, deficit rainfall in the current year will also hit sugar-cane production for the next season. Thus we expect the realisations for the sugar companies to remain robust in the next quarter as well.

Recovering From A Virus Attack - IT Services
After a comparatively weaker performance by the IT sector in the March quarter, many downgraded the estimates for the June quarter. But with this sector out-performing the market estimates in the June quarter (especially the IT biggies) the scrips rallied to catch up with the valuations. The sector topline grew by 8 per cent, while the bottomline grew by 29.78 per cent in Q1FY10, which is more in line with the growth rate posted in Q4FY09. The performance of the IT pack is commendable for sure. This is because these numbers have been posted despite the fact that the rupee appreciated by 5.45 per cent (compared to the 5 per cent depreciation in Q4FY09), volumes continued to remain flat, and pricing pressure aggravated even further. Thus in the light these factors, which continued to dwell even in this quarter, the results look decent. Besides, the cost management initiatives taken up by companies such as the hiring freeze and transferring more work to offshore centres seems to be paying dividends as it led to some margin expansion. In fact, Infosys and TCS, who usually see a net addition of employees every quarter, have seen a net reduction to the extent of 945 and 2,119 employees in Q1FY10 respectively.

But all this seems short-lived as with the overall scenario remaining unchanged clients might pressurise further for renegotiation of deals. This may then impact both, the volumes of business as well pricing. We expect volumes to remain flat in the September quarter, while pricing may remain flat with a downward bias. But[PAGE BREAK] what concerns us the most is the sharp reduction in the number of active clients of IT companies over Q4FY09.

Infosys’ active clientele fell to 569 in Q1FY10 (579 in Q4FY09) while that of TCS is at 933 (985) and Wipro at 830 (863). This indicates that clients are deferring their IT spend at the moment. The September results are expected to remain in line with the Q1FY10 results. But quick recovery in this sector appears to be difficult at this point in time. In fact, Infosys’ full year guidance has been revised downwards from the one it announced in Q4FY09, which itself is a clear indicator of how things actually are. Thus, with the run-up the IT pack has already seen, it would be wishful thinking to expect IT counters to move ahead briskly from here on.

Making The Money Last - BANKING
Banking has been one of the few sectors that have displayed resilience to the recent economic meltdown and the same has been witnessed in Q1FY10 also wherein the overall total income of 40 banks analysed by us has increased by 25 per cent and its bottomline is up by 68.75 per cent on a YoY basis. Like the March 2009 quarter, public sector banks have again managed to out-perform the private sector banks in terms of topline and bottomline growth. But despite this kind of performance there are certain factors which need a mention. First, due to slower credit growth the core income of banks was on the lower side and a major part of the banks’ profits in Q1FY10 came from treasury income. Regarding credit growth, due to the poor macro economic condition, the YoY credit expansion was just 16.3 per cent (25.50 per cent in last year). But the deposits’ growth of the overall banking sector was higher at 21.90 per cent as compared to 21.50 per cent during the last year. The margins reported by banks in the first quarter were the lowest in recent times wherein the net interest margins (NIM) India, “Since September 2008, the more profitable loan disbursals have slowed down but the high-cost deposits continued to bleed the balance sheets”. The magnitude of this problem was much higher for government-run banks since they reduced lending rates the most under government pressure, while private sector lenders mostly held on to their margins. Another factor is that the restructured loans for most banks increased and so did the stressed assets of most of the banks. To sum up, the banks have[PAGE BREAK] recorded creditable increases in Q1FY10 profits and the factors indicate that they are in for improved earnings in the coming months. The worst seems to be over for the bank margins which will gradually improve in the next six months. The credit growth in the last three fort-nights has been good. Secondly, most of the high-cost deposits are going to be re-priced which is expected to result in better margins. Reacting to the situation, M D Mallya CMD, Bank of Baroda, said, “Credit growth for banks is expected to improve in the remaining part of FY10 on the back of budget stimuli and the growing consumption sentiment. As confidence returns among corporates to expand their operations, most banks will once again move their funds from low-yielding bond investments to high yielding loans.” So expect a better performance from the banks in the coming quarters.

No longer fast moving - FMCG
FMCG companies saw smart improvement in their sales as well as net profit for the June quarter. First, the companies got advantage of thriving rural economy despite global slowdown, and second, the falling commodity prices that helped companies to report smarter topline as well bottomline growth. The industry saw its sales growing in June quarter by 10.7 per cent YoY basis and 4.6 per cent on QoQ basis. Net profit saw smarter jump where it grew by 16 per cent, both on YoY as well QoQ basis. Even FMCG companies saw smart improvement in their market cap in the last six months, with companies like Colgate’s market cap up by 36 per cent, Nestle’s by 45 per cent and ITC by 26 per cent.
But FMCG companies will face the challenge of poor performance due to bad monsoons. This despite the fact that agriculture contributes only 17 per cent to the country’s GDP. The reason is that, as a part of strategy, many of the FMCG companies in the recent past focused on the rural market to drive the growth of their products. Due to this, rural market now accounts for 45[PAGE BREAK] per cent of Hindustan Unilever’s revenues, while Godrej Consumer’s stands at 38 per cent. Other leading players like Dabur gets 40 per cent of its revenues from the rural market, while Colgate gets 35 per cent. These numbers clearly indicate that poor monsoon means poor revenue for the FMCG companies in the coming quarters.

We are of the opinion that September numbers would not be as exciting as June numbers for the industry and sales may hardly grow by 1-2 per cent while profit growth would be in single digit. We would advice investors to scale down their expectations from the sector in terms of capital appreciation as the dream run on the bourses may not continue. Readers may think of booking partial profits from FMCG counters and remain in cash.

A Brick At A Time - REAL ESTATE AND INFRA
When we had earlier analysed the Q4 FY09 results of the real estate sector a mention had been made of how even though there were signs of revival full recovery would surely take some time. And that is what has happened in reality. While the sector’s topline for Q1FY10 declined by 53.50 per cent, its bottomline declined by 71 per cent over Q1FY09. But the noteworthy factor is that both topline and bottomline picked up considerably on a QoQ basis. The QoQ growth clearly indicates that the situation is improving slowly. Industry players suggest that the outlook on volumes and property prices has improved as well.

Further, some revival in the stock market and easing of liquidity is expected to make a positive impact. But like the earlier quarters the margins are expected to remain under pressure. In Q4FY09 we had mentioned that the debt burdens were higher. But most of the players have gone ahead with QIP placements and are repaying their debts. This may impact the EPS of the companies but is expected to help them arrest the higher servicing of debt. The performance of infrastructure companies has been very good and the same is vindicated from the quarterly numbers. In Q1FY10 the sector posted a topline growth of 55 per cent and bottomline growth of 93 per cent over Q1FY09. The government’s focus on infrastructure projects and the easing of liquidity has helped the[PAGE BREAK] infrastructure companies post better revenue and earning growth. Further, the lower raw material prices have helped them save costs and improve on the margin front. Here the noteworthy factor is that the order inflow has been good in the quarter and as a result the order book position of the companies has been steadily building up. Industry players suggest that the orders are coming at good prices, thus helping them to improve on the margin front. With funding getting cheaper and easily available, not to forget more viable projects, the outlook remains positive for the infrastructure companies.

Volume Up, Realisation Down - STEEL
The steel companies saw a good amount of volume growth in their sales number for the June quarter but their price realisation was very poor. Due to this the industry saw its sales as well as net profit numbers taking a beating over the June 2008 numbers. The industry as a whole saw its sales de-growing by 13.3 per cent while its net profit plunged by a huge 32.4 per cent. Surprisingly, despite lower net profit numbers, steel companies have performed well on the bourses as the market caps of Tata Steel and SAIL surged by more than 100 per cent in six months while JSW Steel, another steel major, saw its market cap up by more than 250 per cent. This is quite perplexing as companies are surging ahead without much backing on the fundamental side. The largest player, SAIL, saw volume growth of 4 per cent and despite that its sales went down by 26 per cent. In a similar manner, Tata Steel saw its volume growing from 1.15 million tonnes to 1.41 million tonnes for the June 2009 quarter but sales took a beating by 8.9 per cent. The story is almost similar for other steel companies. We continue to feel that steel companies would have a tough time in the coming quarters. There are a couple of reasons for the same. First, the World Steel Association has forecasted that steel consumption would be down by 14.9 per cent in 2009. With excess steel production capacities throughout the world, prices of steel in the international marketwould remain soft. Also, rupee strengthening against the dollar would mean that imported steel would be cheaper. This is bad news for local players. Steel companies were hoping for a hike in import duty in the last budget which did not materialize. The only positive for the industry is a strong domestic growth story but here too concern has cropped up due to a not so good monsoon. Our call on the steel companies for September is that they would see a decline in sales as well as net profit. On the bourses they may not see the kind of surge they saw in the last six months.[PAGE BREAK]

Beginning To Bond Well - CEMENT
If the Q4FY09 results for the cement sector were termed good, then on a comparative scale the Q1FY10 results for the sector can be said to be still better. The sector’s topline grew by 20 per cent and its bottomline by 28 per cent for Q1FY10. The factors that ruled the Q4FY09 numbers continued to drive the results of Q1FY10 even as cement companies put up a strong show for the second quarter in a row on account of strong volumes, increased realisations and lower input cost. The volume growth stood at 12 per cent for Q1FY10. What continued to drive these volumes was the strong rural demand, delay in monsoon, impact of the stimulus package, and pre-election government spend.

Companies such as Shree Cement, Grasim Industries and Ultra Tech Cement led the way and posted 32.8 per cent, 24.4 per cent and 22.9 per cent growth in volumes respectively. Dispatches increased the most in the northern and central region by 22 per cent, followed by 9 per cent and 6 per cent in the western and southern regions. With the volumes’ growth, the sector realisations too improved by around 2.8 per cent in Q1FY10. In Q1FY10 the price on an average increased by Rs 8-10 per bag. It is strong demand, thrust on infrastructure and the forthcoming Commonwealth Games that have kept the prices firm. The quarter also witnessed the commissioning of 7.45MT of cement capacity. That apart, the input cost also stayed low this quarter. Though the coal prices are higher than Q4FY09, yet, at USD 115 per tonne they are certainly lower when compared to USD 200 per tonne last year. This resulted in an EBIDTA margin expansion of 234 basis points, thereby leading to better profitability. As for Q2FY10, the results could be muted as historically the second quarter is always weak on account of a conventional slack in construction activity due to the monsoon. With incremental capacity slated to come in, prices could dip.[PAGE BREAK]

[INSERT_1]Meanwhile, the valuations too look stretched with the sector witnessing a good run-up on the bourses in the current rally. Shree Cement has run up by about 46 per cent in the last one month. Hence as we don’t foresee much upside for cement stock, it would be better to book profits at this stage.

Getting The Right Fit - TEXTILE
A sector that provides employment to 91 million people, contributes 13 per cent to India’s exports and 4 per cent to India’s GDP seems to be showing some strong resilience in the June quarter. In our Q4FY09 textile sector analysis we did mention that the sector has already seen the worst and things could only improve from here on and with the results that are in front of us, a similar thing seems to have happened. The sector topline grew by 5 per cent, while the bottomline grew by a whopping 91 per cent in the June quarter.

The reason the June results acquire more significance is due to the fact that these profits have come after the sector posted net loss for two quarters in a row i.e. in December and March. That apart, though the topline growth of single digit might indicate a weak performance, it should be noted that this topline growth has come after two quarters of a dip in sales, despite the fact that the rupee has actually appreciated in the June quarter by about 5.45 per cent, while total textile exports on a year to date basis are down by 11 per cent. However, there is still a long way to go for textile as global and local sentiments are yet to improve fully.

The sector continued to lose 1.54 lakh jobs in the June quarter. Having taken all this into consideration, we also[PAGE BREAK] believe that every little step will take this sector only closer to its recovery. And one such move is the announcement by the government of a 10 per cent capital subsidy for the machinery purchased by textile companies. The value of this subsidy is worth Rs 2,546 crore. If that was not enough, the government is also setting up a national fibre policy committee which will submit their recommendations within three months. Thus the worst seems to be over for the sector and with such brisk development we could see some re-rating for the sector going forward.

A Quieter Ringtone - TELECOM
The Indian telecom industry recorded double digit growth for Q1FY10 in both, its topline and bottomline for the second consecutive quarter. During the quarter, the major telecom players recorded a decline in the average revenue per minute due to the cut in the mobile termination charges and also the lower tariff in rural areas. Despite this, the 21 telecom companies that we analysed on a YoY basis recorded a topline growth of 11.04 per cent in Q1FY10. Alike Q4FY09, a majority of the telecom players recorded a decline in its average revenue per user (ARPU) and minutes of usage (MoU) in Q1FY10. For Bharti Airtel, the ARPU declined by 8.9 per cent on a QoQ basis and MoU per month per user declined by 1.4 per cent. However, regardless of such fall in the ARPU and MoU, major telecom players recorded a bottomline growth of 16.72 per cent, mainly due to the massive increase in the interest income for the telecom companies on a YoY basis. Going forward, we expect the ARPU and MoU to decline in the next quarter owing to the increasing rural exposure doubled with lower call rates and lowering of tariffs due to intense competition. This is expected to impact both the revenues and margins of the telecom companies in the coming quarter.