IT Numbers shine in Q2FY19 Earnings

It is that time of the year where we take stock of the performance of Corporate India. Almost all the listed companies have declared their quarterly results and the overall performance has been mixed this season. The Nifty 50 stocks delivered a mere 4 per cent growth in Q2FY19 as compared to the corresponding quarter in the previous fiscal. The overall sales for the Nifty 50 stocks surged almost 24 per cent as compared to the corresponding quarter in the previous fiscal. The consolidated figures remained subdued on an average basis for the Nifty 50 stocks as Grasim, Tata Motors and Sun Pharma reported net losses in the quarter, mostly due to one-time loss.



The numbers in Q1FY19 were impressive as the base effect played out well in the first quarter of FY19. Come Q2FY19, we see that the growth is mixed across sectors. Some cement companies have reported good numbers, while some have disappointed.

Here is a sectoral review of the Q2FY19 performance .

Automobile Sector-
The automobile sector produced mixed results for the quarter ended September, 2018. Macroeconomic constraints in the form of rising fuel prices, increasing finance cost and hike in insurance premium have impaired the pace of growth. Commercial vehicles outperformed as their OEMs reported robust double-digit YoY volume growth. However, the two-wheeler and car OEMs demonstrated a mixed performance. While most two-wheeler and passenger vehicle players like TVS Motor Company, Eicher Motors, Maruti Suzuki, Hyundai and Ford witnessed single-digit growth in sales, Bajaj Auto turned out to be an exception. The company produced all-time high sales, posting an impressive growth rate of 30 per cent YoY in August, 2018, owing to strong two-wheeler and three-wheeler sales. Rupee depreciation, rising exports, improving volumes in domestic despatches contributed to revenue growth of the company. However, the shift in the company’s policy of entering the entry-level segment is likely to dilute margins. Tata Motors and Toyota Motors reported double-digit YoY growth in sales. The medium and heavy commercial vehicles (MHCV) sales were positive. Tata Motors and Ashok Leyland particularly stood out in this segment, mainly because of improving network. Volvo Eicher Commercial Vehicles and SML Isuzu also reported healthy sales growth. In the tractor segment, the sales momentum weakened, as was seen in the single-digit YoY growth exhibited by M&M and Escorts. M&M witnessed substantial pick-up in rural demand and it came up with new launches in the automotive space. The MHCV segment of Ashok Leyland witnessed a spurt in demand as well.

Although Maruti Suzuki is suffering margin pressure and slowdown in volume off-take, it is likely to produce positive results keeping a longer investment horizon in mind. The floods in Kerala impaired retail sales and despatches of OEMs, particularly afflicting Maruti Suzuki India and Eicher Motors since these companies have a major portion of sales in Kerala. Some of the challenges faced by the sector include rising diesel prices, particularly in the absence of freight rate hikes. Moreover, the e-way bill has not produced the desired level of impact due to lack of adequate surveillance.

The growth in the automobile sector started climbing since September 2018. The rising fuel prices and insurance costs hampered growth initially as these costs dampened consumer buying sentiments; however, the volumes started picking up eventually with the onset of the festive season.

The momentum on growth was also led by an improvement in rural sentiment. Thus, the companies began building inventory in anticipation of increased demand. In the order of preference, commercial vehicles emerge as the clear winners, followed by two-wheelers and passenger vehicles.



Banking Sector

The results for the quarter ended September, 2018 exhibited early signs of the credit-cost cycle normalising. Private corporate banks produced higher PBT numbers on account of strong net interest income (NII) and lower provisions. On the other hand, public sector banks disappointed on account of higher provisions, lower non-NII income and poor PBT numbers. Retail banks demonstrated an improvement in their PBT figures, with the exception of IndusInd, which underperformed slightly. Corporate banks’ profits declined due to lower trading income and higher operating expenses. Several banks regained pricing power and higher marginal cost of funds-based lending rate (MCLR). This will provide some tailwinds for the net interest margins (NIMs). PNB, Union Bank and Syndicate Bank produced highest GNPA and NNPA ratios, while HDFC, Bandhan and IndusInd produced lower figures.

Banks with higher CASA ratios are well-placed to perform positively in the light of the NBFC scenario. Most banks’ exposure to the IL&FS crisis remained normal as of September 30, 2018. However, some banks such as Axis Bank, IndusInd, BoB, Indian Bank and SBI made provisions to lower their vulnerability. While banks are not averse to including NBFCs in their portfolio, they are more inclined towards retail and SME NBFCs as it presents them with an opportunity to expand their loan books. The equity funding of the microfinance sector has been on the rise. The management commentaries from most banks indicate that exposure to operating entities is relatively easier to manage because of their strong asset base. Contrarily, managing exposure to holding companies is tricky. They are also of the opinion that the high NPA cycle has reached its peak and that credit cost is likely to normalise in the upcoming quarters, as indicated by declining provisions. Most banks experienced sequential dips in slippages in Q2FY19. The outstanding commercial papers gained 6 per cent in October 2018 to Rs.5.8 trillion after posting a fall of 12 per cent in September 2018 to Rs.5.5 trillion. In Q2FY19, the government launched India Post Payments Bank (IPPB) and has opened branches across 650 districts with the aim of achieving financial inclusion.


Money supply as on September 28, 2018, stood at 9.4 per cent as against 5.6 per cent recorded in the corresponding period of the previous year. Currency with the public rose to 23.1 per cent in Q2FY19 from -9.6 per cent in Q2FY18. Time deposits with banks surged to 7.9 per cent in Q2FY19 from 6.7 per cent in Q2FY18. Meanwhile, demand deposits stood at 5.4 per cent in Q2FY19, down from 17.1 per cent in Q2FY18. Growth in bank credit was 12.5 per cent in Q2FY19 versus 6.5 per cent in Q2FY18. The base lending rate as on October 5, 2018 was 8.85/9.45 per cent as against 8.95/9.55 during the corresponding period in 2017. The term deposit rates for more than one year stood at 6.25/7.25 per cent as on October 5, 2018 as against 6.25/6.75 per cent during the corresponding period of the previous year. A research report shared by CRISIL projects the year-end bank credit to soar 8 to 9 per cent in FY18, versus 3.7 per cent in FY17. This is likely to happen on account of improving working capital demand, modest pick-up in private investments, increased government expenditure on the infrastructure segment, rising commodity prices and greater capital adequacy levels on account of the government’s recapitalisation plan.

The growth in the imminent future will be driven by an improvement in the NBFC liquidity scenario, resolution of the IL&FS issues, and increased capital infusion by the government into PSUs and recoveries in the NCLT cases.

Top Performers- Indian Overseas Bank, Yes Bank, IndusInd, Kotak Mahindra


Bottom Performers- Punjab National Bank



Cement Sector

The September quarter witnessed cement companies taking a hit in profitability owing to weak prices and high costs. This is attributed to insufficient demand, heavy rainfall in a few states and the floods in Kerala. Although operating rates improved marginally to 65 per cent in FY18, these are likely to remain under pressure in the near term. The pricing power has not returned substantially. Average cement price at the all-India level corrected by Rs.3 per bag till date in September 2018. The cement companies are struggling to cope with relentless cost pressures. Petroleum coke is a chief input for cement makers. The prices of petroleum coke and coal are still very high. The depreciation of the rupee has further escalated procurement costs as most fuels are essentially imported. It has been observed that around 30 per cent of the costs of cement companies were impacted because of fluctuations in the foreign exchange rate. The rising crude oil prices have resulted in astronomical diesel prices, which in turn drove transportation costs up. The eastern region witnessed a drop in prices by Rs.9 per bag to Rs.336 per bag in Q2FY19. The West witnessed a fall in prices by Rs.4 per bag to Rs.311 per bag. However, prices remained relatively steady in the southern and central regions. The northern regions, on the other hand, witnessed a rise in prices by Rs.2 per bag to Rs.304 per bag. On a Q-o-Q basis, the prices in the northern and central regions rose by 3 to 4 per cent in Q2FY19, because of the price hikes in July 2018. Despite the pricing pressure, higher realisations were observed by premium brand companies. Apparently, investors are not disconcerted by pricing pressure as the shares of major cement players continued to trade at attractive valuations. Q1FY19 was a differentiated quarter as most cement companies shifted their focus to premium brand-centric management. Most cement manufacturers are recalibrating their strategies to launch new brands, achieve better brand positioning and thereby yield higher realisations owing to improvement in pricing. A research report shared by CRISIL predicts the industry’s capacity utilisation to linger around 68 per cent in the next 5 years.

The demand for cement in FY19 is expected to rise by 7 to 8 per cent, driven by affordable housing, rural IHB and increased government expenditure on infrastructure activities in the pre-election environment. The eastern, central and northern regions are expected to propel cement demand. However, the pan-India utilisation rates are lagging on account of poor capacity utilisation in the South (50 to 55 per cent). The demand from the housing sector, a key contributor to overall cement demand, remains subdued.

Top Performers- ACC, Ambuja Cement, Birla Corp


Bottom Performers- JK Cement, India Cements



The companies reporting positive results include Alok Industries, SBI, ONGC, Ruchi Soya Industries and Coal India. Companies that reported poor results include Punjab National Bank, IDBI Bank, Tata Motors and Vodafone India.


IT Sector
The IT sector witnessed acceleration in constant currency (CC) revenue growth momentum on a sequential basis in Q2FY19. Wipro and Infosys exceeded expectations by producing 2.8 per cent and 4.2 per cent QoQ CC organic revenue growth, respectively. On the other hand, TCS, HCL Technologies and Tech Mahindra met expectations by generating 3.7 per cent, 3 per cent and 0.4 per cent QoQ CC organic revenue growth, respectively. Overall, the CC revenue growth exhibited by the top five Indian IT companies lay in the range of 0.4 to 4.2 per cent in Q2FY19, as against 0.1 to 4.1 per cent reported in Q1FY19 and 0.3 to 2.3 per cent reported in Q2FY18. Contrarily, cross-currency headwinds resulted in revenue growth (in USD terms) of -0.5 per cent to 3.2 per cent for Tier-1 IT companies. Mid-sized IT companies, with the exception of Persistent Systems, yielded good CC revenue growth of 1.8 to 4.3 per cent QoQ. In comparison, Cognizant fared poorly as it yielded weak revenue growth of 1.8 per cent QoQ. The EBIT margins of most of the companies, except Infosys and Mastek, demonstrated considerable improvement on account of rupee tailwinds and operational efficiencies. The demand scenario was optimistic as well. In Q2FY19, TCS, Infosys and Wipro demonstrated strong BFSI vertical growth. This can be attributed to decline in client-specific headwinds, improvement in IT budgets by major US banks owing to reduction in corporate taxes and growing interest rates, and rising momentum in digital investments made by financial clients.The IT sector outperformed the broader markets in Q2FY19, primarily on the back of rupee depreciation over the USD and other invoicing currencies. The ramp-up in deals after finalisation of client budgets in Q1FY19 also contributed significantly.

Based on the burgeoning momentum in revenue for the quarter ended September, 2018, the IT sector’s prospects for the upcoming quarters seem promising. Moreover, the revival of the BFSI vertical in conjunction with successful deal closures and booming digital mix, are likely to propel revenues moving forward. However, demand mismatches and high operating costs are likely to manifest, owing to higher visa rejection, growing expenses for controlling attrition, limited availability of talent and localisation initiatives. On a positive note, it has been observed that IT companies have directed capital towards acquisition of digital capabilities and resources. While this will put margins under pressure in the short run, it will open up doors to lucrative opportunities in the long run. This is because most major global IT companies have started adopting digital technologies with a view of realigning their business models.

This rise in digital share is identified as the major growth driver in the IT sector in the quarters to come



Telecom Sector

The telecom sector is burdened due to high levies such as licence fees and spectrum usage charges. Moreover, the operators are under pressure to make upfront payment for radio waves. The ruthless tariff war began in 2016 when Reliance Industries launched Jio. The repercussions of this are felt even today as major players like Airtel, Vodafone and Idea were forced to cut tariffs. This has adversely impacted the sector’s financial metrics, thereby increasing the ramifications of regulatory decisions such as lowering termination charges. Both quarters of this fiscal produced losses. The India telecom services produced total revenue of Rs.2,11,336 crore for the FY2017-2018, down 34 per cent in comparison to FY2016-2017. The decline in revenues can be attributed to the exit of operators and merger and acquisition activities. In an effort to retain customers and entice new ones, the remaining operators were forced to offer free services, which further deteriorated their earning potential. Also, savage price wars are rampant owing to intense competition. If companies carry on producing a downward spiral in their revenue stream, they will face a shortage of much-needed capital for investments in technologies like 5G, IoT and ML/DL and for establishing better coverage. On the bright side, tariff reduction and decline in handset costs has helped the segment to gain in scale. The emergence of an affluent middle class has propelled demand for data-based services. However, these services are heavily concentrated in urban areas. Thus, the main driver for future growth would be the rural areas where wireless tele-density is relatively lower. The government emphasis on formalisation and digitisation of the economy bodes well for the sector. The government launched the National Digital Communications Policy, 2018 (NDCP) during Q2FY19, with the intention of attracting US$ 100 billion worth of investments and generating four million jobs in the sector by 2022. The ratings of telcos are expected to increase in Q3FY19 and Q4FY19, which will award greater pricing power to players.



Conclusion

Overall, corporate India performed well for the quarter ended September, 2018, as the gains were from a low base during the corresponding quarter of the previous fiscal. This is seen in the combined net profit of 1,889 companies across sectors which rose by 16.2 per cent YoY, reporting the fastest growth pace in the last seven quarters. In absolute terms, the combined net profit grew to Rs.1.15 trillion. The combined revenues of companies were up 19.6 per cent YoY, the best in three years. A whopping 60 per cent of incremental growth in the top line can be attributed to oil & gas and metals & mining companies. This can be explained by the recent surge in energy and metal prices. In contrast, the performance of cement, automakers, auto ancillaries, consumer durables, airlines, media and entertainment companies underperformed vis-à-vis expectation. It is observed that the IT sector witnessed considerable improvement in revenues and EBIT margins. The Government emphasis on digitization and cashless transactions presented several growth prospects. With most companies and the country as a whole incorporating digital technologies in their operations, the sector is booming despite high operating costs and difficulty in obtaining skilled manpower. Rupee depreciation played a major role in boosting the performance of the IT industry. However, the same cannot be said for the cement sector. Owing to its dependence on import of raw materials, the deterioration in rupee proved detrimental as it increased costs when companies are already burdened by pricing pressure. Fluctuations in foreign exchange rates also hampered their performance. Although the telecom sector’s earning potential is dampening on account of tariff wars, shortage of capital and exit of operators, government initiatives such as the NDCP and increased FDI inflows offer a positive outlook. However, the telecom sector is in need of a revamp in order to bridge demand mismatch and withstand competition. The banking sector has performed quite well in light of the NBFC mayhem. Private corporate banks and retail banks did well; however, public banks reported a dip in financials. Bank credit is on the rise. The general consensus is that the high NPA cycles have peaked and the credit-cycle is likely to normalize. Increased government expenditure on infrastructure and housing, accompanied by rising disposable income, bodes well for all the sectors. The automobile sector generated mixed results on account of rising fuel prices and interest costs. However, volumes in the automobile sector started picking up from Q2FY19 with the onset of the festive season and an improvement in rural sentiment. Overall, the commercial vehicles outperformed, while the two-wheeler and passenger vehicles did reasonably well.

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