AWAITING A NEW DAWN

A lot has changed in the past few months on the macro as well as micro levels in the Indian equity markets. While there was a change of government at the centre with BJP coming to power with a clear mandate, some of the states too have witnessed a 360-degree shift in political governance. And as expected, with a pro-reform government in place the markets could have only moved northwards. To put it in a perspective, the benchmark index, Sensex, has appreciated by more than 17 per cent since the announcement of the poll results. There were high expectations from the new government and it’s time to take stock how this change has affected the completion of the quarter in September 2014. As such, though the quarterly results are anyway treated as a major trigger for the markets, this time there was an additional wave of curiosity among investors.

If we take a look at the macro-economic factors, a lot has improved with GDP growth estimates for FY15 as a whole having increased to 5.50 -5.90 per cent from the level of 4.00-4.50 per cent for FY14. Inflation has consistently contracted and is slowly inching towards comfort levels of the RBI. There has been a huge relief on the CAD and fiscal deficit front as well. And while the domestic factors were improving even the global markets provided support with positive news’ flow on the macro front. It’s no wonder then that along with global equities even the Indian equity indices touched record high levels. The benchmark indices witnessed a lifetime high and the broader market indices also surged to near historic high levels.

If we take a look at the financial performance of the companies that have announced results till date, it seems that the results are very much in line with the street estimates. A few factors like below estimate rainfall and consistently high inflation were expected to take a toll on the topline and bottomline of the companies. If investors will recollect, we had categorically stated, “We are of the opinion that there are a few green shoots visible and hence the performance of India Inc. is expected to be better in the coming quarters. While the September quarter might be a muted one, H2 FY15 would see some real fireworks.” And if the results of more than 300 companies out of BSE 500 companies are anything to go by, we have been proved right. 

To put the figures in perspective, the topline of 307 companies (BSE 500 companies that account for more than 85 per cent of market capitalisation) increased by 6 per cent and the bottomline (after adjusting for extraordinary income and oil refinery companies) showed an increase of 18 per cent on a YoY basis. Adjusted for the financials of bank and financial institutions, the bottomline witnessed an increase of 16.43 per cent. While the topline performance was in line with street estimates, there was some improvement on the margin front. The PBEIT margins for the September 2014 quarter improved by almost 100 basis points to 17.30 per cent from just 16.20 per cent in September 2013 and 17.20 per cent in June 2014. The EBITDA margins improved and growth in net profit was supported by higher non-operating income in sectors such as IT services, cement, nonferrous metals and lower extraordinary expenses in sectors such as steel and pharmaceuticals.

If we take a look at the overall performance, cost-cutting initiatives taken by the companies seems to be a prime reason that resulted in improved margins. In the manufacturing segment, companies managed to put in a better performance as idle capacities were utilised, thereby helping the companies post better operating margins. However, unlike the preceding June quarter where stability of the INR against USD helped the companies manage forex liabilities well, this time a stronger rupee made things difficult for exporters. Reports suggest that the revenues of export-linked sectors grew at their slowest pace in the last eight quarters as the benefit of the weak rupee was not available in Q2 FY15.

Both pharmaceuticals and IT services witnessed relatively slower revenue growth in comparison with over 15 per cent growth recorded in the past five quarters. Even the stable crude prices resulted in some help on the raw material front. As regards the performance of Sensex companies, there was sort of a mix trend. Sales growth for the September 2014 quarter stood at just 1 per cent and the EBITDA increased by just 7.50 per cent amidst expectations of higher single-digit growth. The EBITDA margins increased to 16.63 per cent, up from 15.47 per cent in September 2013. PAT growth stood at 4.65 per cent.

Interest Cost

Higher interest cost has remained a major worry for India Inc. since the past few quarters. With the RBI maintaining its hawkish stance to control inflation, interest rates remained higher. This very factor in the past resulted in higher interest cost and ultimately led to slower capex for India Inc. However, this time around the interest cost provided some kind of a breather.

Excluding banks and financial services companies, the interest cost for the September 2014 quarter increased by just 2 per cent over the September 2013 quarter. We feel that with the equity markets witnessing new high levels a lot of fund-raising was done though the QIP routes. Further, with inflation witnessing some decline and the RBI providing other ways to infuse liquidity the interest rate factor is unlikely to make any impact in the coming quarters.

Improving Depreciation Cost

Since the last few quarters we have been stressing on depreciation cost. For the September 2014 quarter this cost has increased by 7.50 per cent. The higher single-digit improvement is a positive sign for the markets. In short, the large-cap companies seem to have started their capex activities. In our opinion, with the reforms process being put on fast  track the capex is likely increase in the coming quarters.

Looking Ahead

Whatever we have discussed above pertains to the past and as the equity markets run on future expectations, investors would be more curious to know about what to expect from the next quarter. Taking into account the impact of the September 2014 quarter’s performance on Sensex’ EPS estimates, there are not very significant changes expected in the EPS numbers. While the FY15 EPS is maintained at Rs 1,532, the FY16 EPS is expected at Rs 1,854. This clearly results in a growth of 14 per cent for FY15 and 21 per cent for FY16. As regards the drivers of EPS’ growth, Tata Motors, SBI, ICICI Bank, HDFC and Reliance Industries are expected to be major contributors. In terms of sectors, financial services, capital goods and energy are likely to be the star performers.

There are quite a lot positive factors, first and the foremost being that the global markets are providing positive cues. The inflation factor is already being tamed and there are chances of rate cuts only in Q4 FY15. On the valuation front, the Sensex is trading at 18.21x of its FY15E EPS and this provides some scope for upward movement as it is lower than the long period average. Even if we consider the forward valuation of 20-21x, the target of 31,000 is achievable in the next one year. Further, this is a very conservative estimate and hence looks easily achievable.

[PAGE BREAK]

AUTOMOBILE

One of the largest automotive markets in the world is India. Given that, the first four months of the current fiscal quoted a good set of numbers after two years of shrinking sales, thereby boosting sentiments about this industry. However, the expected results were not on the cards at the end of the September quarter. Predominantly, the festive season in India is assumed to be better for the automotive industry. However, this year the festive season remained disappointing. This was the case even though the automotive OEMs had offered heavy discounts to boost sales. The bleak performance can be attributed to the higher yearly volume numbers for the first four months of the fiscal which had raised the performance barriers.

The topline of the industry showed moderate growth of 15.17 per cent on a yearly basis and 3.61 per cent on a sequential basis. The weak growth was due to stagnant volumes reported during the quarter. Adding to this bleak revenue growth, the industry’s raw material cost increased by 18.36 per cent on a yearly basis (6.55 per cent on a sequential basis), which was higher than revenue growth during the same period.

Meanwhile, the automotive industry’s interest cost showed a sequential negative growth of 6.76 per cent and a yearly negative growth of 17.03 per cent during the period under review. Note though that the data does not include Tata Motors which has considerable debt on its books and is yet to announce its results for the September quarter. However, the industry is expected to post profits in the near future. On the net profit front, the industry reported a handsome growth of 12.71 per cent on a quarterly basis and 9.19 per cent on a yearly basis during this quarter. The sequential growth is predominantly due to considerable lower depreciation charges and lower interest cost.

Similar to the last quarter, two and three-wheeler companies exhibited a good performance. The segment reported revenue growth of 17.96 per cent on a yearly basis and net profit growth of 2.98 per cent on a yearly basis during the second quarter of FY15. However, this segment too saw some pressure on profitability in the said quarter. Serious pain persists in LCV and HCV segments on account of subdued industrial activities across the country. During the quarter under review, passenger vehicles too showed pressure on margins. Going forward, the automobile industry’s sales are expected to be driven by new launches across all segments, falling fuel prices, and expected decline in the interest rate coupled with gradual recovery in macro-economic indicators. Considering the performance of the recent quarter, we expect the automobile industry may take some time to post a good performance despite gradual economic recovery in the coming days.

BANKING

The change in the regime at the Centre has not changed much for the banking sector. The non-food credit growth has slipped below 10 per cent in the month of September 2014; the last time we witnessed such tepid growth was in October 2009. It is far below than what we observed in FY14. The impact of such tepid growth is visible in the growth of net interest income (NII) of banks, which on an average grew by 10 per cent on a yearly basis for the 29 banks analysed, including 13 private sector banks and 16 public sector banks (PSBs) for the quarter ended September 2014.

The average growth was dragged down by lower growth in the NII of public sector banks. The NII of 16 PSBs grew at an average rate of 6 per cent on a yearly basis and out of these 16, five banks saw their NII declining on a yearly basis. The worst performance was by UCO Bank that saw its NII declining by 12 per cent whereas the best was by Bank of India that saw its NII increasing by 20 per cent. The private sector banks on the other hand saw their NII increasing on an average by 18 per cent.

The weak NII growth along with increase in the provisions led to muted growth in the net profit of the banks. Of these, 29 banks reported rise in net profit of a mere 8 per cent on a yearly basis. The PSBs actually saw their profits declining by 8 per cent in the same period. Seven out of 16 banks saw their profit declining on a yearly basis and the worst performer was Indian Overseas Bank, which posted loss of Rs 245 crore for the quarter ended September 2014. The private sector banks, however, saw their profits increasing by 19 per cent in the same period. Lakshmi Vilas Bank saw its profit jumping more than four-fold. Another factor that impacted the profit was higher provisions. The provision of the banks other than tax has increased by 5 per cent on a yearly basis and huge 37 per cent on a sequential basis.

The asset quality of the banks is still showing signs of weakness. On a sequential basis the average gross NPAs and net NPAs of 29 banks analysed has increased by 9 per cent and 11 per cent respectively. Even as percentage of advances, the banks have seen their gross NPAs and net NPAs increasing by 16 basis points and 12 basis points respectively. The PSBs have again lagged in performance as compared to their private counterparts in asset quality. Private banks have in fact seen their asset quality improving on a sequential basis while the PSBs witnessed it worsening.

The next quarter result for the banks will be marginally better as credit growth is yet to pick up and asset quality concerns will remain. We believe that private sector banks will continue to out-perform and PSBs will also see their profit increasing primarily due to profit in treasury portfolio.

[PAGE BREAK]

CEMENT

The cement industry posted strong performance with a robust revenue growth of around 20 per cent on the back of rise in volumes and realisations. On an aggregate basis, the 12 companies in the sector we have analysed have posted topline and EBITDA growth of around 20 per cent and 65 per cent respectively for the September 2014 quarter on a YoY basis owing to weak monsoon and improved sentiment post the general elections. Fronline stocks like ACC and Ambuja Cement’s topline inceased by around 9 percent and UltraTech Cement’s topline increased by 18 per cent while JK Lakshmi Cement and JK Cement grew at 27.6 per cent and 32.6 per cent respectively among the small-caps.

During the quarter, the industry EBITDA margin increased by 210 bps points from 11.4 per cent to 13.5 per cent, driven by healthy growth in revenues, low base effect and lower raw material cost. Cement prices increased by about 7 to 10 per cent YoY in the north, south, west and central regions, while they declined by about 5 per cent in the east. JK Lakshmi Cement’s net sales realisation per tonne increased by 12.9 per cent from Rs 3,931 per tonne to Rs 3,482 per tonne, which is the highest among the companies whereas under EBITDA per tonne category Dalmia Bharat posted highest growth of 47.7 per cent from Rs 759 per tonne to Rs 514 per tonne.

Going forward we will see such momentum growth in the cement sector with a strong and stable government, primarily because there are expectations of positive and quick decisions in housing and infrastructure sectors.

[PAGE BREAK]

FMCG

If consumption is any indication of economic growth and revival, India’s growth momentum is certainly coming back. During Q2FY15 almost all the FMCG companies showed fabulous growth in topline and bottomline. On an aggregate basis, the top eight FMCG companies’ topline grew by 8.8 per cent to Rs 24,836 crore while their PAT jacked up by 9.5 per cent to Rs 4,284 crore as against Rs 3,913 crore achieved during the same period last year.

FMCG giant HUL posted decent topline and bottomline growth of 11 per cent and 8.13 per cent during the second quarter owing to resurgence in sale of soaps and detergents. This comes as good news because the company had shrunk its guidance for the near term owing to weak spending by Indian consumers. During the second quarter ending September 2014, the company’s sales rose to Rs 7,639 crore as against Rs 6,893 crore earned during the same period last year. At the same time the raw material consumed has increased marginally by 1.7 per cent during this period, showing a slackening in inflation and thereby pushing up the profitability of the company to Rs 988 crore.

Quite in line with this growth momentum, ITC’s topline also escalated by 15 per cent to Rs 8,930 crore as against Rs 7,775 crore earned during last year while its bottomline also jumped by 8.7 per cent during the same period to Rs 2,425 crore. The company’s growth came from agribusiness, packaged food, personal care and cigarettes. The company has adjusted some liability during the quarter towards rates, taxes and interest cost of the earlier year; otherwise PAT growth was at 15.6 per cent during the quarter.

An encouraging fact was that during Q2 almost all the companies showed growth in topline as well as bottomline with Godrej Consumer posting the highest PAT growth of 21 per cent to Rs 252 crore, whereas its topline remained at Rs 2,047 crore, showing a growth of 4.6 per cent. On the topline side, Marico posted a whopping growth of 28 per cent in its sales, riding high on a new improved product portfolio.

After a subdued performance during Q1, the FMCG space seemed recharged during Q2 and the EBIT also remained robust, clearly showing the benefit of cheaper raw materials like PFAD, HDPE and other edibles. Almost all the companies showed growth in gross margins with Godrej Consumer and Emami leading the show at 24 per cent and 19 per cent growth respectively. During the quarter, interest burden on the companies also receded and companies discharged their debts owing to lesser requirement of working capital and robust cash flow to the companies. Companies like Dabur and Marico have curtailed their interest cost by 49 per cent and 50 per cent respectively.

INFORMATION TECHNOLOGY

The Indian Information Technology service sector remained popular across both domestic and international fraternity. The IT service sector remains in leadership position for attracting foreign investments than any other sector. The sector has not only transformed India’s image on the global platform, but also fuelled economic growth by energizing the higher education sector. The IT service sector continues to grow from strength to strength, witnessing high levels of activity both onshore as well as offshore. The IT service companies keep on moving up the value-chain to offer higher client satisfaction by more research and analytics services.

However, Q2 FY15 turned out to be a mixed bag for the Indian IT service sector. The earning during the reported quarter was disappointing as most of the companies posted results below investor expectations. Though the investors’ sentiments were impacted with little correction in few companies’ stock prices, the revenue growth on sequential basis was better than first quarter FY15. However, the investor sentiments impacted due to flattish to negative bottomline growth for the sector on sequential basis. Though the growth will be moderate during FY15, good growth expectations are from IT service sector due to recent strong deal pipelines and gradual recovery from global economies.

The IT service industry posted a good 4.4 per cent sequential growth over Q1 FY15 but, 8.8 per cent yearly growth over the same quarter last year. However, the industry was not able to translate into bottomline growth during the quarter. The industry bottomline declined marginally by almost 0.6 per cent on a sequential basis. The recovery signs in the US economy due to increasing discretionary spend while concerns over Euro zone economies remain the concerns for the IT service industry. Further, the margins are impacted with the increasing spend over salary hikes and cross currency translations. The industry’s major expense which is employee-related increased by 4.57 per cent on a sequential basis.

On the dollar revenue front, the volume growth during the second quarter FY15 remained strong than the same in first quarter FY15. However, the companies were not able to gain on the realisation front. The managements of these companies though are still optimistic on back of renewed deal flow in the recent past. Though the US economy remained strong during the quarter, the concerns over Euro zone economies started to impact the investors’ sentiments. However, interestingly, the global peers had posted a good set of numbers and outperformed the street expectations.

In the coming quarter too, the IT service industry is expected to show moderate to positive performance on the back of improved global economic situation and positive management commentary.

The FY15 growth may remain moderate due to delay in signing of some large deals, increase in deal complexity, and smaller deal sizes in digital technologies. However, continued improvement in the macro-economic environment in the US geography and expected recovery in Euro zone economies may result in an increase in discretionary spending. Hence we too maintain overweight on the Indian IT service sector as the sector to outperform the broader Indian market in future.

[PAGE BREAK]

INFRASTRUCTURE

With the new pro-reforms government at the Centre, it was expected that infrastructure companies are likely to come back into action. That is because the government has an agenda of clearing many infrastructure projects’ roadblocks, thereby leading to high expectations. Even in our June quarter analysis we had stated that the capex cycle is expected to revive, thus resulting in better order inflow for the infrastructure companies. Though the infrastructure companies have managed to witness a good show on the bourses with all the leading companies almost trading at yearly high levels, a similar event does not seem to have been replicated on the financial front.

If we take a look at the financial performance of infrastructure companies that have announced results till date (BSE 500), on a yearly basis the topline increased only by 9.52 per cent on YoY basis and bottomline increased by 6.39 per cent. However, one noticeable factor is that the operating margins for the quarter have declined significantly despite the commodity prices witnessing a decline. Just to quantify, the EBITDA margins in September 2014 for the sector declined to 9.35 per cent from the level of more than 10.26 per cent in September 2013. The margins are also lower as compared to 10.77 per cent posted in June 2014.

The largest infrastructure player L&T also witnessed pressure on margins as the EBITDA margins declined to 11 per cent in September 2014 as compared to 13.10 per cent posted in September 2013. However, if we consider half-year results, the H1 FY15 EBITDA margins are almost stable at 12.10 per cent as compared to 12 per cent posted in H1 FY14. A similar trend is being seen in other infrastructure companies as well. At the bottomline level, while on YoY basis the bottomline has increased by 6.60 per cent, there has been some decline on a sequential basis.

The order inflow has also been good for the quarter with L&T witnessing order inflow increase of 17 per cent and the total order book swelling by another 14 per cent. However we still feel execution at higher margins holds the key. Going ahead we are expecting order inflow of companies as reforms are underway and most of the projects stuck in red tape are being cleared.  The only reason why it is not being reflected in the books of companies is that the orders would take some time to trickle into their books. We expect H2 FY15 to be vibrant for infrastructure companies. We also expect improvement in margins and higher execution in H2.

Pharmaceutical

Once again, the pharmaceutical sector has posted good earnings growth in the September quarter on the back of higher volume growth in the domestic market. On an aggregate basis, the 26 companies excluding Cipla (21 Indian + 5 MNCs) in the sector that we have analysed have posted a topline and bottomline (excluding exceptional items) growth of 14.5 per cent and 20 per cent respectively for the Sepember 2014 quarter on Y-o-Y basis.

This was driven by higher volume growth in the domestic market, post the pricing impact from Drug Pricing Control Order (DPCO) 2013, while export growth slowed down. Domestic drug firms expect a slowdown in new generic drug approvals by the United States Food and Drug Administration (USFDA) to weigh on sales in their largest market for at least two more quarters, due to an ongoing overhaul of the review process. EBITDA margins improved by close to 170 bps due to better product mix coupled with higher efficiency.

During Q2FY15, Indian companies grew by 14 per cent in domestic formulation market excluding Cipla. Among large-cap companies, Lupin grew at 20.4 per cent, while among small-cap companies Ipca Laboratories, Ajanta Pharma and Alembic Pharma grew at 18-19 per cent respectively. On export formulations business front, Indian companies posted a slower growth of 25.5 per cent as against 41 per cent growth in June quarter of 2014. However, Aurobindo Pharma posted more than 80 per cent growth as US formulations remained strong despite indication of increased competition in limited competition products (gCymbalta) and recent acquisition of the Western European formulation business of Activas.

During the quarter, The Strides Arcolab approved a scheme of amalgamation between the company and Shasun Pharmaceuticals wherein, Shasun Pharmaceuticals will amalgamate with the company. The merger will create an entity among the top 15 listed domestic drug makers with a turnover of over Rs 2500 crore.Going forward, we expect the Indian Pharma industry to continue its growth in domestic market due to pricing policy. However, slow growth might be witnessed in export formulation business due to the above mentioned facts.

POWER

Though the new government at the Centre has ushered in “achche din” for a majority of the sectors, power is one such which continues to drag. In fact the Supreme Court’s decision to cancel more than 214 coal blocks has played havoc for the power sector companies. Assessing the situation, the Central government has flung into action and forced an ordinance to allocate cancelled blocks to end-user power, steel and cement companies and that has somehow plugged the pessimism prevailing among the power sector companies. In addition to this, due to high interest cost and low PLF and demand, the situation continued to remain grim for power generation companies during Q2 FY15.

During the first half of FY15 total power generation jumped to over 531 BU as against 482 BU generated during the first half of FY14 - a growth of 10.33 per cent with thermal power generation leading with 430 BU. At the same time, capacity addition during the first half ending September 2014 last fiscal has increased by a whopping 87 per cent to 8,978 MW as against 4,798 MW achieved during the corresponding half year ending FY14. This clearly shows that companies have now started beefing up capacities due to a wave of optimism riding on the promises made by the new government and some of the efforts taken to improve the power sector scenario.

Yet, despite this, improvement in capacity utilisation has continued to cause concern due to a sharp decline in the Plant Load Factor (PLF) from 64.6 per cent in September 2013 to 60.86 per cent in September 2014. It clearly indicated lower demand and fuel supply problems. At the same time, during September 2014 the availability of power remained deficient at 85,509 MU as compared to the demand of 89,143 MU.

The present situation in the power sector and the problems related to fuel supply, especially arising out of the cancellation of coal blocks by the Supreme Court, have aggravated the concerns of the power sector companies. This situation has clearly impacted the performance of power companies with the biggest generator of the country, NTPC, posting decline in net profit by 17 per cent during Q2 FY15 to Rs 2,493 crore as against Rs 2,072 crore earned during Q2 FY14. During this period the fuel cost has decreased to Rs 11,439 crore as against Rs 10,139 crore incurred during the same time last year.

The operating income of the company jumped to Rs 16,582 crore as against Rs 16,282 crore - a spurt of a meagre 1.90 per cent. The best performance put forward was by Torrent Power. Its topline increased by 17 per cent to Rs 2,592 crore while its net profit reached Rs 57 crore as against net loss of Rs 26 crore during Q2 FY14. JSW Energy also showed its mettle with a fabulous performance and its net profit jacked up to Rs 232 crore during Q2 as against Rs 75 crore earned during the same period last year, indicating a jump of 208 per cent. SJVN is another company whose PAT rocketed by 92 per cent to Rs 797 crore.

On the lower side, interest cost has continued impacting the financial health of companies as it ate into their profits. The interest cost of companies like NHPC, SJVN, Torrent Power, KEC International and JSW Energy rose by 140 per cent, 87 per cent, 15 per cent, 25 per cent and 1.4 per cent respectively during Q2. Due to drastic increase in interest cost some companies like NHPC, KEC International and Transformers & Rectifiers’ have shown a slide in profits. In fact, KEC and Transformers & Rectifiers have posted net loss of Rs 32 crore and Rs 6.6 crore respectively.

Meanwhile, though the current situation in the power sector, and therefore the power companies, is quite subdued due to myriad problems, not to forget the current gas price hike, the future does spell out hope. Since inflation is quite low there is optimism about a much needed rate cut in the forthcoming review of the monetary policy. Also, the government has pushed power sector reforms in a big way and a path has been cleared for coal pool pricing from next year along with the participation of private and foreign companies in the mining of coal. An improvement in the economic scenario will also provide the booster dose necessary for a rejuvenation in the power sector.