DSIJ Mindshare

Q3 FY 13' Results Analysis

Against the buildup of expectations, the results for the December quarter of 2012 have turned out to be a mixed bag. While certain pockets have surpassed street estimates by a huge margin, others have failed to impress. Here is the full picture of what happened...

There is an interesting similarity between the Indian stock market and the corporate results. Though there are 1.8 crore demat account holders in India, the active investors number only a little over two lakh. These two lakh investors generate a majority of the total volumes on the bourses. Similarly, there are a total of 5400 listed companies (BSE and NSE combined) in the country, but only a handful of them have the capability to skew the corporate results either way. 

Here is some empirical evidence to support our assertion. There are only 203 companies in the ‘A’ Group, but these account for more than 84 per cent of the total market capitalisation and 60 per cent of the total average daily turnover on the bourses. More importantly, they account for 70 per cent and 85 per cent of India Inc.’s sales and profits respectively. Thus, though the overall results are undoubtedly important, what is more significant is how these frontrunners fare. This gives a clear snapshot of the quality of earnings and its impact on the sustainability of the broader market.

If the December 2012 quarter financial results of India Inc. are anything to go by, nothing much has changed. On the back of some revival that was seen in the September quarter of 2012, the expectations of what could emerge in the December quarter were quite high. In fact, the results season began on a very strong note, with IT majors putting in better-than-estimated results. However, as they continued to flow in, the results stopped looking that encouraging.

When we look at the final figures, the December 2012 quarter results have been a no-show as compared to our expectations. On a YoY basis, the aggregate topline for the December quarter increased by 7.79 per cent and the bottomline increased by 6.09 per cent. As per our usual practice, we have excluded the results of the PSU oil marketing companies on account of the inconsistent financial performance and the subsidy burden shared by the upstream oil companies on their behalf.
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On the face of it, you may find the bottomline growth of six per cent to be quite good. However, adjusted for extraordinary income, the growth stands at just around 1.50 per cent. On a sequential quarter basis too, the performance is not that encouraging, with the topline witnessing a growth of 4.10 per cent and the bottomline declining by 5.23 per cent. However, though the results are not in line with the street’s expectations and ours, investors need not be disheartened. As already mentioned, there are only a few large companies that have actually dented the overall financial performance. Prateek Agrawal, CIO, ASK Investment Managers, concurs with our view saying, “If you look at the index and the heavyweights, most of them have been able to beat the street expectations except for a few who have actually created a stress on the overall financials”.

High Hopes: A Real Killjoy

The government had begun taking necessary steps to put economic growth back on track. Its efforts at shaping up its finances too have been quite in progress over the past quarter. The government has made sure that it acts in the direction of reviving the capex cycle and also ensured enough liquidity in the system. All this had led to a buildup of high expectations from Corporate India in the December quarter. In fact, the way the IIP moved up in the month of October 2012 gave enough cause for building up those expectations.

But the story remained positive only until October, and November and December turned out to be rather disappointing months on all counts. To add to this, inflation continued to remain at relatively higher levels. A combination of all these factors resulted in quite a dismal quarterly performance from India Inc. 

However, despite the gloom, there are surely some positive aspects to the numbers that have emerged.

Higher Depreciation: The Positive Fallout

In our analysis of the corporate results for the September quarter of 2012, we had mentioned that depreciation cost has increased, though marginally, and this is a positive sign as it signals higher capex. For the December quarter of 2012, the increase in depreciation was still higher, standing at 11.39 per cent on a YoY basis. Even QoQ, it went up by 3.27 per cent. This clearly shows that the capex cycle is reviving. The impact of this may not be visible in the current quarter, but will surely be seen in next few quarters as the capex cycle always has a reasonably longer gestation period. 

Apart from that, the order inflows for most of the capital goods and infrastructure companies have also increased during the quarter. Here too, companies in the ‘A’ Group have been major contributors, with more than 62 per cent of the depreciation charges being attributed to them. Will the capacity addition yield anything? Well, the higher demand that is likely to crop up in future will be serviced from these additional capacities. 
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Margins Front: Improvement Seen

Some improvement was seen in the operating margins (OPM), with the raw material costs having come down. The raw material costs for the December quarter declined by 4.53 per cent on a YoY basis and the aggregate OPM for the period increased to 17.11 per cent as against 16.59 per cent in the previous year corresponding quarter. “This quarter margins have improved for some companies. Look at RIL, which is a very big company. Its margins have increased substantially, which pulled up the averages. Similarly, we have witnessed better results in technology. Hence, on an average, we have seen better margins in terms of aggregates”, adds Agrawal. 

However, this performance was not replicated at the bottomline level, where interest costs created a lot of pressure. 

Interest Cost: Still No Breather

Most on the street expected a breather on the interest cost front. However, this failed to happen. The interest cost (excluding that for Banking and Financial Services Companies) has increased by 34 per cent on a YoY basis, which is much higher than the 25 per cent rise witnessed in the September quarter. Rather, it went up by 11 per cent even on a sequential basis. The impact of this was evident from the fact that for the December 2012 quarter, the interest cost as a per cent of sales stood at 3.94 per cent as against 3.73 per cent in the December 2011 quarter and just 3.07 per cent in the September 2012 quarter.

Though some leading banks did reduce the interest rates, it hardly helped India Inc. Apart from that, the increased working capital needs particularly of the infrastructure sector sent interest cost aggregates on the higher side. The RBI cut the Repo Rate in January 2013, and the impact of this will become visible in the March 2013 quarter. According to Agrawal, “The financing cost has not improved. Rather, for some companies it has worsened. Under the new norms of reporting the interest cost, if somebody has borrowed in foreign currency and the rupee has depreciated, the loss has to go to the finance cost. This is also a reason why the finance cost has gone up for a lot of companies”.

Performers & Non-Performers

Banking (Private), FMCG, Pharmaceuticals, Oil & Gas, Infrastructure and IT have been the best performers during the December quarter. But the likes of Cement, Steel and Automobile have not lived up to the expectations. On a stock-specific front, the consolidated financial per- formance of companies like Tata Steel, Tata Motors, Bharti Airtel, Dr Reddy’s and Cadila have been a major drag on the overall performance of India Inc. during the period. 

March Quarter: What To Expect

As far as the March quarter of 2013 is concerned, one should not expect much of an improvement. There are some factors that are likely to help, like the Repo Rate cut that was effected in January this year, the pre-budget sales and some improvement on the inflation front. However, we are not expecting a higher guidance in the EPS estimates on an immediate basis. An upward revision in the FY13 EPS estimates for the Sensex companies which we had stated in our analysis of the corporate results for the September quarter has already been discounted. So, while downgrades are a thing of the past, an upgrade from here on till the end of FY13 will also be a remote possibility.
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AUTOMOBILES

Since the beginning of the year, the Indian automobile industry had hopes of a revival parked in Q3FY13. The festive season and end-of-year discounts were expected to bring cheer to the auto makers. However, reduced economic activity, high interest rates and soaring fuel prices managed to shoo the buyers away. Whatever mediocre growth that the industry saw was a result of the outpaced demand for certain segments like Utility Vehicles (UV) and Light Commercial Vehicles (LCV). Those with a strong presence in these segments did relatively well, while the rest continued to suffer.

The above dynamics weren’t applicable to Maruti Suzuki (MSIL) in Q3FY13 because of a series of events it has been witnessing for a while now. Labour issues had left MSIL without production for 14 days in October 2011, leading to low volumes in Q3FY12, thus creating a low base effect for Q3FY13. Moreover, there was a month-long lockdown at its Manesar plant in July-August 2012. However, it continued taking orders, resulting in a strongly built-up order book over the quarter. This and the success of MSIL’s UV ‘Ertiga’ resulted in the sales volumes growing by 25.85 per cent on a YoY basis. 

Tata Motors (TML) witnessed an interesting trend in the quarter under review. In terms of sales volume, the standalone sales of TML declined by 10.24 per cent on a YoY basis and those of Jaguar Land Rover (JLR) grew by 13.24 per cent. JLR contributes about 65-70 per cent of TML’s revenues and more than 90 per cent of the company’s profits. But the management recently raised concerns over the margins forecast for JLR. Unfavourable foreign exchange rates and the ongoing effect of a higher mix of Range Rover Evoque sales, among other factors, were termed as the reasons for the negative impact. In line with this, although the revenues for TML grew by 1.83 per cent, the operating profit margin and net profit margin declined by 281 basis points and 399 basis points respectively. 

Owing to its strong presence in UVs and LCVs, Mahindra and Mahindra (M&M) outperformed on the volumes front. Its volumes grew by 17.51 per cent in Q3FY13 on a yearly basis. Financially, the performance was robust due to healthy growth in the topline and bottomline. The revenues and net profit grew by 24.73 per cent and 29.61 per cent respectively YoY.

The slowdown in demand that has gripped the industry has also caught hold of two-wheelers. Hero MotoCorp and TVS Motors continued to slog in terms of both volumes and finances. Bajaj, however, performed relatively better because of its product portfolio. While the Q3FY13 sales volumes for Hero and TVS declined by 1.02 per cent and 2.11 per cent respectively, those for Bajaj increased by 4.86 per cent.

The same trend is reflected in the topline growth of these two-wheeler manufacturers. The topline of Hero and TVS grew by 2.51 per cent and 1.34 per cent respectively, while that of Bajaj was up by 8.56 per cent. The margins remained pressured for all. On an average, the operating profit margin and net profit margin shrank by 180 basis points and 112 basis points respectively.

Discounts, an unfavourable product mix, higher interest costs and lower sales volumes added up to build margin pressures. The margins shrank considerably even though there was an easing in raw material prices. On an average, the raw material cost-to-sales ratio for auto companies dropped by 277 basis points to 65.32 per cent.

Although the quarter has been lack-lustre, a reversal is expected in the industry in the coming quarters as the demand gets supported by an interest rate reversal and new product launches. Till then, the pressure on margins is expected to continue weighing on the stressed industry.
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BANKING

We have been bullish on the prospects of the banking sector. In fact, it was among our four top  sectors to remain investedin for 2013, and continues to be so. Our bullishness was backed by a host of factors which have played out well until now. The sector continued to outperform the broader indices and did well in the December 2012 quarter too. The BSE Bankex appreciated by 9.18 per cent, while the Sensex was up 3.53 per cent over the same period.

Action from the RBI also remained rather contrary to expectations. Rate cuts remained elusive in the December quarter, though some solace came in the form of a 25 basis points cut in the CRR, which pumped close to INR 18000 crore into the system. So, how have banks performed in the December quarter? 

Overall, business growth showed mixed signals, as the growth in deposits moderated while advances grew almost in line with the RBI’s expectations. Between December 2011 and December 2012 (data as on December 28, 2012), the deposits grew at 11 per cent and advances were up 15 per cent. This prompted the RBI to revise the deposit growth estimate for FY13 to 13 per cent in January 2013, while it left its estimate for advances growth at 16 per cent. Demand deposits (Current Account and Saving Account) declined by 0.45 per cent, while Time (Fixed) deposits grew at decent rate of 12 per cent during the same period. 

For the 40 banks, the results of which we have analysed for the December quarter, the aggregate Net Interest Income (NII) grew by nine per cent and the net profit increased by six per cent on a YoY basis. Profit grew at a slower pace, following the higher provisioning, which increased by 19 per cent. Private banks (16) continued to outperform the Public sector banks (PSBs) (24), as their NII grew by 23 per cent against that of a meagre five per cent growth reported by the PSBs. As far as profitability goes, while private banks reported a handsome growth of 28 per cent in profits, those of PSBs declined by five per cent on a YoY basis. Mixed signals have emerged on the Net Interest Margin (NIM) and the asset quality front. Of the 14 banks which are a part of the BSE Bankex, the NIMs of eight banks decreased and six showed an improvement in on a sequential basis. 

On the asset quality front, seven banks saw their Net NPAs of decreasing to show signs of strength. In case of five banks, the Net NPAs increased on a sequential basis. Two banks, viz. HDFC and Axis Bank saw their Net NPAs remaining unchanged. 

Private banking players would continue with their robust performance going ahead. Revised guidelines on the new banking licenses are awaited and some prominent names from non-banking finance companies (NBFC) space are looking to get these. The next big trigger for this sector may come from the budget to be announced towards the end of this fiscal.
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CEMENT

Construction, repairs, renovation, development of anything from buildings, roads, ports and dams will all fuel demand for one commodity. Cement is that vital commodity which binds together all ingredients that define development as a whole. The sector secularly follows the trend-line of economic development. Drawing its demand from residential houses to large infrastructure projects, the position of the cement sector has long been used as a barometer of the level of development in the economy.

The sector had performed well in the preceding quarter (September 2012), and that was reflected in the strong appreciation in the stock prices of leading cement companies. The lower rainfall during that quarter extended the timeline for construction activity, and hence resulted in better performance of the companies. It had also led to better realisations during the quarter.

The scenario has changed for Q3FY13. For the 30 cement manufacturers that we have analysed, the aggregate topline witnessed a growth of 8.90 per cent on a YoY basis. The aggregate bottomline, however, declined by 19.29 per cent over the same period. But there are some companies that have posted gains at the bottomline level too. These include companies like Shree Cement, JK Cement and Burnpur Cement. 

Cement prices have been quite volatile throughout the country during the December 2012 quarter. For instance, ACC’s realisations in the Grey Cement category declined by 7.5 per cent on a QoQ basis and remained almost flat on a YoY basis at INR 4166/tonne. In the case of Ambuja, the realisations stood at INR 4501/tonne and were lower than what they were expected to be. On a YoY basis, though, Ambuja’s realisations improved marginally by 1.8 per cent aided by the price hikes brought into effect by the company.

The subdued performance of the sector can be attributed to a slowdown in the overall investment cycle. During the quarter, there were also acute concerns on the supply front following the constraints in the availability of sand and aggregates, which in turn affected construction activity across the country. The problem now is that the supply has overrun the demand. This can be substantiated by looking at the volumes growth, which has remained flat during the quarter on a YoY basis.

Cement players have also been under some pressure on the cost front. Raw material prices witnessed a sharp jump in the December quarter and there was a substantial increase in the freight and logistics costs too. The higher logistics costs are due to the diesel price hike that happened in September 2012 and an increase in railway freight that was brought into effect in October 2012. 

The pressures of performance aren’t done yet. Hope now rests on rapid infrastructure development and sops to the Real Estate sector, which alone can prop up demand for the commodity, bring back pricing power and lead to better realisations and in turn, higher profitability. The March 2013 quarter looks to be difficult as the benefits of any positive budget announcements will begin flowing in only with a lag effect.
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FMCG

Have you ever pondered over something very basic like, recession or no recession, do you stop using soaps, toothpastes or shampoos? The obvious answer to this question would be a big NO. At the most, you may scale down the price points at which you buy this stuff and the moment the circumstances change, you tend to come back to what you were used to. 

What does this short discussion lead us to? Well, to something that explains the rise in the BSE FMCG Index over the December quarter of 2012. This index has outperformed the broader market during the quarter, to emerge as one of the best performing indices. The simple reason behind this phenomenon is that this sector was expected to do well during the quarter, and as you know, the market always discounts such expectations in advance. During the quarter, while the BSE FMCG Index appreciated by 7.42 per cent, the Sensex moved up by 3.53 per cent. We too had anticipated quite well in advance that companies in this sector will post decent numbers in the December quarter. 

The aggregate topline of the 11 companies that we have analysed grew by 14 per cent during the December quarter, while the net profit grew at a handsome rate of 19 per cent on a YoY basis during the same period. Companies have reported good volumes growth during the quarter, which has helped the overall rise in turnover. For instance, Dabur reported a 14 per cent growth in its domestic business supported by a 10 per cent growth in volumes, while in the case of Marico, the overall turnover grew by 11 per cent supported by nine per cent growth in volumes. However, Hindustan Unilever, considered as the pillar of the FMCG sector in the Indian context, had a different story to tell. Its domestic business grew by 15 per cent on a growth of just about five per cent in volumes. 

On one hand, where the revenues were supportive of growth, companies in the sector witnessed some easing on the input cost front too. On an aggregate basis, the raw material costs increased by 15 per cent, but as percentage of sales, there was only a marginal rise of eight basis points in this component to 41.13 per cent. The proces of palm oil, a key input for soaps (and a key cost component for companies like HUL and Godrek Consumer Products), decreased apporximately by 23.56 per cent from December 2011 to a December 2012. Also, the prices of copra (a key input for Marico, accounting for as much as 40 per cent of its total input cost) for the December quarter of 2012 decreased by 23 per cent on an average YoY. 

Advertisement cost is another significant cost component for companies in this sector. This went up 22 per cent as a percentage of sales on YoY basis, increasing by 64 basis points to 10.81 per cent. However, despite higher advertisement expenses, the companies have maintained their operating margins. The aggregate operating profit grew by 15 per cent and margins were stable at 14.83 per cent. This is mainly the result of a lower rise in the other cost components, including raw materials. 

Is there anything else that you should know about companies in this sector apart from what has been  stated above? 

Well, HUL’s Board of Directors has approved a hike in royalty payment to its parent company from the current 1.4 per cent of its turnover to 3.15 per cent. This hike will be effected in a phased manner starting from February 2013 up to March 2018. Higher royalty payments would impact the bottomline of the company, in turn impacting its EPS going ahead. 

Overall, companies in the sector have posted a decent performance for the December 2012 quarter. However, the topline growth is showing some signs of moderation in demand, which has cre- ated some pressure on the stock prices of companies over the past couple of months. Companies are likely to face some short term hiccups, but the long-term growth story remains intact for the sector. We would advise investors to remain invested in this space. Our top picks continue to be Dabur, Marico and Bajaj Corp.
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INFRA & REALTY

Nothing facilitates growth like infrastructure does. There is no extra effort needed to bring this fact to the fore. Trade, commerce and the economy thrive on the back of a strong infrastructure backbone. While the sector may be downbeat at present, it will not remain so for long. In fact, the sector can never be out of the reckoning, because if the economy has to grow in a significant manner, the government has to bring about meaningful infrastructure growth. We have been bullish on this sector and have even recommended an offshoot of it (the Capital Goods segment) as our favourite for 2013. 

The infrastructure sector had shown some early signs of improvement on the bottomline front at the end of the September 2012 quarter itself. Considering that the government would certainly do its bit in putting the sector back on track to spur overall economic growth, we had expected it to do well in the December quarter too. 

In reality, however, the results of the infrastructure companies are quite in contrast to what was expected. While the average topline increased to a good extent by 7.87 per cent, the bottomline has actually declined by around 20 per cent. But before you draw conclusions from these figures, here is something that you need to look at. For infrastructure companies, the December quarter tends to sift out the strong players from the weaker ones. Thus, the results for the elapsed quarter clearly indicate that the scenario was fairly competitive and that the larger players have managed to perform better.

A very important indicator of how the infrastructure sector is faring comes from the way the IIP data pans out. After a strong reading for the month of October 2012 (up 8.30 per cent), it went from bad to worse, coming in at -0.1 per cent for the month of November and a dismal -0.6 per cent for December 2012. This is a sureshot indication of why infrastructure companies haven’t done well in the December quarter. Nevertheless, one positive that has emerged is that the performance of companies in this sector has been good on a sequential basis, with the topline growth at 12.75 per cent and bottomline growth of around 7.65 per cent. 

The margins have remained under pressure. But here again, most of the infrastructure companies follow different completion cycle of projects, making the margins incomparable. Interest cost has played spoilsport once more, going up by 34 per cent on a YoY basis. The higher working capital requirement was primarily responsible for this. 

While most of the operational data proved to be a disappointment, a significant increase in the order book positions and new order inflows spelled some good news. The order books of leading infrastructure companies witnessed an upward tick after a long time. Industry leader L&T witnessed a sharp improvement on the order flow front. For the December quarter, its order inflow at INR 19545 crore recorded an impressive YoY growth of 14 per cent, sustaining the momentum seen during the September 2012 quarter.

With the capex cycle on a revival path, we expect the upward momentum in the order inflow to sustain in the March 2013 quarter too. The reforms process is expected to pick up at a faster clip, resulting in the continuation of the capex drive. Further, the 25 basis points cut in the repo rate is expected to help on the liquidity front. This will help control the interest cost and in turn, bolster the performance of infrastructure companies on the bottomline front going forward.

As for the Real Estate sector, when we had analysed the companies’ performance in the September quarter of 2012, we had categorically stated that the scenario is likely to improve, and hence, one should expect better performance from them in the December quarter. While the three per cent rise in the topline may not sound that great, the bottomline growth of 35.70 per cent certainly puts our forward analysis conducted then on a strong footing. Some amount of volumes growth with a marginal improvement in realisations was responsible for the topline growth of companies in this sector. However, higher debt burdens continue to be a concern.

Of course, you must remember that quarterly results do not have much relevance for the valuation of realty firms. It is the change in the net present value (NPV) of the projects that is more important. The NPV increases as real estate prices go up and interest rates decline. Both these factors have started improving. With a cut in the repo rate, housing mortgage rates are expected to witness a decline, resulting in increased enquiries from first time buyers. In addition to this, if sales  vol umes increase it will help realty com panies generate cash flows, eventually improving the financial health of some of the ailing firms. Going ahead, the scenario is expected to improve. Hence, we expect a better March 2013 quarter for companies in this sector. 
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IT/ITES

A host of data and trends had indicated a negative outlook for the Indian IT industry in Q3FY13. So much so that during the quarter, while the Sensex went up by 3.54 per cent, the BSE IT index declined by 4.03 per cent. However, much of the expectations that shaped up during the quarter turned out to be heavily flawed, as IT companies announced a relatively decent set of numbers. Now that’s what you call a positive surprise. 

Delayed hiring by Infosys, Cognizant’s SEC filings indicating a drop in the 2013 growth estimate, downward guidance revision by Syntel and Hexaware, Hurricane Sandy and TCS’ expression of concerns over a gloomy outlook all led to the street expecting a dismal performance by the industry for the quarter. The only positive in this clutter of news was that Gartner forecasted the IT spending in 2013 to grow by 4.2 per cent. However, this figure seems overly optimistic considering the 1.2 per cent growth seen in 2012. 

There are many factors that are changing from where the December 2012 quarter had actually begun. First, the global macroeconomic factors have undergone a structural improvement. Also, companies are increasingly making the effort (and successfully managing to) to incorporate changing technological trends so as to be ready to capture the growth opportunities that are likely to come along. All this makes the outlook not as unfavourable as it is being portrayed. 

Now, let’s take a look at the numbers. Overall, the revenues witnessed an average sequential growth of 3.76 per cent. At the same time, the margins remained under pressure, the net profit margin having declined by an average of 34 basis points.

The show-stopper in the IT space, in fact in the entire quarterly results season, was undoubtedly Infosys. The company beat the street’s expectations by announcing a 6.34 per cent sequential growth in revenues. It also slammed the pessimistic sentiment triggered by doubts of Infosys being able to meet its five per cent revenue guidance for FY13 by revising it to 6.52 per cent (USD 7.45 billion).

Similarly, other biggies including Cognizant, TCS and Wipro also announced a healthy set of numbers. The revenues for the three grew sequentially by 2.96 per cent, 3.33 per cent and 2.4 per cent respectively. HCL Technologies outperformed its larger peers as usual. Its topline grew sequentially by 3.59 per cent. While the others saw pressure on their margins, HCL Tech’s operating profit margin and net profit margin grew by 45 basis points and 80 basis points respectively. 

Tech Mahindra and Mahindra Satyam faced exceptionally heavy pressure on their bottomlines due to Mahindra Satyam’s USD 80 million Aberdeen settlement. The firms’ net profit declined on a sequential basis by 7.27 per cent and 70.59 per cent respectively. Apart from this, the result for the quarter was robust for Tech Mahindra and moderate for Mahindra Satyam.

There was no clear trend that could be driven out of mid-cap IT companies, as their performance was affected by individual, company-specific factors more than cyclical trends. Hexaware, which had lowered its revenue guidance just before the announcement of its Q3 results, announced a growth estimate of 1.73-2.82 per cent for the next quarter. KPIT Cummins revised its annual profit guidance from 15-20 per cent to 35-38 per cent. Persistent Systems, which acquired US based product lifecycle management and search-based technology solutions provider NovaQuest, lagged on the operational front but outperformed at the bottomline level.

Overall, most companies in the sector quarter turning out to be unexpectedly saw a healthy quarter and the managements of these companies have even been talking about a positive outlook for the coming quarters. With the December quarter turning out to be unexpectedly good, the outlook for the coming quarters just becomes brighter, waving off some of the pessimism seen lately.
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OIL & GAS

Petrol, diesel, gas, government, prices – these are some words which have consumed reams of printed pages, terrabytes of digital space and hours of airtime over the past couple of years. India imports almost 70 per cent of its crude requirements, which accounts for nearly a third of its entire import bill. Obviously, this sector holds a place of special importance in the overall economic scenario. The direction of crude prices broadly sets the tone for the performance of companies in this sector. 

For a long time now, the future prospects of companies operating in any segment of the oil & gas sector have largely been dependent on the government. Subsidies and policies have played a crucial role in shaping the future of this sector. Things are changing, and the impact of the changes will certainly be felt over the long term. For now, here is what happened during the December quarter of 2012. 

The performance of the Oil & Gas sector for the December quarter has been in complete contrast to what was seen in the September quarter. Thanks to the inconsistent financial performance of the oil marketing companies (OMCs) like IOC, HPCL and BPCL that are largely dependent on government subsidies, the quarterly results of this sector have always been unpredictable.

This time, despite upstream companies and the government contributing to the subsidy burden, the performance of these companies (OMCs) has not been good. The falling gross refining margins (GRMs) have made sure that the performance remains subdued. 

On an aggregate basis, the sector’s sales grew by a decent 8.50 per cent YoY and 10.23 per cent on a sequential basis. The bottomline performance of the sector, however, remained very bleak. The net profit went up by just around 4.65 per cent on a YoY basis and declined by a huge 40 per cent sequentially. Not just the state-owned OMCs, but even the likes of MRPL and Chennai Petroleum Corporation have witnessed a setback on the profitability front, with losses posted in the December quarter of 2012. 

On the operational front, the OMCs have reported weak GRMs led by a depreciating rupee (down by six per cent in the December 2012 quarter) against the USD. In the case of HPCL, the GRMs stood at USD 1.9/bbl as compared to USD 4.40/bbl in September 2012 and USD 4.8/bbl in December 2011.

Upstream companies like ONGC and Oil India have seen their net profit decline significantly (17.50 per cent for ONGC and 7.25 per cent for Oil India) on a YoY basis. What mainly hurt them were the higher discounts provided by them on crude oil sales to the staterun OMCs. GAIL’s performance for the December 2012 quarter was good, with the bottomline having gone up to INR 1284.86 crore as against INR 1091.42 crore in the December 2011 quarter.

While most of the sector is dominated by PSUs, the performance of private companies also needs to be looked at. Reliance Industries saw profits dur- ing the quarter, which was helped by lower depreciation and higher Other Income. For the December quarter, its topline stood at INR 93886 crore against INR 85135 crore for the December 2011 quarter, while the bottomline stood at INR 5502 crore against INR 4440 crore. 

RIL’s premium to the Singapore GRM stood at USD 3.1/bbl. Sequentially, the GRMs for RIL improved to USD 9.6/bbl against USD 9.5/bbl. However, its Petchem and Oil & Gas divisions did not perform well. 

What can you expect to see in the March 2013 quarter? Companies may report some strong numbers though crude prices have remained at around USD 110/bbl. This is because the gov- ernment has put into place the deregulation of petrol and diesel prices. Hence, one can expect a strong financial performance ahead. The signs of this are already becoming visible in the way companies have been hiking product prices. It is a sure positive if you are a shareholder, but if you look at yourself as a citizen of the nation, you surely have to start worrying about inflationary pressures. Let’s end with a little thought – some pain now will prevent a larger ache on the fiscal front going forward.
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POWER

India is reportedly the fifth largest country in the world in terms of installed capacities for the generation of power. Yet, a large part of the country is still ‘power-less’. This puts the sector on a positive as well as a negative footing. While on one hand it reflects on India’s lagging development vis-a-vis its peer nations, on the other, it underscores the huge opportunity that lies herein.

The power sector has not been doing too well over the recent past. The chasm between the requirement and availability of power is getting broader by the day. This lopsided scenario needs to be addressed at the earliest if one has to see some meaningful development in the sector. After all, power is a key resource that plays a vital role in the overall economic development of the nation.

Not that the government has been oblivious to this scenario. Far from that, it has continued to lend a hand to the sector, trying to pull it out of the dumps. The government first announced a debt restructuring package worth INR 1.9 lakh crore for the state electricity boards (SEBs). It has now followed that up by granting ‘in-principle’ approval to the Coal Price Pooling (CPP) mechanism, which, if executed properly, is slated to be a historic decision.

So, how has the sector performed after all these efforts and what can be expected of it with more to come? For the third quarter, the aggregate performance has continued to be as abysmal as it has been over the past couple of years. Seven out of the 22 companies that we have analysed have reported losses, while another two have reported a deterioration in their net profit over the corresponding period. The aggregate topline grew by 19 per cent, while the bottomline was up seven per cent. Those in the merchant power busi- ness have done well during the quarter, as the volumes and realisations were better. If one adjusts the results for this then the topline growth comes around 17 per cent, while the bottomline declined by three per cent.

During the quarter, 2170 MW of new generation capacity was added. For the April-December 2012 period, the sector has added a total of 9854 MW of capacity, which is 55 per cent of the total planned capacity of 17956 MW for FY13. It will now have to add over 8000 MW of capacity in the fourth quarter, which seems difficult to achieve considering the earlier track record. On the gen- eration front, the sector missed its target by four per cent due to lower gas supply. During the elapsed quarter, the plant load factors (PLFs) for thermal plants (coal and lignite) remained near 70 per cent, while that for the gas-based stations has again remained below 50 per cent at an all-India level. 

The SEB debt recast scheme, which was to close by December 31, 2012, has been extended and will now close on March 31, 2013. Some SEBs are yet to agree to the terms of the debt recast, and this was primarily the reason why the scheme had to be pushed forward.

Of course, the woes of companies in this sector aren’t limited to their debt. They have been facing several headwinds on the operational front too. International coal prices remained close to USD 85 per tonne during the quarter, which were on the softer side. However, the rupee depreciated by more than six per cent against the dollar on a YoY basis, due to which the performance of power companies which depend on on imported coal was impacted. Gas issues surfaced again as the output from the KG-D6 basin fell to record low levels, adding to the worries of the gas-based stations. The commissioning of the Dabhol LNG terminal, however, is expected to increase gas supplies in the southern states. 

Things are changing and the CPP is the first step towards it. This is expected to improve the coal supply. Coal India will be responsible for executing the whole plan as envisaged in the CPP mechanism. This will include prospecting and supplying coal from within India as well as importing coal from international markets. 

Despite all this, the fuel risk still remains very high for the sector. While the outlook for the merchant-based power projects remains positive, our view on the sector remains cautiously optimistic. We would advise a stock-specific approach for those interested in taking exposure to the sector.
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PHARMA

When was the last time you saw your doctor go on a vacation? Let’s make it simpler. Are you aware of the prices of medicines for ailments other than a common cold or a mild viral fever attack? God forbid, those who have been through something worse than this will certainly be bullish on the pharma sector considering the way drug pricing has panned over time. Another very important factor about this sector is that there is no cyclicality or economic pressures associated with it. This is what makes it even more investor friendly. In fact these are the very reasons the sector is called a defensive bet. However good, bad or ugly the economic scene, pharma companies will continue to mint money. 

The above is substantiated with the good set of numbers that the pharma companies have reported in the December 2012 quarter. On an aggregate basis, the topline for the sector grew by 17 per cent, while the bottomline was up by 31 per cent. Now look at what the sector did after we exclude the results of Dr Reddy’s Laboratories from the aggregate. The topline goes up by 19 per cent while the bottomline rises by a solid 44 per cent. This is by far the best quarterly result reported by the sector in this fiscal. Why have we excluded DRL? That’s because they include certain aberrations. The end of exclusivity of a product, which was a part of its sales in the corresponding quarter, led to a high base effect and in turn lower growth for the company in the December 2012 quarter. 

The performance of the sector is reflecting in its stock prices too. The BSE Healthcare Index gained almost 8 per cent during the quarter against a 3.5 per cent rise in the Sensex over the same period.

During the quarter, exports of the top Indian pharma companies grew by 25 per cent. The rupee depreciation also helped companies to put up strong export numbers. A large chunk of the total exports went to the US market (about 50 per cent). Indian exports to the US markets have grown by 27 per cent during the quarter on a YoY basis. The generic boom there is further expected to boost revenues for companies in the next quarter as well. The excellent performance of the pharma companies in the US market, in the absence of any big ticket product launch during the quarter, is a key highlight of the results. 

The pharma markets in the European countries have reported a mixed performance during the quarter. Overall, the outlook remains weak as the countries in the region are still witnessinga slowdown. Government spending on healthcare would therefore remain under pressure. In Brazil, sales remained muted due to the slow growth of their market. 

During the quarter, companies like Sun Pharma, Lupin, Glenmark and Wockhardt have continued to impress the markets with their performance. DRL and Cadila, on the other hand, put up a rather subdued performance. Jubilant and Aurobindo Pharma have come back to reporting profits after being in the red during the corresponding quarter. 

The sector has seen a fair share of mergers and acquisitions during the quarter. Sun pharma acquired URL and Dusa Pharma, while DRL went ahead with acquiring the US-based Octoplus. Cipla on the other hand postponed its proposed acquisition of Medpro in South Africa due to the high valuations. New filings have continued to grow, reflecting on the capability of the Indian pharma companies. The various international agreements that Indian companies, including Biocon and Glenmark, have entered into indicate that the Indian pharma sector has the potential to develop innovative drugs which will create the next wave of growth for these companies.

Going ahead, we expect the growth momentum to continue in the next quarter too. The USD still remains high vis-a-vis the Indian Rupee and this will benefit the sector. However, some margin pressure is expected in the US markets as companies are now required to pay higher generic user fees to the US FDA. It will be interesting to see how the domestic market performs in the March 2013 quarter.
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STEEL

This metal finds an application in almost every aspect of life from a pin to an airplane. Though it may be in varying degrees, it does bring about the importance of the sector as a whole. There is no economic activity, particularly on the manufacturing side, which does not have steel as a component. It is thus considered to be among the core sectors of the economy. The performance of the sector broadly tells you where the economy as a whole is headed. So here is what it did in the December 2012 quarter.

The sector continued with its lacklustre performance this quarter too. The impact is more visible in its bottomline than anywhere else. The decline is both on a sequential and on a yearly basis. For the 62 companies that we have analysed, the aggregate net profit was down 63 per cent on a yearly basis and 87 per cent sequentially. Almost all major steel companies either saw their profits decline or losses widen. Look at Tata Steel; it posted a total loss of INR 763 crore for Q3FY13, which is its highest quarterly loss reported in the last three years. SAIL also witnessed a decline of almost a quarter in its profits on a yearly basis. 

The reason for these huge losses is the muted growth in the topline and an increase in the interest costs. The aggregate net sales have increased by a mere one per cent on a yearly basis. This was further exacerbated by the lower realisation per unit recorded by these steel companies. The average steel prices (for HRC) for the quarter ended December 2012 were down by a little more than 10 per cent on a yearly basis and five per cent on a QoQ basis. A lower demand and higher imports kept steel prices under check. Steel imports, for the first nine months of FY13, increased by 16.2 per cent to 5.79 million tons on a yearly basis. Against this, exports were just around 3.78 million tons during the same period.

Nevertheless, there was some relief for the steel companies on the raw material cost front. The average cost of raw materials declined by 12 per cent on a yearly basis and by eight per cent on a QoQ basis. Raw material as percentage of sales declined from 51 per cent of sales in Q3FY12 to 45 per cent of sales in Q3FY13. Iron ore and coking coal-two important raw materials for the industry-have seen their prices decline on a yearly basis. Iron ore prices that were trading at an average of around USD 140/metric tonne (MT) for the quarter ending December 2011 were down to USD 120/MT for Q3FY13. The prices of hard coking coke too have softened to USD 170/MT for Q3FY13 compared to USD 280/MT in the corresponding period last year. 

Lower raw material costs helped companies to post a marginal growth in profit at the operating level. For instance, JSW Steel saw its operating profit rise by five per cent for the December 2012 quarter. Tata Steel on the other hand saw its operating profit rise by a third during the same period. However, it was the increase in interest expenditure by almost a third on a yearly basis that washed away all the gains which came in due to lower raw material costs resulting in companies reporting a decline in profits. 

With the reform process initiated by the government and the global economy showing signs of revival, there will be an increase in demand. This will lead to a rise in steel during the last quarter of the current fiscal. We have already seen some companies hike steel prices by three to four per cent in the month of January 2013. Even on the interest rate front, the reduction in key policy rates will help steel companies lift their margins at net levels. You could expect a good performance from this sector in the March 2013 quarter.

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