Recharging The Economy

At a time when all the macro economic factors are favouring the economy, the economy is expected to show good growth momentum. However, this is not the case with India. The reasons may be numerous, including political or global factors. What is happening is that the favourable macro economic factors are not getting translated into corporate earnings. Hence, meaningful recovery in Indian corporate earning seems to still be a couple of quarters away. The previous quarter Q1 corporate earning numbers were disappointing for the markets. Since the equity market was also losing its appreciation over the rise of a majority-led government at the centre, Q2 corporate earnings too came up with no surprises.

However, this could be the bottom for the Indian corporate earnings as the sales’ revenue for the top 1,500 companies, including financial companies, by market capitalization showed considerable growth of more than 18 per cent in Q2 FY16 on a yearly basis as against the same period last year. The majority government started increasing its public spending to revive the Indian economy after it came to power 18 months back and the increasing public spending has started showing its effect on the economy. This quarter has displayed really good pick-up in the corporate topline. The half-year revenue growth stood at negative 1.66 per cent in the first half of FY16 as against the same period last year.

The topline of the top 1,500 companies, excluding financial companies, showed a negative growth of 4.36 per cent on a yearly basis. Though there was strong revenue growth across automobile and power sectors, the overall revenue growth was dragged by disappointment from the pharmaceuticals and steel sectors. Revenue growth across information technology, infrastructure and cement sectors remained marginal. On a half yearly basis too, the industry showed disappointment with negative growth of 4.61 per cent in overall revenue on a yearly basis. The Indian economy is severely struggling to register good revenue growth in spite of favourable macro economic factors.

Interestingly, the operating profit has shown considerable improvement for the 1,500 companies, except financial companies. The operating profit was merely 0.73 per cent down as against the same period last year. The low commodity prices helped Indian companies to increase their margins and post good operating results. On a half-yearly basis too, the operating profit of selected companies showed a growth of 3.56 per cent. However, the interest cost for these companies seems to be increasing by 6.11 per cent on a yearly basis. The increasing interest charges dragged the overall net profit by 2.51 per cent during Q2 FY16 on a yearly basis. The half-yearly net profit too showed marginal growth of 1.49 per cent in the first half of FY16.

Going forward, there was no traction in the earnings over the last couple of quarters. However, corporate earnings are expected to take a ‘U’ turn very soon as the newly elected government last year has started taking steps to improve the economy by increasing public spending, which is likely to show its benefit from the coming quarters. Further, the lower commodity prices will definitely lower the raw material and fuel and energy costs for the Indian corporates, thus improving their profitability in the days ahead.
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Automobiles

Picking Up Speed

The Indian automotive industry is one of the largest in the world with an annual production of 23.37 million vehicles, as recorded in FY 2014-15, following a growth of 8.68 per cent over last year. The automobile industry accounts for 7.1 per cent of the country’s gross domestic product (GDP) and employs about 19 million people, both directly and indirectly. It is split into four segments which include two-wheelers, passenger vehicles, commercial vehicles and three-wheelers. India is the world’s second-largest two-wheeler manufacturer and the fourth-largest producer of commercial vehicles.

The rise of the automotive industry is the result of various factors such as growing economy, increasing disposable income of consumers, rising prosperity, easily accessible finance options, and an increase in the working population of the country. India is also a prominent automobile exporter and has strong export growth expectations for the near future. In addition, several initiatives by the Government of India and major automobile players in the Indian market are expected to make India a leader in the two-wheeler and four-wheeler market in the world by 2020.

A total of 19 companies in the industry were analysed, revealing that the net sales of the industry increased by 11 per cent on a yearly basis. The operating profit increased by 40.40 per cent as compared to the same period last year. The PBIT for the industry increased by 53.13 per cent and depreciation increased by 9 per cent in Q2 FY16 as compared to the same period last quarter. There is a decrease in interest expense of around 6.78 per cent in the industry, except for Tata Motors, which is the highest borrower in industry. The company’s interest burden increased by 5.57 per cent. The net profit, after considering extraordinary items, increased substantially by 149.5 per cent this quarter on a yearly basis.

Among these 19 companies, leading automobile maker Maruti Suzuki’s sales contributed around 23.80 per cent of the total automotive industry during the second quarter. The net sales of the company grew by 13.16 per cent in Q2 FY16 as compared to the same period last year. The positive results of the automotive industry are mainly driven by Maruti Suzuki, which showed an increase in profit of 42 per cent this quarter as compared to the same period last year. Secondly, Tata Motors, which makes for 18.23 per cent of the automotive industry’s net sales, grew by 20.14 per cent in Q2 FY16 compared to the same period last year. On the sales’ growth front, Ashok Leyland showed a robust growth of 54.9 per cent in net sales in Q2 FY16 as compared to the same period last year. However, its net sales amounted to just 8.5 per cent of the industry.

The overall two-fold increase in profit across the automotive industry was predominantly driven by lower raw material cost and cost reduction measures. Higher volumes, material cost reduction initiatives and favourable foreign exchange contributed significantly to bottomline growth of the industry during the quarter. The ongoing festival season as well as new launches will further help volume growth. In addition, to boost the automotive sector, the Government of India has allowed 100 per cent FDI under the automatic route, offering rebates on R&D expenses. Considering the current business environment for the automotive industry, we expect the next quarter too will exhibit an impressive financial performance.
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The wait for the bottoming out of the performance of the banking industry seems to get longer. The recently concluded quarterly result shows that there is no respite for banks even in the coming couple of quarters. The profit after tax for 39 banks that we analyzed has declined by 1 per cent on a yearly basis and 8 per cent on a sequential basis. This is after 18 per cent increase witnessed in the ‘other’ income of banks on a yearly basis, which now forms 11.4 per cent of the total income of banks, up from 10.5 per cent that we saw a year ago in the same period.

Out of 39 banks, 10 banks saw their profit decline on a yearly basis, the worst affected being Bank of India, which posted loss of Rs 1,126 crore in Q2 FY16 as against profit of Rs 786 crore in the same quarter last year. State-owned Bank of Baroda too saw its profit declining by 90 per cent on a yearly basis. The reason for such a worsening performance is two-fold: First, the income growth of the banks has been declining and second, the degenerating asset quality is forcing banks to keep aside a large amount in provisions and contingencies.

The net interest income (NII), which is interest earned less interest expended, has grown by a mere 9.9 per cent on a yearly basis and 3.3 per cent on a quarterly basis. There are 18 banks whose NII growth remained below 10 per cent while four banks posted NII de-growth. This has largely followed slower credit growth, which remained in higher single digits. The rising level of non-performing assets and the tendency of banks, especially public sector banks, to conserve their capital are factors that have led to muted credit growth.

The provisions that banks make for non-performing assets has grown by 22 per cent on a yearly basis while on a sequential basis too it has increased by 13 per cent. The gross non-performing assets (NPA) and net NPA in absolute terms continue to show a rising trend in the quarter. The gross NPA and net NPA has increased by 6 per cent and 5 per cent respectively on a sequential basis. Even as proportion of assets, they have increased on a sequential basis. The net NPA as a percentage of net advances has increased by six basis points while gross NPA as proportion to advances has increased by 15 basis points in the same period.

Going ahead, we do not see stabilization in the asset quality of the banks at an aggregate level, which will continue to deteriorate further before improving. The latest data from the corporate debt restructuring (CDR) cell shows a continuous trend of restructuring cases slipping into NPAs, with 11 CDR cases slipping into NPAs during 2Q FY16 as against only a single case exiting successfully. The total restructured assets of Indian banks are around 6.5 per cent of their loan book whereas the banks have provisioned only to the extent of 5 per cent. Hence, the continuous pace of failed restructuring cases will keep the overall provisioning cost high for Indian banks even if fresh accretion of bad loans comes down in time to come.

Going forward, we may see the performance of the banks weakening on an aggregate basis. However, private sector banks (PSBs) will perform better than their public counterparts as visible in the latest quarterly results, wherein they have outperformed PSBs in almost every key performance parameter.
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Weak prices and depressed demand led to another subdued quarter ended September 2015 for cement companies. On an aggregate basis, the 23 companies in the sector we have analyzed have posted topline and EBITDA growth of around 2.6 per cent and 3.2 per cent respectively on a YoY basis. Revenue growth was driven by volume growth since prices remained flat. Large companies recorded growth of around 6.1 per cent with increase in sales’ volumes on a YoY basis. Improvement in EBITDA margins was clipped by provisions made by companies on account of the District Mineral Fund and National Mineral Exploration Trust.

The government’s latest core sector data shows that cement output grew by a sluggish 5.4 per cent and 1.5 per cent in the months of August and September whereas in the month of July the output grew by 1.3 per cent. During April-September, cement grew just 1.3 per cent, which is a tenth of 9.7 per cent growth seen in the first half of FY15. The sector expanded by 5.6 per cent during FY15.

Despite an improvement in overall demand, prices remained weak across the rest of the regions due to intense competition. The all-India average cement prices decreased around 3 per cent sequentially in Q1 of FY16, led by the western region’s price dip of around 8 per cent, followed by the northern belt’s price decrease of around 3 per cent and the central region’s price decrease of around 2 per cent. However, prices remained flattish in the eastern sector on a sequential basis. In the south, prices increased by about 2 per cent.

Strong pricing discipline continued to benefit South-based companies where prices are up by 8-10 per cent YoY despite a 2-3 per cent QoQ decline. Sequential improvement in prices was seen in the north by 3-6 per cent QoQ though prices in that region were also down by 4-8 per cent YoY, compared to the same period last year. The eastern markets were stable on a QoQ basis. With a bulk of the price increase taking place in September, cement players, especially those focused on the north and west, could have better prospects in Q3 FY16 if the pricing sustains and benefits from a low volume base kick in.

Frontline stocks like Ambuja Cement reported de-growth in realisation at around 7.2 per cent due to pricing pressure in the northern and western regions, which contribute up to 70 per cent of the total revenue of the company. ACC’s realisation per ton marginally declined by 1.9 per cent and UltraTech’s realisation per ton increased by 0.5 per cent due to both the companies being well-diversified geographically on a pan-India level. The realisations of India Cement and Ramco Cement increased by 5.3 and 7.4 per cent per ton respectively due to higher exposure in the southern region. On the volume front, Shree Cement and JK Lakshmi Cement reported growth of 8 and 19.8 YoY respectively, led by capacity expansion.

Smaller companies such as NCL Industries, Deccan Cements, Saurashtra Cement and Anjani Portland Cement have reported robust results while mid-sized cement manufacturers such as Ramco Cements and India Cements showed improvement in their earnings in the September 2015 quarter. These cement companies reported a drop in the raw materials-sales ratio, which spurred growth in their operating profits. We believe such mid and small-sized companies are benefiting from expanded capacity base, and still trading cheap compared to pan-India players.

We continue to expect better demand in the second half of FY16, led by the infrastructure sector’s off-take, which will lend support to realisations. With a bulk of the price increase occurring in September, Q3 FY16 is likely to be better across the board, more so for the northern and western region players. Going forward, south-based cement companies’ momentum will depend on development works in Telangana state.
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Companies engaged in the FMCG sector continue to experience pain. They have posted a muted performance with lower side single-digit revenue growth in the September quarter as Nestle India and ITC struggled on the revenue front and put a drag on overall sales’ growth of the industry. Sluggish consumer spending continued to put pressure on topline growth while a weakening trend dominated in rural regions due to below normal monsoon, poor income growth and delayed festive season. Amid high competition, topline growth was largely led by volumes as price deflation punctured value growth. On an aggregate basis, the 31 companies (20 staples + 11 discretionary) in the sector that we analysed have posted topline growth of 2.4 per cent and bottomline (excluding exceptional items) growth of 6 per cent on a YoY basis.

If we look at the volume side, Britannia reported volume growth of 11 per cent by pillar brands, go-to-market initiatives, and new launches whereas Godrej Consumer’s domestic business volume growth of 9 per cent YoY was led by hair colour and household insecticide, even as price deflation marred its soap revenues. HUL reported steady volume growth at 7 per cent YoY led by soaps and personal products. Other than Nestle and ITC, weak volume growth was reported by GSK, Colgate, Jubilant Foodworks, Dabur and Marico at 1.5, 3, 3.2, 5 and 5.5 per cent respectively.

If we look at the smaller companies, Jyothy Labs’ consolidated revenues grew 9 per cent in Q2 FY16 entirely on the back of volume growth as there was hardly any realisation growth. Bajaj Corp’s overall volume grew 8.3 per cent YoY aided by robust spurt in Brahmi Amla Hair Oil by 64 per cent; however, Almond Drop Hair Oil’s volume growth slowed to 6.3 per cent YoY (3.9 per cent YoY in Q2 FY15, 10.6 per cent YoY in Q1 FY16).

In the case of consumer discretionary products, paint companies, especially, reported lower revenue growth due to price cuts implemented to pass on the benefit of decline in the prices of raw material declines. Pidilite posted muted sales growth of around 5 per cent YoY led by flattish volume growth of around 1 per cent YoY in Q2 FY16. The FMCG sector posted an improvement of 103 bps in EBITDA margins to 20.93 per cent on the back of benign commodity prices, which, in turn, aided FMCG companies in increasing their advertisement cost as percentage of sales by around 300 bps.

This trend is likely to continue on account of the soft RM prices. Going forward, we believe the rural demand for FMCG products is expected to remain soft since rainfall remained below normal during the key monsoon period. Hence, FMCG companies are now banking on urban demand, which is expected to improve in the coming quarters.
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Infrastructure

Good Road Ahead

Infrastructure companies in India have posted better results in the September 2015 quarter. The sector witnessed increased government spending, particularly on roads, even though execution levels are likely to improve meaningfully only in H2 FY16 as these projects are still in the early stages. A total of 70 infrastructure companies were analysed by our team, revealing that the net sales of the industry increased by 4.94 per cent in Q2 FY16 on a yearly basis. The industry major, L&T, posted revenue of Rs 23,393 crore with growth of 10.56 per cent in Q2,FY16 as compared to the same period during the previous financial year. The government is keen on rolling out the hitherto delayed projects in the infrastructure sector worth Rs 4 lakh crore.

The infrastructure industry could play a pivotal role in strengthening India’s economic growth. L&T’s order book stood at Rs 54,996 crore in H1 FY16 on a cumulative basis. The total cosolidated order book of the company stood at Rs 2.44 lakh crore as of Q2 FY16, which witnessed a growth of 14 per cent on a yearly basis. The operating profit of the infrastrucutre industry also increased by 7.97 per cent on a yearly basis in Q2 FY16. L&T’s operating profit increased by 10.28 per cent to Rs 2,811 crore in Q2 FY16 on a yearly basis. The sector’s ‘other’ income increased by 18.62 per cent in Q2 FY16 as compared to the same period in the previous fiscal.

The interest expense of the industry increased by 2.8 per cent on a yearly basis in Q2 FY16. Further, the depreciation expense of the sector also increased by 6.15 per cent on a yearly basis in the September 2015 quarter. The infrastructure industry reported net loss in Q2 FY16. However, the loss was very low compared to the net loss posted during the last quarter. The sector’s earning per share (EPS) has been improving since the last three quarters till Q2 FY16.

On a half yearly basis, the infrastructure sector’s net sales increased by 3.55 per cent in H1 FY16 as compared to the same period in the previous financial year. The industry’s operating profit rose by 8.55 per cent in H1 FY16 on a yearly basis. The bottomline of the sector remained under pressure and reported net loss in H1 FY16 as against H1 FY15. The infrastrucure industry’s order inflows are picking up. Roads authority, NHAI (National Highways Authority of India), has been fairly active in its tendering process and has awarded 900 km of BOT (build, operate and transfer) projects and 1,250 km of EPC (engineering, procurement and construction) projects in FY16 to date. There is traction in the industry in the near term as authorities like NHAI, the road ministry and state public works department would try to achieve the government’s target of 9,000 km for the current financial year.

The country’s total infrastructure spending is expected to be about 10 per cent of the gross domestic product (GDP) during the 12th Five Year Plan (2012–17), up from 7.6 per cent during the previous plan (2007–12).There will be significant allocation to the infrastructure sector in the 12th Five Year Plan, and investment requirement of USD 1 trillion is expected to create huge demand for construction equipment in India.

In the road sector, the government’s policy to increase private sector participation has proved to be beneficial for the infrastructure industry with a large number of private players entering the business through the public-private partnership (PPP) model. As of March 2015, projects worth USD 32.69 billion have been awarded through the PPP model and 165 PPP projects are still under progress. In the coming quarters too the sector is expected to show some traction as the government’s higher public spending has started yielding results and is contributing to the economy.
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Information Technology

Keeping Pace Globally

India is the world’s largest sourcing destination, accounting for approximately 52 per cent of the USD 124-130 billion market. The country’s cost-competitiveness in providing IT services, which is approximately 3-4 times’ cheaper than the US, continues to be its unique selling proposition in the global outsourcing market. The IT sector in India grew at a compound annual growth rate (CAGR) of 25 per cent over 2000-2013 and is estimated to expand at a CAGR of 9.5 per cent to USD 300 billion by 2020.

With second quarter earnings’ season coming to an end, the performance in the September quarter (Q2 of financial year 2016) of IT services’ companies would be keenly watched. Especially after the better-than-expected show by global peer companies during the same period. The recent quarter i.e. Q2 FY16 exhibited an average performance. We compared 250 leading IT companies in India, which revealed that the total net sales increased by 4.93 per cent in Q2 FY16 as against Q1 FY16. The overall sector operating profit rose by 11.44 per cent in Q2 FY16 as against Q1 FY16 and the operating profit margin expanded by 139 basis points to 23.78 per cent on a QoQ basis. Depreciation increased by 1.87 per cent on a quarterly basis. Interestingly, the industry’s net profit showed a growth of 21.65 per cent in Q2 FY16 as against Q1 FY16.

The IT industry’s revenue growth was moderate due to subdued business conditions. However, the operating profit and net profit growth surprised the street with its considerable quantum. Further, the industry saw expansion in the operating margins over lower rupee against all major world currencies. The lower rupee will continue to benefit IT service companies in the future also.

The top five IT majors showed 5.83 per cent sequential growth, similar to the industry’s growth in Q2 FY16. However, the operation profit growth stood at 8.59 per cent for these companies in Q2 FY16, lower compared to the industry’s growth. The net profit growth too showed moderate growth of 6.92 per cent, considerably lower than the industry’s growth in Q2 FY16. However, the operating profit margins for these companies stood at 28.32 per cent in Q2 FY16, an expansion of 83 basis points sequentially.

Among the top five companies, Infosys led the pack with 8.92 per cent revenue growth on a sequential basis whereas Wipro registered just 2.25 per cent revenue growth. However, on the net profit growth front, Tech Mahindra scored the highest in the pack with 17.04 per cent net profit growth sequentially. Interestingly, TCS ranked the first on the operating margin front with 31.27 per cent margin and an expansion of 35 basis points. Tech Mahindra remained at the bottom with 19.15 per cent operating profit margin with 212 basis points’ margin expansion.

The IT service industry has changed considerably over the period to become more dynamic and demanding. Value-added services and end-to-end solutions are becoming the key factors for this industry. Further, new technologies are gaining in popularity, shifting the focus of the IT software industry to a new paradigm. The mid-sized companies, along with the leaders in the sector, have been finding it difficult to grow their businesses with a globally subdued business environment adding to the pain. Hence, we opt for a neutral stance, though foreseeing stable business growth. However, over the next couple of weeks, there could be good profit margins due to the lower rupee value.
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Subdued crude prices have placed the petroleum and gas sector in a uniquely positive situation and by all accounts this scenario will continue for some more time

Given the fact that on the international platform crude continues to touch new lows on a daily basis, the petroleum and gas sector is in quite a unique position. For oil marketing companies (OMCs) the situation seems to be getting better by the day since their subsidy outgo has decreased. At the same time, oil explorers like ONGC and Oil India’s numbers have gone haywire due to decline in net realisation coupled with decreasing output. During the second quarter, OMCs have improved upon their profitability or arrested their loss as compared to the same period last year.

Owing to improved gross refining margin (GRM) during the first half of the year, their profitability has gained in strength. Interestingly, Indian Oil has limited its net loss to Rs 329 crore during Q2 as against Rs 898 crore posted during the same period last year. The biggest explorer of the country, ONGC, has displayed dwindling numbers during the second quarter due to stagnant production and decrease in net realisation on account of softening in crude prices. ONGC hasn’t performed on expected lines due to declining production from ageing fields. During the second quarter, ONGC has given subsidy discount of Rs 598 crore as against Rs 1,133 shared during the preceding quarter.

On the heels of subdued revenue and lower realisation, ONGC’s net profit tumbled by around 11 per cent to Rs 4,842 crore in Q2 as against Rs 5,445 crore during the same period last year. The company’s topline also increased marginally by around 0.03 per cent to reach Rs 21,817 crore as against Rs 21,808 crore earned during Q2 FY15. On the other hand, the biggest retailer of the country, Indian Oil, has posted decline in its topline by 23 per cent due to drop in crude prices to reach Rs 85,961 crore as against Rs 1,12,121 crore earned during the same period last year. At the same time, though its GRM has turned positive at USD 0.9/bbl, it was not able to pull the company out of the red during the second quarter. It has posted a net loss of Rs 329 crore during the period. Interestingly, the first quarter GRM was at a whopping USD 10.77/bbl.

BPCL also has put up a decent show as its profitability has spurted by a big margin. In fact, BPCL has posted net profit of Rs 1,018 crore as against Rs 464 crore earned during the same period last year, showing a growth of 119 per cent. Its GRM has also climbed to USD 3.8/bbl. On the other hand, HPCL’s GRM too reached USD 5.45/bbl as against USD 2.09/bbl but it has suffered a net loss of Rs 320 crore owing to inventory loss on account of lower crude prices as against Rs 850 crore profit earned during the same period last year. The company’s topline also declined by 22 per cent to touch Rs 42,367 crore during the second quarter.

Petroleum major Reliance Industries has continued it fabulous run in the petroleum sector during the second quarter as its standalone profit rose by 14 per cent to touch Rs 6,561 crore as against Rs 5,742 crore earned during the same period last year. Its GRM improved to USD 10.6/bbl as against USD 8.3/bbl earned during last year. On the topline front, the company’s total income declined by 36 per cent to Rs 62,434 crore on a standalone basis as against Rs 98,626 crore owing to decline in crude prices. In addition to GRM, the company’s petrochemicals business also remained robust. Considering the present state of the oil and gas sector, it seems that the trend of declining crude prices would continue for some more quarters. That will certainly help the Indian oil and gas sector and the overall economy.
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Power

The demand for power continues to be to one of the biggest concerns for the sector as there has been sustained decline in the PLFs. This dropped from 62 per cent to 60 per cent in September 2015 as against September 2014, while power generation grew around 7 per cent YoY on account of new capacity addition. During the quarter, the EBITDA level also grew by 17.8 per cent with EBITDA margins expanding by 359 bps point to 39.6 per cent on a YoY basis on account of fall in coal prices by around 5 per cent YoY in Q2. On the other hand, significant improvement in profitability on a low base was seen despite higher interest and depreciation costs. Coal prices have continued their downward trend post Q2 FY16, which will lead to further gains for power companies in Q3 FY16.

For regulated players like NTPC, NHPC, CESC and SJVN, Q2 FY16 was a robust quarter as most of them beat market expectations. Power Grid reported strong numbers both across the topline and PAT level during the quarter. Similarly, the performance of independent power producers comprising Tata Power and JSW Energy improved largely due to increased coal supply and, in particular, fall in prices of imported coal. The robust performance of power companies was also due to a slew of reforms launched by the government. The coal auctions were completed successfully while there was increase in coal production, which led to a rise in coal supply to utilities.

Also, capacity addition in power generation and transmission saw the highest increase ever. In a bid to rescue almost bankrupt state electricity retailers (discoms), the government has approved a scheme called UDAY (Ujwal Discom Assurance Yojna). This would lead to increased power offtake by discoms and, thus, better PLF for generating companies like CESC, JSW Energy and Tata Power, going ahead. Furthermore, a rise in power demand would lead to higher power transmission and trading, which would benefit companies like PTC India and Power Grid Corporation.
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Pharmaceutical companies posted single-digit revenue growth in the September quarter mainly due to slow domestic growth, regulatory issues, lack of key approvals in the US and adverse cross-currency movement. However, investment in R&D, lower interest rates and new product launches may help to manage overall growth. On an aggregate basis, the 66 companies (60 Indian + 6 MNCs) in the sector that we analysed have posted topline growth of 7 per cent while bottomline growth (excluding exceptional items) was around 6.3 per cent on a YoY basis. During the quarter, the EBITDA level also grew by 10.6 per cent with EBITDA margins expanding by 75 bps points to 23.1 per cent on a YoY basis.

During Q2 FY16, Indian pharmaceutical companies grew by around 6.6 per cent in the domestic formulation market. Among large-cap companies, Glenmark Pharma grew at 27.2 per cent whereas Dr Reddy’s Lab grew at 13.9 per cent. In the mid-cap segment, Ajanta Pharma grew at 14.9 per cent. Lupin, Cadila Healthcare, J B Chemicals and Unichem Labs grew by 9.4, 10.4, 11.1 and 13.1 per cent respectively. On the export formulation business front, Indian companies posted growth of 8.2 per cent. However, the US’ sales did not witness growth as compared to the earlier quarter due to the higher base effect increase in competition of existing products and slowdown in product approvals from the USFDA.

Surprisingly, Cipla and Torrent Pharmaceuticals reported growth of 50.8 and 99 per cent respectively in the export formulation business due to Cipla’s export sales driven by gNexium supply to Teva under exclusivity and Torrent Pharma launches like gAbilify and gCymbalta exclusivity in the US market. Ipca Laboratories’ export formulation business declined by 25.8 per cent on account of USFDA’s import alert and lower institutional business whereas Sun Pharma’s export formulation business declined by 20.3 per cent due to competitive pressure in existing products and temporary supply constraints from its Halol facility. In the mid-size segment, Alembic Pharma reported 352.8 per cent growth in its export generic formulation business, mainly on account of windfall gains from gAbilify exclusivity launch in the US.

On the margin front, the EBITDA margin of Torrent Pharma jumped by 1,980 bps to 42.2 per cent, driven by higher than expected contribution from generic Abilify. Cipla’s operating margin improved by 700 bps to 27 per cent YoY on account of higher contribution from Nexium (high margin due to profit-sharing). Dr Reddy’s Lab’s EBITDA margins increased 283 bps YoY to 26.6 per cent, mainly on account of higher share of revenue from its generic business and operational efficiency. On the negative side, Lupin’s margin declined by 744 bps to 25.9 per cent mainly due to higher employee cost and other expenditure. Jubilant Life Sciences’s EBITDA margin grew by 1,382 bps to 21.9 per cent, which was similar to Q1 FY16 as the company has been benefitting from volume and price rise in pharmaceutical and nutritional products in H1 FY16.

Now, Indian pharmaceutical companies are planning big on over-the-counter (OTC) drugs with new products and marketing campaigns. The size of the OTC market is pegged at Rs 13,000 crore and is registering double-digit growth. We expect similar growth in the domestic market in H2 FY16, which is witnessing robust volume growth. Further, dollar depreciation will also help on the export formulation front.
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Steel

Losing its Strength

The slump in the commodity cycle is taking its toll and steel remains one of the worst-hit sectors. Despite growth in steel consumption in India, although marginally by 3.1 per cent on a yearly basis, steel companies remained under pressure due to cheap imports. Chinese steel exports continue to increase even at prices below marginal cost as the domestic demand there has fallen faster than production cuts, thus resulting in a global supply glut. Total steel imports, including from other countries, saw an increase of 42 per cent in the first half of FY16. Moreover, exports too have suffered due to oversupply of steel in the global market, which declined by 26 per cent in the same period.

Against this tough backdrop, the topline of the 103 steel companies that we analysed has revealed a decline in revenue by 16 per cent on a yearly basis and 4 per cent on a quarterly basis. The fall in revenue was due to a fall in net realisation as well as volume. The net realisation on an average has declined by almost 15 per cent on a yearly basis. For example, SAIL saw its realisations at Rs 34,285 per ton, down by 14 per cent YoY. Similarly, Tata Steel’s average realisation decreased by Rs 1,600 per ton. The volumes too saw a fall, except in the case of a few companies like JSW Steel that witnessed higher volumes, which led to a fall in the overall revenue of companies.

The bottomline of the steel companies too posted a major fall and on an aggregate basis they posted loss of Rs 1,180 crore as against profit of Rs 3,759 crore in the same quarter last year. Two major companies, SAIL and Jindal Steel & Power, contributed to a large extent to this fall as they slipped into losses in Q2 FY16 against profit in Q2 FY15. SAIL posted loss of Rs 1,055 crore in the quarter ending September as against profit of Rs 649 crore in the quarter ended September 2014.

Besides lower revenue growth, relative increase in total expenditure has also led to such poor show by companies. The total expenditure, though having declined by 10 per cent on a yearly basis, was less than the overall decline in revenue, and hence total expenditure as percentage of revenue increased from 85.4 per cent of revenue in Q2 FY15 to 91.38 per cent in Q2 FY16. Iron ore and coking coal - two important raw materials for steel production - too saw a fall in their prices. In the last one year, international iron ore prices have corrected sharply by around 40 per cent. NMDC Ltd. (NMDC) continued to cut domestic iron ore prices in Q2 FY16 as well and since November 2014, it has cut the price of fines by 54 per cent and lumps by 43 per cent. Coking coal prices too have declined but yet are to bottom out. In the last one quarter they have declined by 5 per cent.

Going ahead, we believe that the weak raw material prices would continue to provide some relief to steel companies. Meanwhile, in September 2015, the government imposed an additional 20 per cent safeguard duty on certain category of hot-rolled flat products for a period of 200 days. This may reduce imports, since the share of the items covered under the safeguard duty in India’s steel imports was close to 50 per cent in the first quarter of FY16. Nevertheless, steel inventory of around 6.5 million tons accumulated by domestic players at the end of 1H FY16 could be an overhang on the realisation front, though volumes may increase due to higher government spending. Overall, the performance of the steel companies is closely tied with the international market and we do not see it improving in the near future