DSIJ Mindshare

Q1FY12 - Accelerating sales but slowing profits

From the US downgrade, to the renewed concerns of a double-dip recession and the Euro-zone worries still rearing their heads, global markets have been in a tizzy throughout August. Add to this the Anna Hazare-led civil uprising on the domestic front, and the picture turns out to be positively turbulent, with uncertainty throughout. With so many events to munch on, the June quarter results season actually looks like it has been largely ignored by investors. All said and done, with some normalcy seen in the markets post the mayhem, investors would now be picking up the bits and pieces to figure out where they stand, and here is where the quarterly results will play a significant role. Now that the results season has ended, it’s time to get back to the drawing board to get a clear picture of how India Inc. has performed and what to expect going forward.

Of the total results of 3619 companies that we have analysed so far, India Inc. yet again gave a pleasant surprise, with a better than expected topline growth of over 26 per cent on a YoY basis. This comes as a surprise, considering that the growth has actually come on a higher base of June 2010, when sales grew by 20 per cent. However, before we can savour this moment with a relieved smile, a quick look at the bottomline numbers takes the wind out of our sails. With a bottomline growth of a mere five per cent during the same period, this is certainly not the start that India Inc. would have asked for in FY12. This gives a rather mixed feeling of joy and sorrow at the same time, and the focus suddenly shifts to gauging what went wrong. While there was an anticipation of a slower June quarter on the bottomline front, the profit growth was worse than expected. However, the eternal optimists that we are, we went ahead and cleared out the usual aberrations of PSU oil marketing companies and extraordinary items. However, even adjusting for these, the picture doesn’t change much. While topline growth stands at over 23 per cent, the bottomline improves a percentage point further to almost six per cent. While many might conclude that these results are in line with street expectations, we feel otherwise, and the June quarter results indeed look to be extreme, both in terms of sales and profits.

While there is no doubt that the results are indeed disappointing on the bottomline front, we remain pleased with the topline growth. Now, this indicates a few things worth noting. First and foremost, the strong sales numbers for the June 2011 quarter, which are already on a higher base, ratify that this is a strong consumption led growth, and the overall demand situation seems to remain robust as of now. Evidently, producers still have the pricing power, and they have managed to pass on some costs to the end customers, and have taken the balance hit onto themselves to avoid dampening the demand.

However, what continues to be a wet blanket are rising input costs. It may be noted that raw material costs have shot up by 28.40 per cent, while power and fuel costs are up by 20 per cent. To make matters worse, the interest cost (ex-bank and financial institutions) has also gone up by 20 per cent to Rs 3239 crore, while depreciation and tax outgo are up by 12 per cent and 14 per cent, respectively. These factors have combined to increase India Inc.’s uneasiness further, thus impacting bottomline growth.

What is even worse than a slower bottomline growth is that India Inc. is losing steam, and that too on both, the topline as well as the bottomline. In Q1 FY12, for every two companies whose sales have gone up, one company’s sales have declined. In fact, this ratio has actually worsened over the same quarter last year, when it was at 3:1. Similarly, on the profit front too, for every one company whose profit has gone up in Q1 FY12, one company has declined. This ratio too has worsened from 1.6:1 during the same quarter last year. In Q1 FY11, about 36 per cent of companies’ profits had declined; this rate has increased to 44 per cent in Q1 FY12. The number of companies posting losses has increased by 16 per cent in Q1 FY12 to touch 925, from 794 in Q1 FY11. This certainly doesn’t paint a pretty picture.[PAGE BREAK]
The immediate future doesn’t look very charming. The coming quarters could be a tough time for India Inc., as we don’t expect input side pressures to relent so easily, and the lag effect of the interest hike is expected to make its presence felt further. In view of the rising cost of funds, India Inc. may delay investments, which could hurt growth further in the coming quarters.

While the RBI is adamant on its stand of arresting inflation, the existing rate hikes have already dampened sentiments and could dent economic growth further, which is already seen at eight per cent for FY12. To make things worse, the overall reforms process is at a standstill, with the government hardly seen taking any strong initiatives to drive growth. The only silver lining to the India Inc. story at the moment is the existence of a strong demand. However, with inflation not in a hurry to soften, it’s about time for the demand to taper off. Unless and until the RBI rolls back the rate hikes, life is certainly going to be tough, and we may see a further downgrade of the consensus FY12 EPS estimate of Rs 1250. Thus, one needs to be cautious and selective while picking stocks, as ‘low’ need not necessarily mean ‘good’ in this market. 

Automobiles
If the performance of the automobile sector in Q1 FY12 is anything to go by, it seems to be losing steam. In our analysis of Q4 FY11, we had categorically stated that, “In Q1 FY12, rising inflation and increasing competition is expected to put pressure on the margin front. The rising interest cost and increasing fuel cost is expected to impact the volumes”. We have been proved right, with a majority of the automobile companies showing only a marginal growth in volumes as well as on the realisation front. Margins too have been impacted for the quarter, on account of rising raw material prices and staff cost. As a result, while the sector as a whole has posted a topline growth of 16.83 per cent on a YoY basis, the bottomline growth has been only 11.96 per cent. The performance on a QoQ basis is even poorer, with the topline showing a decline of 10.20 per cent and the bottomline witnessing a decline of 11 per cent.

The impact of the above-mentioned factors is clearly seen on the volumes front. In the June quarter, the sales volume of Maruti Suzuki was down by 18 per cent on a QoQ basis and 0.60 per cent on a YoY basis. One noticeable factor, apart from the macro factors, is that micro factors like the strike at its Manesar plant have also impacted volume growth. Similarly, Tata Motors as well as Mahindra & Mahindra also witnessed a pressure on the volumes front. Marginal improvement in realisations helped the automobile companies put in some decent performance. Despite this, however, all the companies witnessed a contraction on the margin front. The story is no different in the two wheeler segment. Both the leading players, Hero Moto Corp (HMCL) and Bajaj Auto, witnessed a decline on the margins front. However, both these companies witnessed good growth on the volume front.

As for the next quarter, we are of the opinion that rising interest costs on account of the RBI’s hawkish stance is likely to impact volume growth further. The monsoon is usually a dull season, and hence volumes are expected to be low in any case. Hence, all in all, the September 2011 quarter is expected to be a muted one. On the realisation front, we expect a decline in the number of discounts being offered. Recently, Honda reduced the prices of Jazz by Rs 1.5 lakh. The new launches in the passenger car segment and increased competition will lead to pressure on the margins. The aggressive strategy of HMCL is also expected  to lead to a pricing war. There might be some respite for the players, as metals prices may decline, but this impact will be marginal. Thus, we are expecting another subdued quarter ahead for the automobile sector.[PAGE BREAK]
Banking

With inflation hovering around nine per cent, the RBI hiked the repo rate twice during this quarter (50 bps in May and 25 bps in June), and has revised the GDP growth estimates to eight per cent. This itself suggests that the banking sector did not have a great quarter.
However, thanks to the attractive interest rates that were being offered by banks, total deposits increased by 5.4 per cent during the quarter on a YoY basis. Time deposits grew at seven per cent, while demand deposits declined by six per cent. Credit growth stood at 19.5 per cent, against 22.2 per cent in the June quarter in 2010, on account of slower growth in industrial production, which was 5.7 per cent compared to 10.8 per cent last year.

The RBI also hiked the interest on savings account deposits from the previous 3.5 per cent to 4 per cent. It also raised the provisioning norms from 10 per cent to 15 per cent on sub-standard assets, and those on restructured assets at 2 per cent against the earlier band of 0.25 to 1 per cent. This affected the bottomline of many banks such as Canara Bank (117 per cent increase in provisioning), Bank of India (28 per cent), Union Bank (58 per cent), and so on.

Public sector banks struggled the most this quarter. For the 23 PSU banks which we analysed, the topline was up by 35 per cent but the net profit shrank by three per cent on a YoY basis (excluding SBI). On the other hand, private sector banks posted some healthy numbers, where the topline increased by 39 per cent, while the bottomline growth was 31 per cent on a YoY basis. Induslnd Bank fared the best among them. Its net interest income and other income increased by 51 per cent 34 per cent respectively, while net profit increased by 52 per cent on a YoY basis.

In the case of SBI, the country’s largest public sector bank, the net interest income Increased by 31 per cent, while the non-interest income  declined by 400 bps. The bank witnessed a decline of 45 per cent in its net profit (standalone), on account of a higher provisioning, which increased by 75 per cent on a YoY basis. The cost of deposits was up by 39 bps and its yield on advances increased by 113 bps. However, its NIM increased by 44 bps to 3.62 per cent. ICICI Bank’s net interest income increased by 21 per cent on a YoY basis. Time deposits, which are yielding attractive returns, have affected their demand deposit (CASA), showing a steep decline of 310 bps on a QoQ basis.

Financial inclusion is the top priority while granting new banking licenses. The RBI has already submitted the draft guidelines to the Finance Ministry, and has very conservatively approached the limit of FDI, which would be 49 per cent for the first 10 years and could further be raised to 74 per cent. Many NBFCs may get new licenses, as they have more exposure in rural and semiurban areas where customers can get more benefits.

Corporates and NBFCs are coming into the market with NCDs which have an edge over bank fixed deposits. Slowing credit growth may also bring some hindrances for bankers in the next quarter. Going forward, banks may face margin pressures, deterioration in their asset quality and still no confirmation on the interest rates front, which has peaked. We maintain a neutral call on the sector, and expect moderate performance in the next quarter.[PAGE BREAK]
Cement

For the June quarter, the performance of the cement industry has continued to be lacklustre. The growth in net sales on a yearly basis was not very encouraging. Sales grew by only 13 per cent on a YoY basis, with the aggregate dispatch for the sector declining by 0.6 per cent to reach 42.17 million tonnes. This was mainly because of a slowdown in demand from the infrastructure and real estate sectors. The net profit for the 34 companies that we have analysed grew by 6.5 per cent on a yearly basis, however it has come down by 5.3 per cent from that in the previous quarter.

Only a few companies have reported a jump in net profit, thanks to decent volume growth and better realization figures that they reported. Higher raw material costs as well as power/fuel and freight costs impacted the margins of the others. ACC, for instance, reported a decline of 6.2 per cent in its net profit on a YoY basis, despite decent volume growth at 12.5 per cent YoY to reach 5.93 million tonnes, and better sales realisation. This was primarily on account of higher raw material and power/fuel costs, which were up by 34 per cent and 45 per cent respectively. On the other hand, companies like India Cements, JK Cement, Madras Cements, and Ultra Tech witnessed relatively good performance, either due to an increase in sales volume, or higher realisations and lower cost of production, or a combination of both. India Cements’ sales volumes declined on account of sluggish demand in the southern region, but it was able to negate this by maintaining production discipline and higher price realisation, which was up by 37 per cent YoY.

However, major concerns for the sector going forward are increased freight costs, higher prices of raw materials like fly ash and gypsum, which have not seen a major correction and were up by 12-15 per cent on a YoY basis, as also prices of coal, which were up both in the domestic as well as international markets by 20 per cent.

The September quarter is normally weak for cement companies, as the monsoons slow down activity in the construction and real estate sector. This, along with a slowing economy in general, and higher financing costs, will lead to a further slowdown in demand, indicating a gloomy scenario for the sector in the coming quarter. Cement prices have corrected by Rs 8-15 per 50 kg bag, due to lower demand in most of the markets, barring the southern markets where they have remained firm.

The cement industry is reeling under a supply glut. 20 million tonnes of capacity is expected to be added during this fiscal, which will take the total capacity to 315 million tonnes per year, putting further pressure on the pricing front if demand doesn’t pick up. Further, we believe that firm input costs could impact the overall performance in the coming quarter, which is expected to remain muted.

Fertilisers

The April-June quarter witnessed a key event in the fertilizer sector, when an empowered group of ministers (EGoM) cleared the proposal to free the prices of urea and bring it under the Nutrient Based Subsidy (NBS) policy. It was decided to raise urea prices by 10 per cent in the first year of the policy, after which the industry would be free to determine the prices. This is an extremely positive step by the government. It augurs well for all urea producers, as they have a more transparent mechanism of subsidy determination, along with the power to price their product at the industry level. This results in better control over their profitability. The draft policy is currently awaiting approval from the Cabinet Committee on Economic Affairs (CCEA).[PAGE BREAK]
The April-June quarter also witnessed the proposal to set up a way to transfer cash subsidies directly to the end-consumers of fertilisers. This marks a major step, and if carried out with necessary policy changes along the supply chain management, it will surely help the end consumers of the fertiliser sector.

The fertiliser sector, in the aggregate, witnessed a good 27.47 per cent growth in its topline on a YoY basis. This growth was largely on the back of SPIC reporting a massive 832 per cent rise in sales, as it resumed production of urea in Tamil Nadu, which was shut down over the past 3-4 years as a result of operational inefficiencies The bottomline increased by 15.58 per cent on a YoY basis. 
During the quarter, Coromandel announced the acquisition of Sabero Organics at an investment of Rs 470 crore. This acquisition will complement Coromandel’s presence in the agrochemicals market, and will add to the growth synergies. Coromandel also signed an agreement with the Qatar Fertiliser Company for the supply of urea, which would ensure uninterrupted supply. This will be beneficial once urea is included under the NBS policy.

Zuari Industries plans to set up two soluble specialty fertiliser plants in Rajasthan and Orissa over the next 2-3 years, with installed capacity of 30000 tonnes each, at an estimated cost of Rs 45 crore. Water soluble fertiliser, which is said to be the product of the future, augurs well for cash crops. Through the new plants, Zuari plans to expand its product portfolio. The state-run Rashtriya Chemicals and Fertilisers (RCF) had a disappointing quarter, as its Trombay unit suffered a 63-day shut down due to compressor failure. This resulted in an exceptional loss of Rs 21 crore and de-growth of 80 per cent at the PBIT level for the Trombay unit. A weak US economy, coupled with the Euro zone crisis and the overall slower global growth expectations have led to a considerable cooling off in international commodity and crude prices. If this trend continues, it could ease the pressure on the fertiliser companies on the production costs’ front.

Moreover, with global urea and DAP prices touching new highs, at close to USD 500/tonne and USD 650/ tonne respectively, backed by the proposed urea deregulation policy, the sales realisation of industry players would improve going forward. The rise in urea prices can be primarily attributed to a slowdown in Chinese exports and low inventory in major markets. Overall, based on a satisfactory monsoon this year, a decent performance in April- June quarter, expectations of favourable government policy, a fall in international energy prices and a spike in global fertiliser prices, we expect the next quarter to be positive for the sector.

FMCG

In uncertain times, defensive sectors offer the most comfort to investors. This is best exemplified in the way the FMCG sector has been performing of late. Against a 17 per cent Year-to- Date decline in the Sensex, the BSE FMCG Index has gone up six per cent over the same period. The performance of companies in this sector in the June quarter has been fairly decent. For the 16 companies that we have analysed, growth in the June quarter has been a combination of higher volumes and stronger prices, which saw the topline grow by 19 per cent YoY. The margins at the operational level faced some headwinds due to higher raw material prices, which were up 23 per cent YoY. Lower ad spends helped to some extent. Other components, like crude prices (up 60 per cent), palm oil prices (up 46 per cent), coffee prices (up 38 per cent) and copra prices (at their peak at Rs 70 per kg), have squeezed margins. However, there is some comfort in the fact that these prices are gradually comingdown.[PAGE BREAK]

G
odrej Industries showed a strong performance at the topline level, which grew by 28 per cent on a YoY basis. However, higher raw material prices, which were up 400 bps, have hit margins at the operating level.Its operating margin contracted by one per cent. The sales of Hindustan Unilever (HUL) increased by 14 per cent, and net profit was up 18 per cent on a YoY basis. Eight per cent of the growth was contributed by a rise in volume, while the remaining came in due to product price hikes effected by the company during the quarter. Growth was aided by a cut in advertisement expenditure, which was down by a huge 400 bps.

Marico had an unusually upbeat quarter. Despite having increased its product prices (Parachute by 32 per cent and Saffola by 12 per cent), it witnessed good volume growth (10 per cent for Parachute and 15 per cent for Saffola). Its topline increased by 37 per cent and the bottomline by 21 per cent on a YoY basis. Like HUL, Marico too brought down its advertising expenditure by 210 bps on a YoY basis.
ITC also performed well in the June quarter. Its earnings grew by 21 per cent and EBDITA increased by 17 per cent on a YoY basis. The cigarette segment witnessed a growth of 16 per cent, of which eight per cent was volume-driven. Other segments also witnessed a 20 per cent-plus growth.

Rising input costs continue to be a major concern for the sector. Many companies have passed on the higher input prices to their customers. With a good monsoon and the recent correction in crude oil and other commodity prices, margins for these companies are expected to strengthen going forward. With a strong consumption-led demand, we also expect volume growth to remain intact, which will benefit companies in this sector. We remain positive on the sector, and expect a Q2 on similar lines, where companies will balance their volume and price growth strategy.

Infrastructure and Real Estate

The June quarter of 2011 started on a poor note for infrastructure companies. Many issues like rising interest cost, non-availability of long-term funding, higher working capital requirements, soaring working capital cost, slower capex cycles and rising raw material prices haunted the sector. The impact of these issues is clearly seen in the quarterly financial performance too. The topline growth was just 13.93 per cent, and after adjusting for the extraordinary income, the bottomline witnessed a marginal growth of 1.47 per cent. This has been the slowest bottomline growth on YoY basis in the past six quarters. Factors like aggressive bidding for contracts on account of fierce competition and higher raw material prices impacted margins. Even a market leader like L&T witnessed a contraction in EBITDA margins, at 11.90 per cent in Q1 FY12 from 12.80 per cent in Q1 FY11. In addition, higher interest rates resulted in higher working capital cost for the companies. The interest cost for the quarter has gone up by more than 40 per cent, which is the highest in the past six quarters.[PAGE BREAK]

Order book positions of companies in the infrastructure sector are pretty good, and the order book to sales ratio also looks to be comfortable  However, on the earnings front, the September quarter is not expected to pan out favourably for them. This is primarily because interest rates are not likely to soften at least over the next three to six months, which will add further pressure to the earnings. In its analyst presentation, L&T stated that it is expecting a 50- 60 basis points decline at EBITDA levels from here on. There might be some softening on the commodities price front, but again, the impact will be marginal and could come in only after the next two quarters. The second quarter being seasonally the weakest quarter for infrastructure players, and with macro headwinds still surrounding the sector, the earnings growth for the next couple of quarters is likely to remain muted. 

The realty sector continued to bleed through the June quarter as well, thanks to rising interest rates and higher debt burdens. It continued to face funding constraints due to higher borrowing costs, lack of private equity interest and a slack capital market. On the financial front, fewer new scheme launches, lower volumes, minor price appreciation and sale of plots resulted in a marginal growth of just around 3.18 per cent in the aggregate topline. 

The inability of the sector players to pass on inflationary input costs to their clients resulted in a 14 per cent decline in the bottomline.
We are of the opinion that the problems for the realty sector will be further aggravated in the next quarter. Recent developments, such as the proposed land acquisition bill may have an adverse impact. Inventory liquidation by most of the companies may result in a price decline in the micro markets. We expect that the current scenario will persist in the next quarter, and hence the sector may witness a muted performance for the September 2011 quarter.

IT and ITES

In a topsy-turvy market like this, it doesn’t take much time for perceptions about certain stocks or sectors to undergo a sudden change. It seems that the IT sector is a victim of this phenomenon. IT sector stocks have been serially dumped by investors over renewed macro-economic concerns buzzing through the US and Europe. This begins to seem like a doomsday prophecy for the sector, which has been beaten down by 20 per cent. Is the IT fairytale really over, though?

Well, looking at the June quarterly numbers, it doesn’t seem so. Revenues and profits in the sector grew at over 19 per cent and 14 per cent respectively, on a YoY basis. These numbers are quite reassuring, especially on the topline front, as it indicates continued business  momentum for IT companies. Though some may point at the stunted bottomline growth, one should note that profit growth also bears the impact of the salary hikes of the last fiscal.  All in all, the results look in line with expectations.

What lies ahead are renewed fears of a recession in the US and Europe, growing anti-outsourcing sentiments, social pressure on clients to create jobs in their countries due to rising unemployment, anti-visa policies, the probability of spending curbs by clients leading to pricing pressures or cuts, or even a drop in volumes altogether. While the management-side of IT biggies acknowledges these facts, they remain optimistic about the business pipeline. In fact, companies such as TCS, in line with the Q1 FY12 numbers. Infosys and Wipro continue to add new clients, have won big deals and are also seeing a good pipeline ahead. TCS and Infosys are also managing to stick to their yearly hiring targets of 60000 and 45000, respectively.[PAGE BREAK]

Clients too aren’t altogether shaken up yet, and are expected to continue with their existing IT budgets. The impact would be minimal in the short term, as IT majors usually work on multi-year projects. The only impact we see is that clients may come to renegotiate on pricing, though not on volumes, as it makes sense for them to outsource in order to control costs and increase efficiency. Besides, Indian IT, with its experience of the 2008 recession, looks well-prepared to tackle any similar situation that may arise again. The increasingly stringent visa policies is definitely a concern though, as rejection rates for Indian IT companies have increased to around 40 per cent from just five per cent almost 18 months ago. This could affect small to mid-sized IT companies more than the larger ones. Having said that, we don’t see any major impact on the September quarter numbers, which should be more in line with the Q1 FY12 numbers.

Oil and Gas

The oil and gas sector has emerged a clear winner in the recently-concluded June quarter, with the aggregate topline and bottomline of the nine companies  comprising the sector rising by a whopping 42 per cent and 51 per cent, respectively (excluding OMCs). The aggregate net profit, excluding that of the OMCs, stood at Rs 10763 crore. These figures are largely on the back of a Rs 2727 crore profit reported by Cairn India, which benefited from a rise in crude prices and the ramping up of production at its Rajasthan block.

A sharp spike in crude oil prices in the past one year following rising political unrest in the Middle East and North African region and geo-political tensions in Libya, pushed Brent crude beyond the USD 120/barrel mark, resulting in an increase in the subsidy sharing burden for upstream companies like ONGC and OIL. Despite gross realisations of close to USD 123/barrel, net realisations were impacted and came to around USD 48.80 and 59.60/barrel for ONGC and OIL, respectively. OIL’s performance got a boost from its highest-ever volumes, better gas price realisations and the low base of the June 2010 quarter. These factors combined to garner a massive 70 per cent rise in its net profit, taking it to Rs 850 crore. ONGC reported a marginal 12 per cent rise in its net profit, which went to Rs 4095 crore. With the subsidy issue being favourably addressed by the GOI, net realisations of upstream companies are expected to improve going forward.

In sharp contrast, the three OMCs have reported a loss in the June quarter, due to inadequate subsidies from the government. They have also reported refining margins below expectations.

Historically, quarterly results for the public sector OMCs have become irrelevant. This is because their financial performance is mostly based on budgetary support by the government and upstream companies, which is decided only at the end of the year. On a consolidated basis, the OMCs have reported a constant rise in net profits annually, and are expected to remain profitable. Moreover, the recent downtrend  in crude oil prices have enabled them to perform well on the bourses – lower crude oil prices will help them to cut their losses on the sale of subsidized fuels.[PAGE BREAK]
In case of RIL, the GRMs were up 41 per cent at USD 10.30/barrel, as against USD 7.30/per barrel last year. This offset lower oil and gas production from its KG-D6 blocks, and helped the company post its highest net profit in over three years. Further, the USD 7.2 billion RIL-BP deal, which received GOI approval this quarter, is expected to accelerate development and production from the under-performing KGD6 block.

Crude prices have cooled off considerably in the recent past, thanks to the global macro-economic factors at play. From around USD 125/barrel at the start of the Libyan crisis earlier this year, Brent crude has slipped by 13 per cent. This trend, if continued, could see domestic oil companies ending their losses on the retail of petro products like diesel and petrol. Overall, backed by strong margins and the robust performance in the April-June 2011 quarter, coupled with a fall in global crude price and hike in domestic fuel rates, we expect the next quarter to be positive for the sector.

Pharmaceuticals

The pharmaceuticals sector grew at a much better pace in this quarter than it did in the previous quarter. Companies in the generics business have done well, while those in contract research and manufacturing (CRAMs) have shown a mixed trend in the June quarter. The overall topline grew by 11 per cent and the bottomline grew by 17 per cent on a YoY basis. Industry EBITDA margins remained at 21 per cent. Out of the total 124 companies that we analysed, 107 reported a profit and more than 36 clocked a growth rate of above 25 per cent in their net profit over the corresponding quarter last year. The export business was good, but companies faced some amount of price competition in the Indian market. Large-sized companies launched new products, backed by their success on the ANDA and FTF front. Many ANDAs were filed by Indian companies during the quarter. Glenmark Pharma, for example, has a pipeline of 69 generic products and 40 ANDAs due for approvals. On the licensing income front too, the industry  has faced some headwinds during the June quarter. This is visible in the licensing income of Biocon, which declined to Rs 14 crore from an average of Rs 21-77 crore.

Companies in CRAMs have posted a mixed performance in this quarter. Dishman Pharmaceuticals and Chemicals posted a 51 per cent growth in topline, though its bottomline decreased by 13 per cent due to higher raw material prices. Material costs increased by 14 per cent this year, as compared to seven per cent last year. Contract manufacturing, clinical research facilities and the generic drugs market remain the key growth drivers for the pharma sector. The new trend in the international market is to outsource manufacturing from the same supplier for quality purposes, due to which CRAMs companies will see a growth in revenues. However, the Indian market for pharmaceutical products is shifting more towards lifestyle diseases. During this quarter, anti-diabetic, cardio-vascular and the nervous system were the therapeutic segments which recorded higher growth.

Companies like Piramal Healthcare and Biocon, who have business operations in the Middle East, suffered some losses in critical care products due to the political turmoil in this region. Many companies have reported growth in the European and African markets. We expect a slower growth in companies with a higher exposure to the US market. However, companies in the domestic, Asia-Pacific or African markets are expected to put in good numbers going forward.[PAGE BREAK]
Power

The power sector has been making it to the headlines quite often in recent times. Higher fuel costs and interest rate pressures have been plaguing the sector severely. This is evident in the way the stocks of companies in the power sector have fared on the bourses. The BSE Power Index has ended higher in only three of the past seven quarters, and has actually declined by 17 per cent on a YTD basis in FY12. Delayed projects, huge transmission and distribution losses, low tariff rates and the weak status of the state electricity boards has been hurting sector players. The impact is visible in the June quarter results as well. The sector, as a whole, has posted 14 per cent growth in the topline and 10 per cent growth in the bottomline on a YoY basis. These results are weak even when compared to the sector’s performance in the March quarter. 

While as a whole the sector wasn’t better off, some individual performers like Adani Power posted a healthy growth in the topline (132 per cent) as well as the bottomline (54 per cent) on a YoY basis. This was primarily on the back of capacity additions of close to 1320 MW that the company effected in the June quarter. Reliance Infrastructure posted a 64 per cent growth in topline and a 75 per cent bottomline growth on the back of its strong EPC and contracts business. NHPC posted a topline growth of 47 per cent on the basis of a well-managed plant loading factor and one time revenue accumulation from tariff changes. Adjusting the sector results to these companies, the topline and bottomline growth drops drastically to eight per cent and one per cent on a YoY basis respectively. The weaker links were Tata Power, which (standalone) posted a three per cent growth in topline as well as bottomline on a YoY basis. NTPC, the biggest company in the power sector in India, recorded a nine per cent growth in its topline and a 13 per cent growth in bottomline on a YoY basis.

The thermal coal prices in the international markets have gone up in the last 12 months, mainly on account of a higher demand. Indonesia, one of the biggest coal exporters to India, has asked its miners to bring coal prices to the international level. This is a cause of concern for the Ultra Mega Power Plants (UMPPs) and some merchant power plants, which mainly consume imported coal. Australia has also increased carbon tax recently, due to which coal prices will grow in the future. We expect some movement in electricity rates. The normal tariff rates, which currently lie between Rs 3-4 per unit, will rise on the basis of requests for tariff revision from some independent power producers. Merchant power rates, which are at Rs 4-4.50 per unit, will come down with new capacity additions. The domestic electricity demand is steadily growing. However, delays in coal supply have seriously affected the supply- side scenario. The only exciting event expected in the next quarter is the commissioning of new capacity in the Maithon and Mundra power plants by Tata Power. The gross power sector results may look decent, but adjusted results clearly reflect how feeble the power sector story is. Currently, it is advisable to stay away from this sector.[PAGE BREAK]
Steel

Despite a slowing demand, declining steel prices and higher raw material prices, steel companies have managed to keep their heads well above water in Q1 FY12. For the 117 steel-producing companies that we analysed, the aggregate sales have grown by 23 per cent and net profit by six per cent on a YoY basis. However, EBITDA margins have declined by 290 bps to 21.4 per cent on the back of higher coking coal prices and lower realisations, which have particularly hit the largest steel maker, SAIL. The company reported weak performance due to the higher import and consumption of coking coal, which lowered its operating margin by 820 bps to 14.7 per cent.

In addition to this, SAIL has also witnessed some pressure on account of a rise in other costs.Better sales volumes and higher realisation on the back of an improved product mix and higher contribution from value added products has helped JSW Steel overcome the hiccups faced due to the disruption of supply of iron ore from Bellary. Realisations have improved from Rs 43804 per tonne in Q1 FY11 to Rs 46645 per tonne, thanks to the higher contribution by value added products in its portfolio. Companies like TATA Steel and Bhushan Steel showed exceptional performance, witnessing robust growth in their consolidated sales, which were up by 20 per cent and 62 per cent respectively. 

However, on the bottomline, while Bhushan Steel’s net profit was up by a marginal 2.1 per cent, that of Tata steel was up by a whopping 40 per cent. This is however, the result of a one-time gain from the sale of its investments. On the other hand, 52 per cent of its revenue comes from the European region, which is currently facing a lot of problems. This could have a bearing on the future of the company, impacting volumes from this region. However, domestic operations would continue to be the earnings driver in the coming quarters.

Another significant worry for the steel sector is the Supreme Court’s disallowance of private players from iron ore mining in Bellary, and allowing only the National Mineral Development Corporation (NMDC) to produce one mt a month of iron ore till the next proceedings. JSW Steel was majorly hit by this judgment, for which it had to shut down one of its blast furnaces. This will impact the company’s total production by 20 per cent. Looking at the macro-economic situation across the globe and also in India, the demand for steel and steel products may see a decline in the next couple of quarters. Higher coking coal prices are another major area of concern for the steel industry. Australia is yet to resume normal supply of coking coal after the disastrous floods that hit the region last year, and the demand from China continues to be fair. These two factors are likely to keep coking coal prices on the higher side. Bearing in mind the performance during the quarter, and in view of the present situation, we believe that the performance of steel companies in next couple of quarters will remain muted.

Textiles
After two fiscals of a strong run defying gravity, the textile sector is experiencing a hard landing, with the Q1 FY12 profits dipping 98 per cent on a YoY basis. This was bound to happen sometime, and it is happening now. While this was certainly not the kind of start that the sector would have looked out for in FY12, the dip doesn’t come as a surprise. In fact, the industry did expect profitability pressures with the wild gyrations seen in raw material costs. However, the sector topline continued to grow at a robust 21.5 per cent during the same period.[PAGE BREAK]

Out of the 320 companies’ results that we have looked at, the sales of 201 have increased on a YoY basis, those of 93 companies have dipped and 26 have not shown any growth. On the profit front, the picture gets even grimmer, with profits of 176 companies dipping over the corresponding period and 13 companies not reporting any growth. 131 companies reported a rise in profits over the same period last year. The worst part is the rise in the number of companies reporting a loss. 127 companies, i.e. 40 per cent of the sector results, have reported a loss in Q1 FY12. This is higher than the 73 companies that had reported a loss in Q1 FY11 and 114 companies in Q4 FY11.

Cotton prices have played spoilsport for textile companies in the June quarter. Cotton prices swayed wildly from Rs 30000 per candy (one candy equal 356 kgs) in October 2010, to a peak of Rs 63000 per candy in March 2011. This resulted in companies accumulating huge inventories at higher costs. Nearly 70 per cent of the textile industry’s total products are cotton-based.  A sharp correction in cotton prices, which brought them back to Rs 31000 per candy, has added further insult to injury. Companies are still stuck with high cost inventory, which has not only impacted the current quarter results, but will have a spillover effect in the September quarter as well. To make matters worse, demand is expected to take a dent, both on the domestic as well the export fronts.

The  signs are already seen on the domestic front, where off season sales by textile companies has been extended by a month, with massive discounts being offered. Renewed fears of a double-dip recession in the US and macro-economic fears surrounding the Euro zone are bound to impact textile exports too. Exports account for 50 per cent of textile produce, with the US accounting for 50 per cent of that. Besides, the low base effect is also out of the system and with the base already high, it is highly unlikely that the sector would see higher growth rates. Hence, it is better to stay away from this sector at least for now.

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