DSIJ Mindshare

Q2 FY13 - Results Analysis

We were the only one to call the bottom of the market bang on target. Ever since fresh economic reform was initiated, the markets have been on an upswing. Now, why do we have wave that flag all over again? Look at how India Inc has performed in the September quarter of 2012 and you would know why.

Fast Facts

  • Out of a total of 2125 companies (from groups ‘A’ and ‘B’) that we have considered, the sales of 1273 companies have increased, while those of 780 companies declined and those of 72 companies remained stagnant.
  • Out of a total of 2125 companies (from groups ‘A’ and ‘B’) that we have considered, the net profit of 1114 companies has increased, while that of 968 companies declined and those of 43 companies remained stagnant.
  • The interest cost for India Inc. (excluding that for banks and financial services) has increased by 25 per cent on a YoY basis and has actually declined by 7 per cent on a sequential basis. This comes as a respite as the interest cost was witnessing a rapid increase in the past few quarters.
  • India Inc. sustained its margins in the September 2012 quarter at 18.43 per cent as compared to 18.44 per cent in September 2011. On the sequential front, however, the margins witnessed an upmove as compared to 17.97 per cent in June 2012.
  • As expected, the depreciation cost has increased marginally by 3.37 per cent, indicating some improvement on the capex front.
  • Private Banks, Pharmaceuticals, FMCG, Infrastructure and Cement were the star performers for the quarter.
  • PSU Oil Marketing Companies like HPCL, BPCL and IOC have posted a strong financial performance in the September 2012 quarter as the government (60 per cent) and up-stream companies (40 per cent) shared the burden of fuel under-recoveries.

When we had analysed India Inc’s performance for the June quarter, we had categorically stated that the September quarter would turn out to be even better. And, it is not by any chance, but the sheer prowess of our cutting edge research which has seen us repeat our performance of being correct yet again. Corporate India has put up a very strong performance against all odds that it faced during the September quarter. Dismal industrial production numbers, higher inflation levels and a weaker Indian Rupee were spelling a rather bleak performance to come in from India Inc. However, the ground reality has turned out to be on exact lines of what we had predicted. Here are some of the broader indicators:

  • Though at slightly lower levels than what it was during the preceding quarter, inflation  as measured by the WPI, continued to remain above the comfort levels of the RBI. It came in at 7.5 per cent in July, 8 per cent in August and 7.8 per cent in September.
  • The IIP (Index of Industrial production) was marginally negative for the months of July and September. IIP Growth stood at -0.2 per cent in July, witnessed an up-move 2.3 percent in August and was again negative (-0.4 per cent) in September 2012. However for H1FY13 the industrial production remained under pressure.
  • The Rupee remained highly range bound trading within a band of 52-55 against the USD, though it found some respite as compared to the June  2012 quarter. [PAGE BREAK]

Despite all these odds, India Inc  has put up a rather good show during the September  quarter of 2012. Topline growth of the 2125 companies that we have looked at (We have only considered BSE ‘A’ and ‘B’ Group companies for the purpose of this study) stood at 9.85 per cent. Growth at the bottom-line level came in at 8.41 per cent. For a practical approach, we have adjusted the bottomline for the extra ordinary income and have excluded the performance of PSU oil marketing companies. We have further refined our analysis by excluding the financial performance of ONGC and Oil India, as their September 2012 numbers are inclusive of their share of amount paid to compensate for the under recoveries. Excluding the numbers of Oil India and ONGC the topline growth stands at 10.67 per cent while the bottomline growth stands at 13.34 per cent. The performance has improved significantly on a sequential quarter basis where the topline growth stood at 1.67 per cent while the bottomline grew by 6.68 per cent.


Here are some more pointers on what has helped a good performance despite the overall scenario not seeming to be that good.

‘A’ 1 Performance

Performance of companies in the ‘A’ Group had been pretty good in the June quarter itself, with enough indications that the September quarter would be even better. Accordingly, ‘A’ group companies (that account for around 85 per cent of market capitalization on the BSE) have put up a dazzling performance for the quarter ended September 2012. The aggregate topline witnessed a growth of 13 per cent while the bottomline growth stood 14.30 per cent. A good volume growth and some improvement on the realization front have helped in this. The best part is that, depreciation charges have increased significantly (by 12.80 per cent) in the September quarter. Regular readers of the magazine would have noticed that we had been voicing our concern on the declining Depreciation cost which suggests a slower capex cyle. A strong double digit growth in Depreciation in the September quarter clearly indicates that the capex cycle may have revived significantly. Here is something more on this front.

A Good Depreciation For Once

As mentioned earlier an increased depreciation cost indicates that the capex cycle has revived. Led by the ‘A ‘group companies, the overall depreciation cost of India Inc increased by 12.15 per cent in the September quarter of 2012 on a YoY basis. After having gone up by 12.56 per cent in the June quarter, the momentum has sustained in the September quarter too. The ‘A’ Group companies accounted for up to 62 per cent of total Depreciation cost, suggesting that the capex growth is being led by larger companies. Increase in capex is always necessary as inflation has been on the higher side on account of supply side crunch. It is only additional capacities that can take care of the higher demand and in turn help control inflation. Depreciation going up is probably among the best features of the September quarter results. 

Change In Scenario
Septemebr 2011 Septemebr 2012
GDP growth for FY 12 was estimated at 6.5 per cent (revised from 7.5 per cent). GDP growth for FY13 estimated at 6 per cent.
Inflation was higher at 9.4 per cent in July, 9.8 per cent in August and 10 per cent in September 2011. WPI inflation showed signs of improvement; at 7.5 per cent in July, 8 per cent in August and 7.8 per cent in September 2012.
Strong IIP numbers – 3.7 per cent for July, 3.4 per cent for August and 2.5 per cent for September 2011. IIP growth was at -0.2 per cent in July, showed a good up-move by 2.3 per cent in August and was again negative (-0.4 per cent) in September 2012. However, for H1FY13, the industrial production remained under pressure.
The global markets were struggling, with European concerns looming large and the US losing its AAA rating. The global markets are showing some improvement with marginal improvement of macro data in the US. Even the actions taken by the European Union on the debt front are showing signs of improvement. But apprehensions about the ‘fiscal cliff’ persist in the US. France has witnessed a cut in ratings.
Sentiments were negative on account of political paralysis. Sentiments improved a bit with the reforms process catching pace.
The rupee traded in a narrow range and depreciated against the USD. The rupee traded in a narrow range and depreciated against the USD.

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Favourable Scenario On The Raw Material Cost Front

Raw material costs have remained a big worry for at least some time now. While they kept on rising, companies found it very difficult to pass these on to their customers, directly impacting operating margins. However, the situation on this front which began improving in the June quarter further bettered in the September quarter. Unlike the last few quarters where the increase in raw material cost was in double digits it has actually settled at just 7 per cent on Y-o-Y basis in the September quarter. Also, on an aggregate level, raw material cost as a percentage of sales remained stagnant at 45.87 per cent as compared to 45.89 per cent in the September quarter of 2011. This has translated into an improvement on the margin front, as well as on the EBITDA margins which stood at 18.42 per cent as against the 18.43 per cent in the September quarter of 2011. The best part is, margins have increased by 45 basis points on a sequential basis. We are of the opinion that, a fall in commodity prices, stability in Crude oil prices and the rupee are major factors which have contributed to a controlled raw material cost scenario. 

Interest Cost - The Really Big Reason

Interest Cost has been one factor which has had an impact straight on the bottom-line of India Inc. As inflation remained at higher levels, the RBI did not go in for rate cuts having last done so in April when it had cut the repo rate by 50 basis points. However it carried out certain actions like bringing down the CRR and reducing the statutory liquidity ratio to inject some amount of liquidity into the system. The impact of this was marginally visible in the June quarter. Though interest cost (excluding that for Banks and Financial Services companies) increased significantly (Up 54 per cent) in the June quarter on a Y-o-Y basis, it was lower as compared to that incurred in the March quarter of 2012. The situation on the interest cost front has improved significantly in the September quarter. While on a Y-o-Y basis it has increased only by 25 per cent, on a sequential quarter basis it has actually declined by 6.84 per cent. Further, interest cost as a part of sales stood at 3.11 per cent as compared to 2.68 per cent in September 2011 and 3.38 per cent in June 2012. One important point worth noting is that, the gap between the figures (Interest as per cent of sales) is narrowing. The steps taken by banks for reducing rates on their own, rather than waiting for the Central Bank has helped India Inc. 

The Performers

For the September quarter of 2012, Cement, Private Banks, Pharmaceutical and IT companies have performed well. In the Cement sector, increased realizations as well as higher volumes have helped the Industry perform better while Pharmaceutical and IT companies  benefited from a depreciating rupee. Among those that performed well are Maruti Suzuki, Dr Reddy’s, IDFC, Sun Pharma, Zee Entertainment, NTPC and HCL Technologies that have performed well.

As far as front-line companies which  form a part of the Sensex are concerned, the aggregate topline witnessed a strong growth of 11.41 per cent while the bottom-line was up 8.80 per cent on a YoY basis. The EBITDA  growth too was good, coming in at 10.20 per cent. Among the lot, Sun Pharma, TCS, NTPC, Coal India, SBI, ICICI Bank, HDFC Bank, Cipla and Dr Reddy’s came as the fastest growing companies. On the other hand, Tata Steel (reported a loss), Tata Power, ONGC (performed badly on account of the Subsidy sharing it did for under recoveries), Bharti Airtel, Hero Moto Corp, Hindalco and JSPL were among the laggards. 13 of the 30 companies that comprise the Sensex reported a net profit above street estimates; four reported profits below street estimates and the profit of 13 of them were in line with estimates.

December Quarter – The Road Ahead?

Our cover story last time had already told readers about what to expect in the December quarter of 2012. We reiterate our stand that, while the results for the September quarter of 2012 are indicating toward a betterment in the domestic economic scenario, the December quarter of 2012 will also have many positives. With some improvement on the liquidity front, interest cost is expected to decline in the December quarter. Other factors like declining commodity prices, a stabilizing rupee, expected decline in inflation and an improvement in industrial production is expected to help India Inc put up a better performance going ahead. Add to this the slew of reforms that are expected from the government and you can expect a better performance from corporate India. Rising capex will probably gain momentum in the December quarter. Considering  all these factors, we will not be surprised if the December quarter of 2012 turns out to be even better.

We leave you with a detailed analysis of 12 most important sectors. As always, it is as incisive as it can be and will certainly help you decode the facts and figures of what happened during the September quarter.
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AUTOMOBILES

The festive season has amounted to good sales. However, going ahead, there would be no great revival in sales and volumes would not be significantly higher. Passenger Vehicle growth has been driven by diesel vehicles so far but with talks of additional taxes, uncertainty prevails on the outlook. 
R C Bhargava, Chairman, Maruti Suzuki India

A general slowdown in the economy always tends to have the worst impact on sectors like Auto which primarily are about discretionary spending. Add to this the higher excise duty and fuel prices and it spells a perfect recipe of doom for the sector. This is exactly what has happened with the Auto sector in the September quarter of 2012. Although raw material costs were stable, margins were pressured due to increased marketing costs, a weak product mix in case of some players and adverse currency movements which impacted raw material imports and royalty payments.

Four-wheeler companies fared better than two-wheelers, thanks to their ability to absorb shocks due to a presence in multiple segments and as a result of lesser competitive pressures. On an average, four-wheeler companies saw their net sales increase by 18.41 per cent and the net profit rising by 11.20 per cent on a YoY basis during the September quarter. Meanwhile, net sales of two-wheeler companies declined by an average of 9.76 per cent and the net profit stood at 21.97 per cent lower than it was during the year ago period. For Hero MotoCorp, the average revenue realised per unit increased by INR 1194.94 to INR 38921.37 and for Bajaj, this declined by INR 590.34 to INR 44328.28.

Apart from the generally lower demand, the three principal two-wheeler companies have also been facing fierce competition from Honda, which has been binging on market share with rapid growth. In Q2FY13, while the sales volumes of Hero, Bajaj and TVS reduced by 13.70 per cent, 2.17 per cent and 19.57 per cent respectively, those of Honda grew by 43.39 per cent YoY. The lower volumes had a direct impact on the financials of these companies, resulting in a decline in net sales for all the three listed entities.

In the case of four-wheelers, the  results were driven differently for individual companies. Maruti Suzuki (MSIL) saw an action-packed quarter. The company’s production halted for a month due to violence at its Manesar facility on July 18, 2012. This resulted in a 40.78 per cent decline in sales in August 2012, as the company ran out of inventory. However, due to a continuing order inflow, MSIL recovered when production gradually came back to normal. Despite these events, MSIL surprised the markets by posting an 8.53 per cent increase in net sales.

Tata Motors witnessed a moderate 6.94 per cent growth in sales volume. However, its financials were strengthened by the strong demand for Jaguar Land Rover (JLR) products worldwide. JLR contributes to roughly 70 percent of the company’s revenues and 60 percent of the profits. Robust growth on this front resulted in the company’s revenues and profit growing by 19.90 percent and 10.55 percent respectively.

Mahindra & Mahindra (M&M) announced a good set of numbers on the back of increased demand for its utility vehicles and the company’s positioning being apt to make the most of current market conditions. M&M saw its sales volumes increase by 16.29 percent and the revenues and profit growing by 26.80 per cent and 28.44 percent respectively.

Although the overall results of the industry were a mixed bag, the festive season was being awaited for a revival in sales and a reversal in the downward trend. Festive sales have been good so far, and are expected to translate into better financials for the quarter ending December 31, 2012.
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BANKING

Banks continued to face headwinds on their asset quality front. Of the 14 banks that are part of the BSE Bankex, the Net NPAs of nine banks worsened.

At the start of the fiscal, there was a lot of hype around the banking space. The market expected the Reserve Bank of India (RBI) to slash interest rates and spur economic growth. So, what exactly happened in the first half of  FY2013? The RBI slashed the repo rate and reverse repo rate by 50 basis points to 8 and 7 per cent respectively only once in the first half. After that though there have been expectations that it would do so, it hasn’t. This resulted in the deposit rates of scheduled commercial banks declining by 13 basis points across all maturities and the base rate of lending for banks declining by 25 basis points. The Cash Reserve Ratio (CRR) was also reduced by 25 basis points to 4.50 percent and the Statutory Liquidity Ratio (SLR) by 100 basis points to 23 percent in HIFY13. The slashing of the CRR by 25 basis points resulted in the injection of around INR 17500 crore into the system, helping the banking sector to solve its liquidity crisis.

Deposit growth between the beginning of this fiscal and the week that ended on October 5th 2012 moderated to 13.3 percent and advances growth stood at 15.4 percent. Business growth for banks is lagging behind the RBIs expectations. The RBI’s has projected a growth of 15 and 17 per cent for deposits and advances for FY2013. Deposit growth decelerated majorly due to a moderation in interest rates of term (fixed) deposits, while advances grew at a slower pace due to a slowdown in the investment demand, especially with regard to infrastructure.

Within the overall scenario that has panned out for the banking sector so far of the 40 banks that we have analysed, Private Sector Banks (16) continued performing extremely well as compared to their Public Sector counter parts (24). On an aggregate basis, the Net Profit for private banks grew by 26 per cent while profit growth for PSU banks came in at a meager nine percent on a YoY basis for the September quarter. The growth seen in PSU banks was also majorly driven by SBI. If SBI’s results are excluded, the overall profit for PSU Banks stands lower by one per cent as compared to the same period last year.

Banks continued to face headwinds on their asset quality front. Of the 14 banks that are part of the BSE Bankex, the Net NPAs of nine banks worsened, while those of four banks showed an improvement and that of only HDFC Bank remained unchanged on a sequential quarter basis (See table: Net NPAs). The banks showed a mixed response when it came to the Net Interest Margins (NIM). Seven banks saw a rise in their margins and  six posted a decline. Kotak Mahindra Bank’s margins remained unchanged on a sequential basis.

In its recent meet held in October 2012, the RBI did not revise the deposit growth forecast for FY2013, while it slashed the advances growth estimate by 100 basis points to 16 per cent. The  apex bank once again slashed the CRR by 25 basis points bringing it down to 4.25 per cent. Further, it revised the GDP growth and WPI inflation targets for the second time during this fiscal, which now stand at 5.8 and 7.5 percent respectively for March 2013. It also decided to increase the provisioning for restructured standard accounts by 75 basis points to 2.75 per cent. This would create some pressure for the banks in the December quarter of 2012. Nevertheless, we continue to be bullish on the sector, largely on the private banking players.
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CEMENT

Cement companies saw their realisations increasing on a yearly basis that helped the sector to post better-than-expected topline growth despite only a marginal increase in volumes.

Delayed monsoons, which are actually a bane for an economy, worked as a boon for the cement companies. The second quarter of the fiscal year normally witnesses a seasonal dip in cement prices due to the monsoons, and hence, lower construction activity. Q2FY12 had witnessed a four per cent YoY drop in cement prices. However, due to the delay in monsoon this year, there was a lower seasonal price drop in cement. The average increase in cement prices on a yearly basis was 17 per cent. Both UltraTech and Ambuja Cements saw their realisations increase by around 17 per cent on a YoY basis to INR 5217 and INR 4637 per tonne respectively.

Such an increase in realisations helped companies in the sector to post better-than-expected topline growth despite only a marginal increase in volumes. For the 32 companies that we have analysed, we saw the average topline growing by 18 per cent on a YoY basis. Some of the companies like Shree Cement, JK Lakshmi Cement and JK Cement posted higher-than-average increase in revenues on a yearly basis at 55 per cent, 39 per cent and 38 per cent respectively.

However, the companies saw a lacklustre volume growth in this quarter. On an average, the volumes grew by merely around two per cent on a yearly basis. Companies like Ambuja Cements and UltraTech saw a marginal increase in their volumes and ACC saw a decline in its volumes by three percent to 5.43 million tones on a YoY basis. Some east and south-based cement companies, though, saw a healthy volume growth. For example, Shree Cement and Madras Cements saw their volumes growing by 21 percent and 11 per cent respectively in the same period.

Nonetheless, higher realisations helped the companies to post a decent bottomline growth. The average bottomline growth for the 32 companies was an eye-popping 122 per cent. This was mainly helped by the stupendous performance of some of the companies like Mangalam Cement, which saw its profit grow by 40x from INR 0.68 crore (Q2FY12) to INR 8.6 crore (Q2FY13). Similarly, JK Cement and Shree Cement saw their profit grow by 14x and 5x respectively in the same duration.

Such growth in profits was despite an increase in power and fuel expenses by 28 per cent on a yearly basis. Energy costs were affected by an increase in the cost of e-auctioned coal and a hike in the transportation cost of the fuel. Though the prices of international coal declined during the quarter, currency depreciation restricted the benefits emanating from the same.

Going forward, we believe that cement companies will improve their performance. The reason for such optimism lies in the favorable pricing scenario of cement in the key northern, central and southern regions. In addition to the pick-up in construction activities, companies have already hiked prices by INR 8-12 per bag in the month of October 2012 in the northern and central regions, while some of the companies have increased the prices by as much as INR 25 per bag. Expect a good December quarter for companies in this sector.
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FMCG

We delivered another good quarter with strong financial performance in both our domestic and international operations. 
- Adi Godrej, Chairman, Godrej Consumer Products

The FMGC sector, which is considered as a defensive bet, continued to perform well in a volatile market. The elapsed quarter is yet another one in which companies from this sector have posted favourable numbers. For the 12 FMCG companies that we have analysed, the aggregate topline grew by 17 per cent while the bottomline grew at 15 per cent on a YoY basis. Further, most of the companies, more or less maintained their EBITDA and Net Profit margins at levels comparable to that of last year.

The growth was both, volume and price driven, which is evident from the fact that the domestic business grew by 16 per cent for HUL (volume growth was of around seven per cent), Dabur India saw a turnover growth of 20.6 per cent (volume growth of 10.5 per cent) and Marico reported a 19 per cent growth (volume growth of 14 per cent).

On an aggregate basis, the raw material-to-sales ratio increased by 78 basis points to around 44.40 per cent, which was particularly after FMCG major Hindustan Unilever (which accounts for 36 per cent of the total turnover) witnessed a rise in the ratio by 197 basis points to 42.8 per cent. The prices of palm oil, a key input for manufacturing soaps used by companies like HUL and GCPL, have declined by around 12 per cent in US dollar terms. However, because of the rupee depreciation, the prices have seen a rise of one per cent in rupee terms from September 2011 to September 2012.

Further, on an aggregate basis, the advertisement-to sales ratio increased by 56 basis points to 12.02 percent on a YoY basis. Marico spent heavily on advertising, and its ratio to sales increased by 456 basis points to 13.68 percent.

This was after the company benefited from the softening of the copra prices which were lower by 33 per cent on a YoY basis (copra accounts for 40 per cent of its total input cost). One could note that the benefit of the lower input cost was reinvested in the business in the form of higher advertisement spends, which is again very important for the company’s growth prospects.

From the sectoral point of view, the raw material and advertisement expense did not have a major impact on the EBITDA margins, which remained stable at around 15 per cent. This was after companies in the sector passed on the price rise to customers (almost completely on a proportionate basis), thus protecting their margins.

With the festive season currently going on, we hold that the company would post good numbers in the December quarter of 2012 too. We, at Dalal Street Investment Journal, believe that this was yet another quarter where companies in the sector have posted good numbers, and maintain our bullish stance on the sector as a whole.

Many market experts believe that with the government putting an end to the policy paralysis, one must go and invest in the high beta space. However, we believe that one should remain invested in the FMGC space to garner handsome returns going ahead.

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INFRA & REALTY

The order books of leading infrastructure companies witnessed an upward tick after a long time. Industry leaders like L&T witnessed a sharp improvement on the order flow front with an impressive YoY growth of 30 per cent, sustaining the momentum seen during the June quarter.

Infrastructure is one sector that has been at the core of India’s growth story. It is infrastructural development that mirrors the overall health of a nation’s economy. The Government of India has always been quite forthcoming when it comes to upgrading infrastructure. Even in a difficult economic scenario, the government maintained its focus on infrastructure activities. Though the infrastructure spend continued, in the past few quarters, infrastructure companies witnessed a contraction on the margins front on account of higher interest costs and rising commodity prices.

However, things started to improve in the June quarter of 2012, where-in commodity prices witnessed some decline. In our analysis of the results for the June quarter of 2012, we had categorically stated that with some decline in raw material prices and improved capex, infrastructure companies can expect a better September quarter. This is exactly what has happened. The September quarter results of infrastructure companies have been good, with the aggregate topline increasing by 9.58 per cent and the bottomline going up by 7.33 per cent on a YoY basis.

These numbers are better than expectations. Despite dismal IIP numbers (-1.80 per cent for July, -0.20 per cent for August and 2.7 per cent for September), industry leaders have performed well. The best part is that, the operating margins for the quarter have improved to 17.23 per cent from the levels of just 16.66 per cent in September 2011 and 17.03 per cent in June 2012. The rise in margins was partly on account of higher realisations and partly on account of a decline in raw material prices. However, with the increased working capital requirement, the interest cost has gone up significantly.

Another noticeable factor was a significant increase in the order book positions and new order inflows. The order books of leading infrastructure companies witnessed an upward tick after a long time. (See table: Order Book Position) Industry leaders like L&T witnessed a sharp improvement on the order flow front. For the September quarter, the order inflow at INR 20967 crore recorded an impressive YoY growth of 30 per cent, sustaining the momentum seen during the June quarter.

As for the December 2012 quarter, we feel that the upward momentum in the order inflow is likely to sustain as the capex cycle revives. The reforms process is expected to pick up soon, furthering the capex drive. Improvement on the liquidity front is expected to bring the interest cost under control, helping infrastructure companies put in better numbers on the bottomline front. We expect the momentum to sustain in the December quarter too.

As far as the realty sector is concerned, we had categorically stated in our June quarter analysis that the scenario is unlikely to improve and another poor quarter could be in the offing. With the topline witnessing a decline of seven per cent and the bottomline declining by 21 per cent on a YoY basis, the September 2012 quarter has been no different from what we predicted. Lower sales volumes and a marginal decline in realisations, higher debt burden and higher mortgage rates has resulted in a poor performance.

This quarterly result analysis of real estate companies does not have much relevance for realty firms on the valuations front. In fact, it is the change in net present value which is important. The net present value (NPV) increases as the prices of real estate increase and the interest rate declines. In the September 2012 quarter, both these factors did not go in favour of the sector.

However, things have started to change with some economic improvement happening due to the reforms announcements. Housing mortgage rates are witnessing a marginal decline, resulting in increased enquiries from first time buyers as also from investors. In addition, if the sales volumes increase, it will help the realty companies generate cash flows, eventually improving the financial health of some ailing realty companies.

Thus, the scenario is expected to improve going ahead, and we expect a better December 2012 quarter for realty companies. 

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IT & ITES

Customers are increasingly looking for a partner who not only understands the technical aspects of a project, but also brings deep vertical, consulting and business knowledge.
R. Chandrasekaran, Group CEO – Technology & Operations, Cognizant

The Indian IT industry’s performance has always been directly linked to global macroeconomic trends, considering the fact that 90 per cent of the sector’s income is derived from exports. Secular economic, regulatory and technological trends have raised hurdles for companies to jump over. While some companies have successfully braced themselves in a timely manner, many are readjusting themselves to cope with these changes.

Over the last few quarters, Mid-Cap IT companies have been outperforming the bigger ones due to industry-specific specialisation, rapid adaptation to changes as also on account of reduced pricing. This trend continued in Q2FY13 as well, however with a tremendous pricing pressure. There have been some surprises on the volume front, with Infosys growing by 3.8 per cent and TCS by 4.95 per cent. Companies with quarterly revenues exceeding INR 5000 crore (TCS, Infosys, Wipro and HCL Tech) averaged a sequential topline growth of 3.19 percent and a bottomline growth of 4.71 percent. A striking difference is seen in the average results of Mid-Cap companies, which had their revenues growing by 4.17 per cent and their net profits declining by 14.44 percent.

Among these results are some out-performers like Cognizant and Persistent Systems. “Clients are looking to develop industry-specific strategies around fully globalised business models and leverage emerging technology architectures such as social, mobile, analytics and cloud, while re-architecting their organisation to appeal to a new generation of consumers and employees”, says R Chandrasekaran, Group Chief Executive – Technology and Operations, Cognizant. Companies that have managed to adjust themselves to these changes and place themselves in sync with the industry have reaped benefits.

Apart from the shift from plain vanilla application development and maintenance, inorganic growth is also being looked at to fuel growth. The quarter also saw a few acquisitions, with Tech Mahindra taking over Hutchison Whampoa’s call centre business and Bharti Group’s Comviva Technologies and Infosys acquiring Lodestone and Marsh. These would not only help companies to effortlessly expand their spectrum of expertise but also to improve operational efficiency in some cases, particularly with the stagnation of linear growth models. Despite a sloppy yearly guidance of five per cent, Infosys is expected to perform better in H2FY13 as the acquisition deal closes and starts adding to revenues.

The outlook for the IT industry has been turning all the more hazy due to increasing concerns around the US going over the ‘fiscal cliff ’ and the development of an anti-offshoring sentiment. We believe that these pressures will have a limited effect on the IT industry considering the fact that economies will focus on reviving growth, and the creation of employment through a pro-business model would be in focus. Moreover, these trends have been playing out since 2007 and the industry has managed to adjust itself and find new avenues for growth. We think that the sector will continue to perform at the current levels regardless of the dodgy environment.



Performance of the Indian IT sector has been in line with predictions. Interestingly, demand has been picking up from Europe. The global macroeconomic situation remains subdued and there seems to be no major changes taking place in the foreseeable future. Companies have already factored in these changing trends and performance is expected to be reasonable. 
Says - 
Manu M. Parpia, MD and CEO, Geometric

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OIL & GAS

On the bottomline, apart from the subsidy burden sharing, other factors like inventory gains and forex gains have helped companies to put in better numbers.

The performance of the Oil & Gas sector for the September quarter of 2012 is in complete contrast to what it was in the June quarter. Thanks to the inconsistent financial performance of oil marketing companies (OMCs) like IOC, HPCL and BPCL that are largely dependent on government subsidies, the quarterly results for this sector have always been unpredictable. While OMCs made heavy losses in the June quarter, as government subsidies were nil, in the September quarter, they returned to profits, with the government contributing 60 percent and upstream PSU companies like ONGC and Oil India contributing to the remaining 40 per cent of the under-recoveries.

As for the sales growth, it has been a good 20 percent on a YoY basis and 4.40 percent sequentially. On the bottomline, apart from the subsidy burden sharing, other factors like inventory gains and forex gains have helped companies to put in better numbers. OMCs reported strong gross refining margins (GRM) led by a higher inventory and forex gains, as oil appreciated 17 per cent and the rupee appreciated by 5 per cent against the USD. This helped companies to post a profit of INR 16973 crore in the September quarter of 2012.

Upstream companies like ONGC and Oil India, have reported a significant decline in net profit (32 percent for ONGC and 16 percent for Oil India) on a YoY basis, hurt by higher discounts on crude oil sales to state-run OMCs. Of the total gross under-recovery of INR 8200 crore, share of upstream companies stood at around 39.7 per cent or INR 15150 crore. Within upstream companies, OIL India’s share stood at INR 2070 crore and the remaining was that of ONGC.

The performance of GAIL too was not satisfactory. Declining KGD6 production impacted the transmission volumes of GAIL and GSPL, with limited scope to compensate from higher LNG imports. The company’s profit for the September 2012 quarter declined 10 per cent on a YoY basis. However, the domestic gas scarcity augurs well for another company in this sector, Petronet LNG.

Among private sector oil companies, the profitability of Reliance Industries (RIL) was helped by a lower depreciation charge and a high Other Income. For the quarter that ended in September 2012, its topline stood at INR 93265 crore and the bottomline came in at INR 5376 crore against INR 80790 crore and INR 5703 crore for September 2011 respectively. RIL’s premium to Singapore GRM stood at USD 0.4/bbl. Sequentially, the GRMs for RIL improved to USD 9.5/bbl against USD 7.6/bbl mainly on the back of refinery outages, particularly in Japan, China and Taiwan, leading to a tighter market. This has been reflected in the benchmark Singapore GRMs at USD 9.1 for the September quarter of 2012, up from USD 7.1/bbl in the June quarter. However, the petchem margins at 7.9 per cent were the lowest since 3QFY05; the average gas production at KG-D6 declined 14 per cent sequentially to 28.5 mmscmd.

Cairn India’s, revenue and EBIDTA remained flat sequentially at INR 4440 crore and INR 3400 crore respectively due to a higher discount to Brent at 10.8 per cent (7.3 per cent QoQ), despite an improvement in production by 1.7 per cent.

For FY13, the total under-recoveries are estimated to be around INR 138541 crore. We expect 60 per cent of these to be funded by the government and around 40 per cent by upstream companies. Though the OMCs are expected to make profits on a yearly basis, there would be some quarterly fluctuations. Further, crude prices have declined marginally since October 2012 (compared to the September 2012 quarter). Hence, we can expect a muted quarter ahead for the upstream companies.
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PHARMA

The future growth of domestic pharma market remains under the shadow of the new drug pricing policy, which will impact the pharma companies. The new draft of the policy is estimated to cover about 20-30 per cent of the domestic pharma industry, with marginal negative impact on the players.

The pharma sector which had been reporting a consistently good performance for the past many quarters and it did so during the September quarter of 2012 as well. Barring a few exceptional results, the pharma sector has witnessed an aggregate growth on 17 percent in topline and 39 percent in bottomline. These fantastic results were aided by limited competition product launches and a strong growth in exports. The depreciation in the rupee was also a positive, as the net profit margins improved by more than 200 basis points.

The generics segment, which has been the key growth driver of the pharma sector, has fared well this time round too. Top Indian companies like Dr Reddy’s Labs (DRL), Cipla, Sun Pharma, Lupin and Ranbaxy have seen a strong double digit growth in their US business. The selective launches of low competition products have supported these good results. In the emerging markets, the growth has remained at a promising rate of over 20 per cent. In Russia, few companies saw a delayed off-take, which is a seasonal impact and will recover in the December quarter. We expect good times to continue in the December quarter as well due to the strong base business, launches of products as well as the weakening of the rupee.

In the domestic market, the growth of large-cap companies like Ranbaxy, DRL, Cipla, etc. seems to be slowing down, while companies like Glenmark, Cadila and Unichem have performed really well by outpacing the industry growth rate by more than 400 basis points.

Amid these impressive results, there were few laggards like Sterling Biotech. The company defaulted on its FCCBs of about INR 1000 crore. Orchid Pharma reported a loss due to the working capital constraints and higher interest outflows. Piramal Enterprises also posted a loss as its interest payments soared six-fold after it raised more debt.

Mergers and acquisitions have again picked up in the sector. Sun Pharma acquired US-based Dusa Pharmaceuticals for USD 230 million (about INR 1265 crore). Piramal Enterprises acquired US-based Decision Resources Group for USD 635 million (about INR 3492 crore) while DRL acquired Netherlands-based Octopus NV for INR 193 crore. Cipla is also reported to be in the process of acquiring a distribution channel in South Africa for USD 220 million (about INR 1210 crore). Operating under the trade name of Cipla Medpro, this company is promoted by individuals in South Africa and have been sole agents for Cipla products for quite some time now.

The future growth of domestic pharma market remains under the shadow of the new drug pricing policy, which will impact the pharma companies. The new draft of the policy is estimated to cover about 20-30 per cent of the domestic pharma industry, with marginal negative impact on the players. Overall, we remain bullish on selective companies that have a sizable presence in the exports category, as the patent expiries in the US market still offer a huge business opportunity. 
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POWER

Besides the bailout package, many state governments have raised the tariffs, and this is now reflecting on the results of the companies. NTPC and Power Grid posted a good profit growth, and JSW Energy threw up a surprise with its higher short-term sale and better realisations.

The power sector has shown some signs of revival in the September quarter of 2012 after the central government took a few steps towards improving the business environment. At face value, the sector seems to have witnessed a 13 per cent topline growth and 40 per cent bottomline growth. However, these figures do not present a realistic picture. After adjusting for the exceptional results of Tata Power, we get a bottomline growth of around 15 percent, which was also due to the robust performance of NTPC, Power Grid and JSW Energy. In fact, of the total of 22 companies that we have considered, two companies have posted losses and another nine have reported a decline in earnings.

During the quarter, the government announced a bailout package of INR 1.9 lakh crore to the state electricity boards (SEBs). Under this, half of the SEB debt will be taken over by the state governments while the remaining half will be restructured by providing softer repayment terms. This decision improved the sentiment for the sector, and the BSE Power index surged eight per cent in the month of September 2012. However, eventually these gains were evaporated as the fuel issues surfaced again. During the July-September 2012 quarter, the index gained only 2.6 percent as compared to 7.6 percent rise of the BSE Sensex.

On the fuel front, worries related to gas and coal have not been resolved so far. Coal India, which was asked to sign the fuel supply pact by March 2012, is yet to find out the coal price pooling formula. SEBs have voiced their concerns saying that pooling will increase coal prices for domestic players, which raises a question mark on the fuel supply pact. So far, 30 power utilities have been contracted by Coal India. On the gas front, production remains subdued with no sign of improvement. Due to this, the PLFs of the gas-based thermal power plants have now declined below 50 per cent, indicating a severe gas shortage.

During the quarter, a total 2370 MW of coal-based power generation capacity was added. Power generation, however, remained flat on a YoY basis. The total generation also fell short of the sector’s target by three per cent due to fuel shortage, transmission constraints and the grid failure in the month of July. Hydro power generation declined by 15 per cent, taking a hit between July and August due to the uneven monsoon. Thermal power generation increased by eight per cent in the quarter. However, the plant load factors (PLFs) of the thermal power generation plants from April 2012 to August 2012 were down to about 69 per cent as compared to 73 per cent in the corresponding period last year.

Besides the bailout package, many state governments have raised the tariffs, and this is now reflecting on the results of the companies. NTPC and Power Grid posted a profit growth, and JSW Energy threw up a surprise with its higher short-term sale and better realisations. Reliance Power has posted good results after commissioning its generation capacity, but the fate of its Ultra Mega Power Projects (UMPPs) and gas projects remains a concern due to fuel worries. On the other hand, Tata Power and Adani Power posted losses again, while Torrent Power posted a deep cut in its profits due to the fuel shortage.

Though the results of companies in this sector are better than those seen in the June 2012 quarter, fuel security for future capacity additions is something that needs to be addressed. In the next six months, large capacities will be added by the private sector, and hence, the next two quarters are very important for the sector as a whole. For now, we maintain cautious optimism on selective stocks due to the SEB debt restructuring, but a majority of the scrips are best avoided.
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RETAIL

The economic climate has improved thanks to the series of reforms which seem to have done the trick to mitigate the negativity in the market. 
- Govind Shrikhande, Customer Care Associate & Managing Director, Shoppers Stop

Usually, the second half of the calendar year is good for companies in the retail sector. This is because it spans across the festive season and consumers tend to spend more during this part of the year. This obviously spells a good growth for the companies. However, the September quarter numbers for the retail space have not been awe inspiring with companies like Shoppers Stop, Pantaloon Retail and Trent facing some headwinds.

Of the total six companies that we have analysed in this space, the aggregate topline grew by 11 per cent while the bottomline grew by a solid 123 percent on YoY basis. However, after adjusting for extraordinary items which include a one-time profit earned by Pantaloon Retail of INR 294 crore and the impact of taxes thereon, the aggregate Net Profit registered a decline of around three per cent on a YoY basis.

One should further note that, Pantaloon Retail accounts for 50 percent of aggregate sector profit, and had an exceptional item of profit on sale on investments. Its Aggregate Operating Profit margins improved by 252 basis points to 12.85 per cent on a YoY basis, mainly due to lower raw material expenses and also because of stock adjustments. The raw material-to-sales ratio declined by 337 basis points to 26.64 per cent on a YoY basis.

Pantaloon Retail’s, same store sales growth (SSSG) for the quarter in life- style retail segment came in at 10.8 percent, while it declined by 0.2 and 3.5 percent for the value and home retail business segments. In case of Shoppers stop, its SSSG a grew by 5 percent on YoY basis. Pantaloon Retail and Shoppers Stop added 0.17 and 0.14 million square feet, taking the total operational retail space to 16.36 and 3.3 million square feet, respectively by the end of this quarter.

Titan Industries reported a robust bottom line growth of 21.5 percent to INR 180 crore on a YoY basis. This was majorly after the Jewellery segment’s (which accounts for more than 75 percent of the company’s business) EBITDA margins improved by 274 basis points to 12.47 percent on a YoY basis. Margins in the segment expanded due to a rise in the sale of studded jewellery. It has been increasing the sale of studded jewellery which now accounts for 32 per cent of its total jewellery sales up from 28 per cent during the same period last year.

There is a slight change that is being witnessed in consumer spending patterns and the just gone by festive season should see retail companies posting better results in the December quarter. Demand is reviving and is picking up which will result in a better business growth going ahead. The government also has put an end to policy paralysis and hopes of FDI in multi-brand in India have once again taken centre stage.

While the cabinet has already approved the FDI in multi-brand retail, it now awaits a green signal from parliament. Expect a better future if things materialize on these fronts soon. 
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STEEL

Global factors like the subdued demand from China and the escalating Euro zone debt crisis have resulted in a decline in steel prices globally. Although the depreciating rupee shielded Indian players for the first few months, the prices started declining with the rupee stabilising.

The steel sector does not seem to be looking up, and this is reflected in its quarterly results. After reporting a subdued performance in Q1FY13, the sector seems to be further losing it sheen, largely due to lower volume growth. The Indian steel industry witnessed a demand growth of a mere 2.8 per cent for the quarter ending September 2012 as compared to 7.7 per cent in the previous quarter. A leading company like SAIL saw its sales volumes actually declining from 2.9 MT at the end of Q2FY12 to 2.6 MT at the end of Q2FY13. However, others like JSW Steel and Tata Steel saw sales volumes increasing, but only marginally.

Coming to the prices of the metal, factors like the subdued demand (especially a slowdown in demand from China) and the escalating Euro zone debt crisis have resulted in a decline in steel prices globally in the first half of FY13. Although the depreciating rupee shielded Indian players for the first few months, the prices started declining with the rupee stabilising. Therefore, the sequential decline in the price of steel, though it did see an increase on a yearly basis.

Tata Steel’s realisations per tonne declined by six per cent from INR 51530 per tonne at the end of Q1FY13 to INR 48459 per tonne at the end of Q2FY13. However, this marked an increase by five percent from INR 46345 per tonne at the end of the same quarter last year. Similarly, JSW Steel saw its realisations decline by seven per cent sequentially and increase by 1.2 per cent on a YoY basis.

This marginal increase in volumes and prices has resulted in the topline of the 103 steel companies analysed by us showing an eight per cent increase on a yearly basis and a two per cent sequential decline on a standalone basis.

Besides a lower demand, the global decline in steel prices was also attributed to the lower cost of raw material, which has come off sharply in the last one year. Iron ore prices, which were around USD 170-180 per tonne in the same quarter last year, have come down to USD 100-130 per tonne for Q2FY13. The contracted coking coal prices have also declined gradually over the last one year. Coking coal prices for Q2FY13 were between USD 140-170 per tonne as  against over USD 350 per tonne in the same quarter last year.

However, the domestic iron ore prices have  ot declined in line with the prices in the international market. This was due to the suspension of mining operations in Goa and the continuation of the mining ban in Category-B and Category-C mines in Karnataka, which curtailed the domestic availability of iron ore. Even for coking coal with an inventory of 45-60 days, the benefit has not been in the same proportion. Therefore, on an average, the raw material cost as percentage of sales has increased from 53 per cent (Q2FY12) to 54 per cent (Q2FY13).

Despite such an increase in the cost of raw material, the average Profit After Tax (PAT) of companies in the sector has increased by a whopping 69 per cent on a yearly basis. Such a rise may be attributed to the extraordinary items (mostly forex gain or losses), which recorded a 147 per cent jump on a yearly basis. JSW Steel for instance saw a forex gain of INR 422 crore in this quarter against a loss of INR 512 crore in same period last year. If we remove these exceptional items, its net profit has increased at a modest rate of 11 per cent.

Going forward, we feel that steel prices could continue to be under pressure. This is because global steel capacity utilisation remains at 77 per cent, implying an overcapacity. Moreover, a rise in imports mostly from FTA countries will check any price rise. Therefore, we believe that this sector will continue to under-perform at least for the next few quarters.

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