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Business News/ Market / Stock-market-news/  Silver lining: A year-end prognosis of corporate earnings
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Silver lining: A year-end prognosis of corporate earnings

Faster economic growth and low inflation haven't translated into an earnings rebound in 2015, keeping the stock markets muted. Will 2016 bring better tidings?

Factors such as low capacity utilization and high leverage at Indian companies are likely to ensure that the pace of recovery will continue to be unexciting. Photo: MintPremium
Factors such as low capacity utilization and high leverage at Indian companies are likely to ensure that the pace of recovery will continue to be unexciting. Photo: Mint

Mumbai: The 8.96% fall in the S&P BSE Sensex so far this year is evidence enough that the markets had run ahead of themselves in 2014. Valuations have remained rich, however, as the fall in the markets has been accompanied by sharp cuts in earnings estimates.

But in the midst of all this, the silver lining is a gradual recovery in the economy. Early signs suggest the recovery will continue in 2016, with government spending playing a significant part, and the government’s decision to implement the 7th Pay Commission recommendations on salary and pension increases helping consumption demand as well. However, factors such as low capacity utilization and high leverage at Indian companies are likely to ensure that the pace of recovery will continue to be unexciting.

Economists at Citigroup Global Markets India Pvt. Ltd said in a recent note to clients that India had fared relatively well, compared with most emerging markets. Gross domestic product (GDP) growth has picked up marginally from 7.3% in fiscal 2015 to an estimated 7.5% in FY16, thanks to an accommodative monetary policy, the government’s reform agenda and an increased focus on project implementation.

Analysts at Credit Suisse (India) Pvt. Ltd said in mid-November that the pick-up in growth in oil demand, power consumption and auto sales in the preceding two months points to a revival in economic momentum.

But all this is not expected to result in a fast-paced recovery next year. Kotak Institutional Equities’ economists say, “We expect FY16 GVA (gross value added) growth at 7.4%. This will likely be followed by a slight uptick towards 7.7% in FY17 as constraints in the form of low capacity utilization, private sector debt overhang and fiscal limitation will keep the recovery tepid.

It’s important to note here that the signs of recovery notwithstanding, brokers have been cutting earnings estimates for FY16 almost each passing month. At the beginning of this fiscal, Kotak had estimated Sensex earnings will grow 18%. By November, it had cut earnings growth estimates to a mere 6.5%.

Of course, the moot question is what has happened to FY17 earnings estimates. As of now, they have been reduced, in line with the cuts in FY16 estimates; but analysts still estimate healthy earnings growth of 20%, year-on-year. This depends on factors such as global commodity prices and the pace of recovery and, hence, can be at risk of being cut further. This year, automobile and consumer goods firms benefited from weak commodity prices. This advantage will be lost, unless commodity prices fall further. Worse still, if prices of raw materials rise, calculations will go awry. The high amount of non-performing loans at banks could mean increased provisions in future and, hence, lower earnings.

The risks to earnings growth and rich valuations are hardly a recipe that will excite investors in Indian markets. But on the other hand, the markets are better positioned, thanks to better demographics and the resultant domestic demand-led growth. And if the government is able to push through reforms such as the goods and service tax, investors will undoubtedly be enthused.

In sum, the lack of great investment alternatives in other emerging markets could well ensure global investors stay interested in the India story. Economists at Morgan Stanley India Co. Pvt. Ltd say, “India remains one of the few bright spots in Asia: it is one of the few emerging markets which has completed its macro adjustment phase and also one of the few Asian economies which is not facing issues of a high level of debt and unfavourable demographics."

AGRICULTURAL INPUTS: monsoon rains key for revival

Agriculture input providers are entering the New Year with trepidation about how the monsoon will pan out in 2016.

Especially so as the crucial levers of Indian agriculture—notably farm incomes—are already under pressure due to low product prices and two successive years of below-normal monsoon rains.

The year 2015 started off well with the early onset of monsoon rains. But, after the initial splash, a long dry spell ensued, hurting the summer crops and demand for agriculture inputs.

“Though the acreages were a tad higher by 1% y-o-y (year-on-year), poor moisture content in the soil adversely impacted yields. Also, a shift in the cropping patterns from key crops (cotton and paddy) to short-duration crops (such as pulses) impacted the consumption of agrochemicals in the domestic market," Emkay Global Financial Services Ltd wrote in a note.

In the crucial September quarter, the aggregate sales of eight notable agrochemical companies dropped 3%. The sales of seven fertilizer firms grew by a muted 4%.

These dismal conditions overshadowed the winter crop season. The major reservoirs accumulated less water and crop sowing was delayed. The scenario changed with the strong onset of the north-east monsoon. But cyclonic weather and excessive rains in the southern states have dimmed crop prospects. With sales already slow in the summer crop season, companies are worried that poor off-take in the current season will lead to a pile-up of inventories.

“The takeaway from the managements’ conference call indicate(s) that higher inventory in fertilizer poses near-term concern while delayed rabi crop sowing to impact near-term demand," Emkay said.

Hence, the crucial importance of the monsoon rains in 2016. Compared with the previous year, many agrochemical companies are expected to end 2015-16 with subdued growth or a drop in sales.

Even the exports of agrochemicals are facing headwinds due to low crop prices and depreciation in the currencies of importing countries. A good monsoon will set agricultural activity in motion, clear inventories and reduce pricing pressure.

That, in turn, will help bring normalcy to the industry.

“Though monsoons are always very crucial in India’s rain-fed agricultural system, their onset assumes all the more significance for next year as farmer sentiments/profitability have hit new lows this year," B&K Securities India Pvt. Ltd said in a note. R. SREE RAM

AUTO: Demand-pull key to earnings upgrade

After two dull years, the auto sector is poised for a revival in 2016. However, the growth rates are likely to be uneven across various segments.

Of the pack, medium and heavy commercial vehicles should continue riding the robust double-digit growth that market leaders Tata Motors Ltd and Ashok Leyland Ltd posted in the last few quarters. Even after the low base effect wears off, truck sales would be supported by low interest rates and the need to replace an aging fleet.

However, the same is not true of light commercial vehicles (LCVs), which are still languishing with declining year-on-year sales for several months.

Excess capacity in the system and high delinquency on loans to this segment is keeping lenders away. But, eventually, higher truck sales will trickle down to boost this segment and 2016 may see the segment recover from contraction to flat sales.

Ashok Leyland’s stock has surged over the last few quarters, riding on strong volume growth. Tata Motors’ fortunes, however, are weighed down by LCVs, which account for a significant portion of its overall volumes.

Meanwhile, passenger cars posted decent growth in the mid-single digits until November. New launches boosted sales and discounts continued to aid volumes. Market leader Maruti Suzuki India Ltd mirrored this in that most of its sales accretion in the last few months came from new launches.

The company will continue to be among the best plays in the auto sector as sustained volume growth and benign commodity prices will sustain profit margins and earnings growth in the quarters ahead.

But two-wheeler firms, especially those with a higher proportion of motorcycle sales such as Hero MotoCorp Ltd, may face declining growth rates. In November, after the festive season, Honda Motorcycles and Scooters India Ltd’s sales of motorcycles and scooters declined from the year-ago period. Overall exports, too, have not seen much traction across two-wheeler makers.

The prospects for 2016 for two-wheelers is not encouraging, with only urban discretionary spending being the trigger for sales.

In terms of profitability, auto firms may continue to reap the benefits of low input costs. That said, a very cautious growth in volumes may cap upsides in operating margin from current levels. Any triggers to earnings and valuation upgrades will have to come through higher demand and sales growth.

VATSALA KAMAT

AVIATION: Lower oil price bonanza to continue in 2016

Lower crude oil prices are the primary reason why Indian aviation firms were able to report profits in the first half of this fiscal. The typically stronger December quarter is expected to show up a remarkable performance, too, which means the New Year shall start on a positive note. What’s more, the outlook on crude prices in 2016 is subdued, and that means the party should continue.

In its Asia Pacific Transportation report on 25 November, Citigroup Global Markets Asia analysts pointed out that for January-October 2015, the average Brent prices came in at $55 per barrel, declining 48% on a year-on-year basis. “Currently, Citi’s in-house commodities team forecasts Brent oil price at $53 in 2015E and $52 in 2016E," said the report.

The lower crude price has meant aviation fuel expenses as a percentage of revenue have declined substantially in the last 10 quarters for both Jet Airways (India) Ltd and SpiceJet Ltd (see chart). The June quarter financial results of InterGlobe Aviation Ltd, which runs IndiGo and listed on the stock markets in November, also show the enormous benefits it enjoyed from lower crude prices. To that extent, the profitability of aviation companies will get a boost in 2016.

The other factor that investors must watch out for is domestic passenger growth, which has been nothing to complain about in 2015. For January-October, passengers carried by domestic airlines increased about 20% on a year-on-year basis, according to data from the Directorate General of Civil Aviation.

Even as the numbers for this year are encouraging, the high base could well mean slower growth in the coming year. CRISIL Research estimates strong 18-20% growth in domestic passenger traffic in fiscal 2016. “This is expected to moderate slightly to 12-14% growth in 2016-17, owing to a high base," maintains CRISIL.

While the operating environment is likely to be healthy for aviation companies in 2016, investors would do well to keep a tab on how the balance sheets of Jet Airways and SpiceJet shape up. Shares of both companies have outperformed the benchmark Sensex in the recent past, as market leader InterGlobe Aviation’s listing led to a re-rating of the sector. Investors will also keep an eye on developments on the government’s aviation policy. PALLAVI PENGONDA

BANKING: Bad bad loan problem

At the press conference after the December monetary policy review, Reserve Bank of India (RBI) governor Raghuram Rajan expressed the hope that bank balance sheets would clear up by March 2017.

How banks remove non-performing loans from their books will be a key theme to watch out for next year.

On the face of it, an economic recovery has started and, indeed, growth accelerated in the second quarter. However, gross bad loans still increased 6% over the quarter and 26% from a year ago. The problem is worse for public sector banks.

If one adds restructured loans to the equation, then the total stressed assets in the banking system are close to 10%.

Yes, RBI has dissuaded banks from restructuring any more loans by asking for increased provisioning for such advances. But loans refinanced under the 5:25 schemes and sales to asset reconstruction companies show the underlying stress in company balance sheets. The 5:25 scheme allows banks to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every five or seven years.

The high level of bad loans has made banks reluctant to lend. The numbers till end-October show bank lending to industry contracted 0.3% this fiscal. Credit growth usually lags gross domestic product growth, and that does offer hope that things will improve next year. However, that has to be weighed against the fact that there is a lot of unutilized capacity in the system, especially in industries such as cement and power. Until this slack is absorbed, banks may not see serious project finance proposals.

The struggle to lend more will come against the backdrop of threats to profitability, and margins, from two factors.

One, RBI is keen that banks pass on rate cuts more to their borrowers. It will soon introduce a new system of marginal price costing to calculate base rates.

Second, the existing lenders will face competition from new payment banks, which might eat into their deposits’ market share.

On top of all this, there is the googly of the government introducing the bankruptcy code in the budget. It might disrupt many practices and change lender and borrower behaviour. RAVI KRISHNAN & KRISHNA MERCHANT

CAPITAL GOODS: Winter is still here

That an economic recovery is on can be seen from the second quarter gross domestic product (GDP) growth of 7.4%. Gross fixed capital formation contributed as much as 29.9% of this growth. Clearly, the government’s effort to increase its capital expenditure is having an effect. But is it enough to turn around the fortunes of capital goods makers in 2016?

The big firms don’t seem to think so. After domestic order inflows of the top seven capital goods makers in the September quarter fell almost half from a year ago, several have pared their guidance for this fiscal. Many see growth only three to four quarters from now.

Not without reason.

The pace of recovery in key sectors is still slow. Even if order inflows increase, execution challenges persist. Land problems and resource non-availability continue to haunt. Revenue for capital goods makers is also suffering because of tight liquidity conditions and stretched balance sheets of clients.

Then there is the matter of over-capacity. Take thermal power, for instance. In April-September, plant load factors for thermal plants were a poor 61%—a five-year low. Note that this sector is unlikely to see a government push—like in some other industries such as roads—because of the thrust on renewable sources of energy. Or, take the cement industry. Trailing 12-month capacity utilization is at 70%.

Thirdly, any hopes of making up for weak domestic orders from exports have also dissipated. Weak prices of oil and other commodities mean several key export markets are no longer lucrative. “Even as net profits of companies in the industrials sector under our coverage declined 26% in (fiscal) 2015, we expected a sharp recovery in (fiscal) 2016 and (fiscal) 2017, with estimated profit growth of 78% and 38%, respectively, at the start of this fiscal; these estimates have now been revised down to 14% and 47%, respectively. There could be further downside risks to (fiscal) 2017 estimates," said a note from Kotak Institutional Equities. That sums up the medium-term outlook. RAVI KRISHNAN

CEMENT: The long wait for demand recovery

The outlook for the cement sector remains difficult going into 2016 as the much awaited demand from the real estate and construction sectors is yet to take off.

Even though a stable government has been in power for a year-and-a-half, cement demand growth remains at a decadal low of—2% so far this fiscal. “Theoretically, volume growth of 6-7% in the second half of FY16 is possible but credible catalysts are missing; hence, FY16 is likely another sub-5% growth year. Volume growth of 8-10% cannot be achieved before FY18 and this, too, will require a sharp jump in public infra investments beyond roads," said Ambit Capital Pvt. Ltd in a note dated 19 October.

High capacity and weak demand continues to ail the cement industry. Public infrastructure investment remains elusive, subdued rural growth because of weak monsoon rains, diversion of farmers’ cash flows for purchase of agricultural machinery rather than housing construction and a clamp-down on black money is hurting urban housing demand in tier-II and tier-III cities, Ambit added in the note.

Supply continues to exceed demand. The cement industry cranked up 119 million tonnes (mt) of incremental capacities over the past five years versus ~78 mt over FY05-10, anticipating super-high demand. However, the expected demand failed to fructify, triggering overcapacity, with utilization rates plummeting from 89% in FY10 to 74% in FY15, said Vinay Khattar, head of research at Edelweiss Financial Services Ltd, in a note dated 1 December. Currently, utilization levels for the cement sector are close to a historical bottom at around 70%.

Depressed prices and poor demand led to another quarter of subdued performance for cement firms in the September quarter. Overall, net sales grew at a slightly better rate—2% year-on-year, against the decline seen in the past two quarters for the top 10 firms by market capitalization, according to a Mint analysis (see chart 1). The top 10 firms include ACC Ltd, Ambuja Cements Ltd, Birla Corp. Ltd, India Cements Ltd, JK Cement Ltd, JK Lakshmi Cement Ltd, Prism Cement Ltd, Shree Cement Ltd, Ramco Cements Ltd and UltraTech Cement Ltd.

Net profit of cement firms continued to shrink, down 12.4% in the September quarter, compared with a year ago, as volume growth remained tepid and prices declined in all the regions, except the south. Earnings were also affected by provisioning, which companies had to set aside for the state-run District Mineral Foundation.

Mid-size firms JK Lakshmi Cement and Dalmia Cement Ltd clocked slightly better volume growth, helped by expanding capacities. Even the large south-based firms such as Ramco and India Cements saw higher realization, helped by pricing discipline.

The only silver lining is the lower price of imported coal and increase in spending on infrastructure by the government.

Cement stocks continue to trade at expensive valuations in the absence of a demand-led recovery. The upside may be capped as there may not be a re-rating in the near term. KRISHNA MERCHANT

CONSUMER GOODS: Firms wait for the shopping bags to fill

In 2015, the packaged consumer goods sector has seen sluggish growth in sales by volume as rural demand slowed and urban demand did not accelerate to the extent expected. After the September quarter results announcements, companies reported some improvement in urban growth rates but not enough to offset the slowing rural demand.

The path to a recovery does not seem well defined. For one, falling commodity prices are a problem. They have given firms the legroom to spend more on advertising, cut prices and even boost profitability. But combine this with weak volume growth, and we get slowing sales growth. This has depressed sales growth in many categories.

So far, the signs are that demand conditions may weaken as rural distress is spreading. Consumers in cities bear the task of propping up growth. They have the numbers to do that but have lacked the appetite. It is not clear why that should change in 2016. Sure, lower interest rates could be a factor, although it matters more to consumer durables than to mass consumption products.

The overseas operations of Indian-owned companies are in some trouble, chiefly due to volatility in emerging markets. That area of operation, too, is not supporting growth.

A recovery in economic growth could do the trick. Recent gross domestic product data suggests that the going is good, but there are doubts on whether the new data is overstating the growth phenomenon. Activity on the ground and corporate earnings are not supportive of this level of growth.

In 2016, the hope is that urban demand will recover faster and drive sales growth. Otherwise, it will be a washout year for the sector. A bottoming out of falling commodity prices, too, could stem declining inflation; in turn, providing a floor for sales growth to recover.

A recovery in consumption trends, especially in urban markets, is a key trigger to watch out for in the medium term. An impending increase in central government pay scales could be a trigger for consumption, too, although it is usually visible with a lag and may be more evident in the consumer durables and automobile sectors.RAVI ANANTHANARAYANAN

INFORMATION TECHNOLOGY: DIgital is the name of the game

For some time now, the performance of India’s top information technology (IT) services firms has diverged. Until the last year, Tata Consultancy Services Ltd (TCS), Cognizant Technology Solutions Corp. and HCL Technologies Ltd were doing well, while Infosys Ltd and Wipro Ltd had been laggards.

In 2015, the theme of divergence has continued, although there has been some shift. Infosys has bounced back well under its new leadership, while TCS has slipped, underperforming Cognizant by a wide margin. There’s nothing much to write home about HCL’s performance, while Wipro remains a laggard. Interestingly as a result, growth in most of the India-listed companies has been in a similar range (single digits, year-on-year), while the rate of growth of Cognizant has been far ahead (high teens).

As far as the outlook for 2016 goes, the overall demand environment looks fairly sanguine, although one cannot expect one particular trend across companies.

Growth will depend on how companies position themselves to take advantage of emerging spending patterns. Companies that have an edge in the area of digital services will stand out with superior growth, just as they have in the past couple of quarters. Commentary from IT companies suggests that much of the discretionary spending is happening around digital services.

JP Morgan’s analysts name one of their reports, “Digital—sweet and rosy top-down, but less so bottom-up; we see Digital as a wave with polarized outcomes."

Analysts at Kotak Institutional Equities wrote in a note last month, “It does appear that firms with inherent strength in run-the-business services are struggling to sustain momentum while those with greater exposure to discretionary spending are gaining."

Another trend that is expected to continue is the resurgence of mid-cap companies, thanks to the decrease in average deal sizes in the industry.

Those firms that have a created a niche in particular service lines have managed to outpace large companies on growth. Again, mid-cap firms that have a handle on digital capabilities can be expected to outshine peers.

Finally, forex analysts expect continued strength for the US dollar in 2016, which augurs well for the industry. MOBIS PHILIPOSE

INFRASTRUCTURE: New orders trickle in but financial stress remains

Infrastructure construction companies’ fortunes will continue to be a mixed bag in the near term.

The trend of rising government tenders so far in fiscal 2016 is likely to continue. Note that the public sector tenders between April and October were 34% higher than a year ago and that the contracts awarded also grew by 19%.

However, this would take time to trickle down to improve the balance sheets of infrastructure firms.

A delay in project execution for want of timely clearances and strained financials continue to plague the sector.

The average net revenue of 52 large and mid-sized companies on the Capitaline database contracted in the last four quarters (see chart).

And, with fixed costs remaining elevated, the operating profits across most companies are also sagging.

Some companies are doing better by curtailing variable costs to improve operating margins.

Individually, across infra companies, the trend is mixed in that the firms with operational road assets are likely to fare better in the coming quarters, as has been the case in the recent past.

Of course, the orders in telecom and power have been picking up, which will reflect in higher revenue after a few quarters.

Road orders are switching lanes from the build-operate-transfer model to engineering, procurement and construction.

Efforts to ease clearances and revive old projects may see results in the coming year. Interestingly, the latest (October) data shows that the contribution of infrastructure loans to total credit was stable at 15%.

However, the key concern is the increasing interest burden for companies in this universe.

Data analysis show interest costs inching up and the interest cover falling. However, the declining interest rate regime in the near to medium term might bring respite as monetization efforts by firms are few.

Analysts feel the sector has seen its worst and things should improve. The newer firms may see faster improvement in operating performance and even net profit. Older firms are still caught in a web of sticky legacy orders and losses. VATSALA KAMAT

METALS: A year of cuts

What could reverse the grim outlook for metal producers? As New Year wishes go, a return of investment-led growth in China, a flood of liquidity that lifts global demand or a global economic recovery would all be good news. If one is realistic, then, measures such as production cuts, better efficiency and lower costs and lower capital expenditure can help.

Metal companies have been affected by weak demand. China’s shift to a consumption-driven economy is hurting. This shift has also coincided with slower economic growth. This lower appetite is not being offset by growth elsewhere. Weak conditions in emerging markets and parts of Europe are actually making matters worse.

Prices have taken a hard knock. In 2015, iron ore prices are down by over 40% so far, aluminium prices are down by 18%, zinc by 30.3%, and copper by 27.7%. Falling iron ore prices have put pressure on steel prices, which have declined sharply.

Since demand is not in their control, companies are cutting costs and improving productivity. New projects are being delayed. The overall effect of these measures has not been much so far. New capacities are creating supply-side pressures, notably in iron ore. Companies with new capacity want older ones to shut shop, especially those in China. That country’s excess metal is flooding global markets.

In 2016, a shutting down of unviable units could go a long way in restoring the demand-supply balance and support prices. A near-term risk is if the US Fed decides to hike interest rates. Commodities may lose more sheen then.

In India, this difficult period for the industry coincides with new capacity coming on the market and higher royalties.

The pressure on profitability can be expected to continue in 2016.

The government may restrict imports to protect domestic industry. But that may see international prices slide further. A declining trend in interest rates should provide some relief on the working capital front. If 2015 was a difficult year, the prospects for early 2016 don’t look bright either. RAVI ANANTHANARAYANAN

OIL: What’s in store for companies next year?

Singapore complex gross refining margins (GRM) have averaged higher so far in this quarter, compared with the September quarter when it was $6.3 a barrel. Accordingly, state-owned refining and marketing firms such as Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd should report better results in the December quarter. The New Year should, therefore, start well for refining firms. Reliance Industries Ltd, too, will benefit.

GRM is the difference between the price at which refiners purchase crude oil and the price at which they sell the end product after distilling it.

However, the outlook on refining margins for 2016 is expected to be a tad worse than 2015. In a note to clients on 30 November, Nomura Research analysts forecast (Singapore) complex margin to rise to $7 a barrel in 2016, reflecting the tight supply environment. “In 2016F, we expect demand to continue to outweigh net capacity addition, with total capacity addition (net) of 1,211k bpd (barrel per day) vs. demand growth of +1,300k bpd," Nomura said. The brokerage forecasts Singapore GRM for 2015 at $7.6 a barrel. Vikas Halan, Moody’s vice-president and senior credit officer, says regional benchmark Singapore complex refining margin will remain healthy, averaging $7-$7.5 per barrel in 2016. However, this will be a tad lower than $7.5-$8 per barrel Singapore margin that Moody’s estimates for 2015.

It goes without saying that investors must follow global crude oil prices as well. Lower prices have taken a toll on oil producing firms and Oil and Natural Gas Corp. Ltd, Cairn India Ltd and Oil India Ltd are no exceptions. Their price realizations have taken a beating in recent quarters.

Sure, lower oil prices help curtail under-recoveries for selling fuel below cost. But under-recovery is no longer the menace it once was. Diesel deregulation has ensured under-recovery falls substantially. According to data from Petroleum Planning and Analysis Cell, under-recovery of oil marketing firms fell to 72,314 crore in FY15 from 1,39,869 crore in FY14. Analysts expect under-recovery and subsidy (direct benefit transfer on cooking gas) to drop to about 30,000 crore for FY16.

For January-November, shares of state-run oil refining and marketing firms have outperformed the benchmark Sensex while those of oil producing firms have underperformed. PALLAVI PENGONDA

PHARMA: Battles on many fronts

Since the year was difficult for most sectors, investors should have flocked to pharmaceutical stocks as a defensive bet.

Indeed, the sector is up by 12.5% on BSE Ltd so far in 2015, compared with a 6.7% decline in the broader markets. That looks good but was not its best performance, as the sector is actually down by 11.2% from its peak.

A number of reasons are behind this.

The US market is one main reason for this decline. Its generic drugs market is important for sales growth and profitability. Sales here are under pressures for various reasons.

The US Food and Drug Administration’s (FDA’s) inspections of Indian facilities have unearthed problems at some units, affecting new approvals for the companies concerned.

This is taking longer than expected to resolve. The market itself is seeing stiff competition and consolidation of distribution channels, which is affecting price realizations. The pace of new launches that can potentially be large contributors to sales, too, has been slower.

Now, the Indian market has been on a steady recovery path but not enough to offset the US market’s underperformance.

The September quarter saw slower sales growth as a poor monsoon affected seasonal drug sales.

Sales growth in the earlier quarters was relatively better.

Companies have been seeking growth opportunities in other emerging markets, but the picture is clouded by sharp currency fluctuations. That has affected performance in multiple ways and, in some cases, local economic crises have affected sales growth as well.

In 2016, one can hope that the Indian market will do its bit for growth. The US market could remain a question mark, but the second half may be better.

If any of the big companies such as Sun Pharmaceutical Industries Ltd or Dr Reddy’s Laboratories Ltd get a green signal from the US FDA for their affected units, it will be a positive trigger.

There is hope the US FDA will step up approvals in 2016. But the price erosion risk remains. Even as sales growth is under pressure, companies continue to invest in research, need to pay employees to retain talent, and spend more to improve compliance. These reasons have and may continue to affect profitability.

Even now, the sector is one of the more promising ones, with very low debt levels and a robust product pipeline. And, many factors affecting the sector are external.

If companies use this period to put their house in order (from the US FDA’s compliance viewpoint), then they should be able to win back investor confidence. RAVI ANANTHANARAYANAN

POWER: Policy execution should gather pace

The outgoing year has been a remarkable one for the power sector. Not only have fuel (coal) costs softened, coal availability also improved. The number of plants facing critical coal stocks fell sharply last year. The supplies for gas-based power plants also increased.

A government package helped improve generation and utilization levels of gas-based plants. From 18% in January, the plant load factor or utilization levels of gas power plants improved to 25% in September and 23% in October.

As the adjoining chart shows, the utilization of thermal plants also improved in September and October. The improved metrics helped several companies perform better, though only incrementally.

In the September quarter, NTPC Ltd’s coal plant utilization levels increased four percentage points from a year ago. Tata Power Co. Ltd benefited from low fuel costs and better generation. Hydro power generators NHPC Ltd and SJVN Ltd clocked better return ratios.

“The Q2FY16 numbers of both regulated players and independent power producers were above our estimates, driven by better availability of fuel, declining imported fuel cost and better realization during the quarter," ICICI Securities Ltd said.

But the performances are far from optimal. Around one-third of the thermal power capacities remain unused. In the gas sector, only a quarter of the capacities are being used. Many private plants are awaiting tariff orders. Several others are looking for buyers.

The solutions to most of these problems lie at the troubled state electricity boards (SEBs). Due to a weak financial position, the SEBs are not purchasing sufficient power. To revive the SEBs, the Union government introduced a new scheme.

Dubbed as the best attempt yet, the plan aims to reduce debt, costs and structurally bring down distribution losses. But, much of the success of the new plan will depend on execution, especially at the state level. “Effective execution of this programme remains to be seen as our calculations suggest that the top three loss-making discoms (distribution companies) would still need annual tariff hikes of 4-7% to turn profitable—a tough proposition in the run-up to state elections," Religare Capital Markets Ltd said in a note.

That makes 2016 a crucial year for the Indian power sector. This year will give vital clues on the progress of this potentially game-changing programme. Any indication that the scheme is on track to achieve the intended benefits will infuse a fresh lease of life into the power stocks, which are trading at multi-year lows. R. SREE RAM

REALTY: Outlook better for real estate firms

The odds appear to be improving for the real estate sector, signalling a better outlook for 2016.

The first ray of hope came a couple of quarters ago, with reforms such as allowing foreign direct investment, or FDI, and real estate investment trusts. This revived some projects that were stuck for want of funds. Also, private equity (PE) investment into realty reportedly trebled in the first six months of 2015.

However, these measures did little to push sluggish property sales. Consumer and investor confidence went up a few notches due to the proposed salary hikes in the 7th Pay Commission (from 2016). Meanwhile, home loan rates are down by about 100 basis points in the last few months. They are expected to soften further. Together, they may boost demand for housing. One basis point is one-hundredth of a percentage point.

The September quarter already saw a 27.6% rise in aggregate net sales of the BSE realty index firms, although the previous year base was low with a negligible 1% growth. Credit deployment by banks also showed healthy growth in the last few months (see chart).

Operating cash flow should improve in 2016, but the stress would continue given project delays and high inventory of unsold projects in the pipeline. That said, the trend may be mixed given that housing prices are still high. A Moody’s Investors Service report says DLF Ltd, Lodha Developers Ltd and Oberoi Realty Ltd will see most sales and cash-flow pressures as they operate in high-priced Delhi and Mumbai. Prestige Estates and Projects Ltd and Brigade Enterprises Ltd, with projects in southern cities, may fare better amid stable housing demand.

Meanwhile, activity on commercial leasing, which picked up in the last two quarters, may get better, with the improved business milieu. This will have a trickle down effect on the residential segment, too.

Yet it may be too early for retail equity investors to cheer. The BSE realty index contracted 16% over a year, more than twice that of the BSE Sensex. A report by Cushman and Wakefield says that while PE deals scaled up to 2008 levels, this time around they were through special purpose vehicles for specific projects, and that, too, by way of structured debt, not equity.

What’s weighing down the sector is the high interest outgo of these debt-laden firms. The September quarter interest cost at 15.2% of sales was about 130 basis points lower than a year ago. Therefore, it would take time for the sector as a whole to turn around and deliver healthy investor returns. VATSALA KAMAT

RETAIL: Awaiting revival in consumer spending

The New Year will start well for retail firms. December quarter results are expected to be strong, considering the period includes the impact of the festive and wedding seasons. Navratri has completely shifted to the December quarter this time unlike last year when companies had felt its impact in the September quarter, resulting in a lower base this time. In fact, management commentary (from Titan Co. Ltd and Shoppers Stop Ltd) on initial festive sales has been quite encouraging.

This should translate into better like-to-like or same store sales growth for retailers. As the chart shows, barring Future Retail Ltd, other retailers had a rather dull September quarter on the same store sales growth front. Like-to-like or same store sales growth refers to comparable sales growth from stores that have been open for at least a year.

But the real test will be after the December quarter. Economists forecast the implementation of pay and pension increases recommended by the 7th Pay Commission with effect from 1 January will boost consumption. Accordingly, spending on discretionary items is likely to increase. While that augurs well, competition from online retailers continues to be a threat, although analysts reckon the impact of online competition is moderating. Brick-and-mortar firms are expanding online and it will be interesting to watch how things pan out of this front.

What matters for stocks, apart from better sales growth? For Shoppers Stop, subsidiary HyperCity’s performance is key. After consistently reporting profit at company Ebidta (earnings before interest, depreciation, tax and amortization) level for four quarters, HyperCity posted a loss in the September quarter.

For Titan, gold prices will matter. Redemptions from the new Golden Harvest Scheme are expected to contribute 450 crore to revenue in March quarter. On the other hand, Titan’s watch segment may continue to remain subdued. “We believe the underlying sentiment remains weak. This, along with continued regulatory risk, makes Titan a fit case for our reduce rating," Nomura Research analysts wrote in a note on 2 November.

While Bata India Ltd grapples with internal challenges on supply chain, subdued demand, surge of online retail and its offline retail-based business model have magnified the complications, Spark Capital analysts wrote in a report on 9 November. Even as stock-specific concerns remain, it is essential that there is a meaningful pick-up in demand; and unless that happens, it is not going to be a smooth ride for retail companies in 2016. PALLAVI PENGONDA

TELECOM: R-Jio holds key to industry fortunes

Telecom stocks have underperformed the broader markets by around 20% in 2014, and around 5% so far this year. Will 2016 be better? The answer, of course, lies in the strategy Reliance Jio Infocomm Ltd (R-Jio) will adopt. The problem is that its strategy remains a big mystery.

Left to their own, the incumbents are expected to have better pricing discipline, resulting in an increase in average revenue per user (Arpu). But R-Jio is expected to launch operations in 2016, finally, and early indications suggest it will cause a major disruption. Already, large firms such as Bharti Airtel Ltd and Idea Cellular Ltd are positioning themselves to meet the challenge. They have raised capital expenditure estimates, are front-loading investments and spending increased amounts on spectrum purchases.

Analysts expect R-Jio to offer bundled packs to customers, with pre-determined limits on voice and data usage. If it is able to wean away customers, incumbents will be forced to cut tariffs and match R-Jio’s offerings. Both data and voice tariffs may come under pressure, as a result.

The big question is when Jio eventually launches operations. If its launch gets pushed further, or if it manages only a soft launch next year, the environment will be far more sanguine for the industry.

Another trend that is likely to play out is the gradual phase-out by small firms such as Videocon Telecommunications Ltd. This has already started happening since end-2015, when Videocon sold a part of its spectrum to Idea and Sistema Shyam Teleservices Ltd decided to sell its business to Reliance Communications Ltd. Those who have valuable spectrum, especially ones that can be used for the roll-out of data services, are likely to exit at healthy valuations. Videocon, for instance, has sold spectrum in two of its circles at 2.5 times the amount it paid for it. MOBIS PHILIPOSE

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Published: 11 Dec 2015, 01:22 AM IST
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