BackIndia’s corporate sectors: What’s hot, what’s not
Our Mark to Market team examines earnings in key sectors during the September quarter
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Mumbai: The September-quarter results of Indian firms were marginally ahead of expectations although, on an aggregate basis, there was nothing much for the markets to cheer. Aggregate earnings estimates were more or less unchanged, which is also reflected in the fact that BSE’s Sensex index is currently at almost the same levels as mid-October, when the results season began.
Cumulative revenues of the 30 Sensex companies rose by 14.8% year-on-year, while their operating profit increased by 18.5%, according to data compiled by Citigroup Research. Though the numbers look impressive, it’s important to note that some of these companies got a boost in revenue and profit owing to the plunge in the rupee last quarter. Earnings growth in the domestic sector fell to just 1.6%, if one were to exclude firms that are sensitive to forex movements from the universe of about 120 companies tracked by Citi. The performance of domestic cyclical businesses was weak and reflects the underlying weakness in the economy. Export-oriented sectors such as information technology and pharma did well, as did companies whose domestic selling prices are linked to the landed price of imports.
Interestingly, the skew between large firms and mid- and small-cap companies widened, with the latter underperforming by a large margin, according to Citi. All told, the results weren’t spectacular, and the commentary by various firms suggests that the outlook isn’t too bright either. That is also seen from the macro data as well as by the expected tightening of both fiscal and monetary policy, which will hurt domestic demand. The silver lining is that market expectations for growth in the current fiscal are low.
The fact that the markets have recently tested all-time highs despite all this shows clearly that factors other than corporate results and earnings revisions are driving valuations.
AUTO: Operating margins surprise amid sluggish demand
Auto companies marked a strong recovery in profitability during the September quarter. The fall in quarterly sales volumes was compensated by higher realizations, which, along with stringent cost management, lifted operating margins by 200-300 basis points (bps) from a year ago. One basis point is one-hundredth of a percentage point.
At some companies such as Mahindra and Mahindra Ltd, a better product mix, with the share of tractors rising from one-fourth to one-third of revenue, helped. Tractor sales have been improving on the back of good monsoon rain. Also, some two-wheeler makers such as Bajaj Auto Ltd had higher exports, which realized better revenue during the quarter, as the rupee depreciated significantly. Stringent cost controls, mainly on “other expenses" related to marketing and promotion, were seen across the board and shored up profit margins.
Maruti Suzuki India Ltd’s (MSIL) operating margin, at 12.6%, jumped 650 bps from a year ago, well above consensus estimates. A stronger rupee versus the Japanese yen, which affects the company’s import costs, helped. Meanwhile, the management told analysts that it intends to cut import costs by 2-2.5% annually from the current 19.5% of sales, which bodes well for profit expansion. That said, the firm’s outperformance, including the 20% growth in sales by volume, can be partly attributed to the weak base of the year-ago period.
The medium and heavy commercial vehicles segment remains the problem spot with no recovery in sight even in the second half of fiscal 2014. Plummeting sales and hefty discounts have finally led to margin erosion. Ashok Leyland Ltd’s September quarter operating margin shrank to 2.5%, even as Tata Motors Ltd’s domestic entity continues to clock losses. In fact, for Tata Motors, the Chinese operations and other overseas subsidiaries under the JaguarLand Rover banner together comprise around 70% of consolidated revenue and all of the net profit. This is unlikely to change in the next few quarters, as the domestic commercial vehicle segment is currently weighed down by low growth, inflation and tight liquidity.
The auto sector, where net profit in aggregate terms expanded by about 40% from the year-ago period, was clearly among the top three outperforming industry segments during the quarter.
Will this continue?
Yes, albeit after a dip in the December quarter, which is normally the weakest of the four, one may see sales gathering momentum. But this would largely come from two- and three-wheelers. Passenger cars may only see flat sales for fiscal 2014, although the following year may see an improvement. Further, the profitability of some firms may take a beating in the December quarter, which will see the full impact of the depreciated rupee on imports of components.
Shares of leading auto firms have seen earnings upgrades after the September quarter results, with prices rallying in the last one month, too. However, valuations, which range between 15 and 18 times one-year forward earnings per share, are fair. A further appreciation in stock prices will come only with sustained improvement in sales volumes, expected from the fourth quarter of fiscal 2014. — Vatsala Kamat
BANKS: asset quality woes worsen
The September quarter saw a host of familiar themes again play out in the Indian banking industry. The dichotomy between private and public sector banks continued. Asset quality worsened, a particularly volatile quarter hit the investment book and provisions weighed down profits. With continued sluggishness in the economy and a contraction in manufacturing output, expect more of the same for the rest of this fiscal.
The increasing stress for banks is evident, albeit slightly, even in the books of private lenders. The combined net profit of this group grew 19.1% from a year ago, the lowest in at least 15 quarters. For public sector banks, net profit fell by almost half, the fourth straight quarter of decline.
Sure, the money set aside for bad loans was one reason for this fall, but a worrying trend for state-owned banks is the slip in pre-provisioning profits as well. Operating profit for this set of lenders declined for the first time in many quarters, owing to mortality table revisions (leading to higher pensions) and increased wages. Cost-to-income ratio increased almost across the board and is likely to squeeze profitability in the coming quarters as well.
Bad loans continued to grow, if at a slower pace. The banking system added ₹ 20,650 crore in bad loans, against ₹ 28,371 crore in the three months to June. A bulk of this addition was from public sector banks. Not only were slippages (or fresh additions to bad loans) elevated, “recoveries/upgrades came in lower than anticipated, which, coupled with lower write-offs", led to rising gross non-performing assets (NPA), says an analysis by Edelweiss Financial Services Ltd.
A second worrying sub-trend in the asset quality numbers is the increasing stress in the mid-corporate and small and medium enterprise (SME) book. State Bank of India’s (SBI) mid-corporate NPA ratio hit 10.21% while for Bank of Baroda, this rose to 5.56% at the end of September from 3.29% six months earlier. Thirdly, gross NPA numbers don’t capture the whole picture, given the massive amount of loan recasts and technical write-offs. If one includes the renegotiated loans, then total stressed assets reach close to 16% of the loan book for Punjab National Bank (PNB) and 9% for SBI. A few banks also reported higher slippages from the recovered book during the quarter.
Given the Reserve Bank of India’s stringent views on write-offs and lower recoveries and upgrades, gross NPAs should continue to rise, especially in a rising interest rate environment. Moreover, the provision coverage ratio of the industry is around 50%, low by global standards and declining in recent times. Further provisions to sustain even this coverage will be another drag on profitability. That will limit internal capital generation, especially for public sector banks, despite government promises of recapitalization, which could leave them underprepared when the next growth cycle kicks off.
— Ravi Krishnan
CAPITAL GOODS: tough times to continue
The bright spot in the September quarter earnings of the capital goods industry was the slight improvement in order inflows. Part of that was owing to a low base, such as in the case of Bharat Heavy Electricals Ltd (Bhel), and some other firms were helped by government orders. But these gains were not spread across the board and some companies such as Thermax Ltd saw a decline in order inflows. Moreover, the outstanding order book of most firms declined from a year ago, raising questions on revenue gains in the coming quarter.
As it is, the combined revenue of the firms that make up the BSE Capital Goods index fell 7.3% from a year ago, the third straight quarter of decline. That was owing to the slow pace of execution, mostly because private clients have pulled back. As the firms struggled to match cash flows with revenue, the resulting pile-up in receivables meant that the net working capital cycle for many firms in this industry is stretched, weakening their balance sheets.
For instance, Bhel’s debtor days increased to 320 days at the end of the September quarter, against 306 days at the start of this fiscal year. For Thermax, the number of days taken to collect revenues after a sale has increased to 118 days, compared with 98 days six months earlier.
Slow execution, weak order inflows leading to under-utilized capacity and cost overruns put pressure on operating margins. Moreover, some of the orders executed were so-called short orders, which are not as profitable. Thus, the combined operating margin of these firms stood at 6.49%, down from a year ago, but better than the June quarter numbers.
Many capital goods makers are also saddled with huge debt, which is squeezing profitability owing to increased interest costs. Thus, net profit for this set of firms declined 43.5% from a year ago, the sixth straight quarter of decline.
These very set of factors that hit the September quarter performance will trouble the capital goods sector in the medium term. Sure, the government’s Project Monitoring Group has cleared ₹ 3.69 trillion worth of stuck projects, according to a Citigroup Global Markets Inc. report. However, over 90% of these are related to the power sector, where there are concerns of overcapacity. In any case, average realizations of power equipment have declined nearly one-third from their peak, as Religare Capital Markets Ltd calculations show.
Above all, a sluggish macroeconomic environment and lack of business confidence are drags. A rising interest rate environment will dampen hopes of a revival in the capital expenditure cycle, and add further pressure to profitability of these firms. “Companies have cut guidance for FY14 (Larsen and Toubro Ltd being the only exception) and continued to focus on rationalization of cost structures," sums up Motilal Oswal Financial Services Ltd. In short, till the economy improves, capital goods stocks will continue to languish. — Ravi Krishnan
CEMENT FIRMS: cost pressures persist
Cement companies had a dismal September quarter. Even though the top three firms—UltraTech Cement Ltd, ACC Ltd and Ambuja Cement Ltd—clocked flat or marginally better volumes when compared with the year-ago period, net realizations plunged as firms vied for greater market share. This, coupled with a sharp spike in freight and power costs—an unfavourable currency for those importing coal—and negative operating leverage dragged operating profit down for most companies.
Cement companies (46 listed ones) recorded the worst quarter in three years as net sales declined 6.7%, operating profit halved and net profit slumped 64% from the year-ago period. In any case, given that the monsoon rain slows construction and infrastructure activity, not much had been expected by analysts for the quarter.
What’s hard to tell is whether this marks an inflection point and profits would improve given that attempts are being made at the macro level to tame inflation and currency volatility. Cement prices have been fluctuating in the last two months, rising by 5-6% in the last few days after falling unexpectedly in October. The only reason for this is that in spite of some demand recovery, the oversupply due to huge capacity additions that took place in the last couple of years played spoilsport, hampering price stability. Within the sector, southern manufacturers like India Cements Ltd and Ramco Cements Ltd are likely to post lacklustre December quarter earnings as rains will hurt economic activity in November and December in the region.
Strangely, cement company shares have surged in the last three months, especially those of Ambuja Cement, Shree Cement Ltd, JK Lakshmi Cement Ltd and UltraTech Cement. A sustained rally will hinge on a host of factors, the key being government spending, which could be conservative, as revenue collection remains low. Meanwhile, an increase in housing and commercial real estate activity and industrial projects will increase the demand for cement and improve prices, too. Needless to say, this should offset the cost pressures, which the industry has not been able to overcome for the last several quarters. — Krishna Merchant
CONSUMER FIRMS: falling input costs soften the blow
The packaged consumer goods sector has not been immune to the economic slowdown but companies have tried to keep the growth flag flying, endearing them to investors. A key determinant of how consumer companies are doing is volume growth. On that front, the industry has seen slower growth, especially in the premium and discretionary categories such as personal care. Staples have done better, in comparison.
But there is no major strain visible in the performance of the big consumer companies.
They seem to have managed to do better than the smaller and mid-sized firms and have perhaps snatched market share from them. They have also been expanding their presence in rural areas by increasing the availability of products and widening their own distribution reach.
Rural areas have been doing relatively better, compared with urban India. Packaged consumer goods makers have one more advantage on their side: raw material prices have been soft and that has helped them improve their gross margins. But they have chosen to use these savings not to pad up operating profits but to spend heavily on advertising and promotions and also fund higher salary costs.
Thus, the sector’s sales rose by 8.8% in the September quarter from a year earlier. Market leader Hindustan Unilever Ltd’s domestic sales rose by 9.9% while volumes increased 5%. Volume growth for the home and personal care sector is showing signs of moderating but has not declined sharply. The oral care sector, where competition has increased, is doing well as companies pull out all the stops to expand their market share. ITC Ltd’s cigarettes business is seeing slower sales growth because of sharp price increases, but operating margins expanded as a result.
Soft trends in raw material prices have been helping the sector tide over a difficult period. In the September quarter, material consumption rose by only 4.3%, less than half the rate at which sales grew. That gave the sector ample room to spend more on advertising and promotion (up by 21.5%) and also fund a 20.8% increase in employee costs and all this without denting margins.
The moderation in volume growth is expected to continue as consumer inflation shows little signs of easing. Raw material prices continue to be in the sector’s favour, though some pressure can be expected from the lagged effect of a weak rupee on imported raw material costs.
Companies have taken a pragmatic view, focusing on volume growth and using price hikes in a very limited manner. Reinvesting cost savings in advertising and promotions is also a positive trend. Companies are playing a waiting game, doing everything in their power to stay focused on volume growth. When demand improves, they will be in a position to capitalize on it. The weak link in the chain is raw material costs. If input cost inflation rears up, then companies will be forced to raise prices, putting pressure on volume growth. — Ravi Ananthanarayanan
FERTILIZERS: volumes up, falling global prices a challenge
The September quarter results of fertilizer companies reinforce the belief that the sector is firmly on the recovery path.
Total sales volumes rose by about 6%. The rebound is led by urea, sales of which increased by a healthy 15%. Sales of more remunerative complex fertilizers, though, continue to slide. Due to high inventories in the retail system and subdued demand, firms were forced to cut imports. This led to a 4% fall in complex fertilizer volumes. Nevertheless, the slide in complex fertilizer volumes has slowed considerably. While this points to an improving demand environment, most fertilizer firms reported weak operating performance for the last quarter. Coromandel International Ltd was able to report a healthy operating profit due to low costs. But the fertilizer business of Chambal Fertilizers and Chemicals Ltd, Gujarat State Fertilizers and Chemicals Ltd (GSFC) and Tata Chemicals Ltd suffered because of high inventories in the retail system. Chambal’s trading volumes, for instance, slumped 13% in the last quarter. To liquidate excess stock, GSFC introduced discounts on diammonium phosphate (DAP), a note from Espirito Santo Securities India Pvt. Ltd says. Tata Chemicals’ fertilizer business, on the other hand, was hit by rupee volatility and a subsequent spike in raw material costs.
The outlook for fertilizer firms will depend on inventory liquidation and imports. In a post-earnings conference call, Kapil Mehan, Coromandel International’s managing director, said inventories in the system fell from 7.2 million tonnes (mt) in April to 4-4.5 mt. According to Mehan, if one takes the normal inventory level at 2 mt, the excess stock now is estimated at 2-2.5 mt.
With comfortable water levels in reservoirs and the environment for winter crops conducive, analysts expect excess inventories to get liquidated soon.
What is bothering analysts, however, is a sharp fall in fertilizer prices in overseas markets. Prices in global markets are trending lower due to greater supplies, the break-up of a cartel and subdued demand. Low prices can help improve margins of domestic firms as they import raw materials to manufacture complex fertilizers. But a sharp drop in prices (which are down over 24% in October alone) can lead to a spike in imports, which could send prices lower in the domestic markets. “Our recent interaction with companies’/industry participants corroborates the fact that traders have started becoming aggressive in the marketplace. Likelihood of reduction in farm gate prices has become imminent during the rabi season and we expect reduction to the tune of ₹ 1,500-2,000/mt on DAP," Prabhudas Lilladher Pvt. Ltd said in a note.
Reduction in farm gate prices will give a fillip to complex fertilizer usage. But a deluge of low-priced imports can cap gains.
With the industry already struggling to cope with subsidy payment delays from the government, competition from cheaper imports is the last thing that fertilizer makers would wish for. — R. Sree Ram
INFORMATION TECHNOLOGY: broad-based growth, finally
The information technology (IT) industry reported broad-based growth in the September quarter, which came as a heartening sign as Infosys Ltd and Wipro Ltd had been lagging by a huge margin until the June quarter. The results also indicate that discretionary spending by clients is rising. Growth in key regions such as North America, and in segments such as banking and financial services and manufacturing, improved.
According to a recent report by JP Morgan Research, current indicators suggest that growth will be sustained or will marginally increase in the next year. Still, most top-tier IT stocks have fallen since their respective results announcements, indicating that all of these positives had already been priced in. Revenue growth of both Tata Consultancy Services Ltd and HCL Technologies Ltd matched the growth in the June quarter and didn’t materially beat street expectations. And while Wipro’s performance improved, there weren’t enough indicators to suggest it will match industry growth rates anytime soon. Only Infosys’s results were materially better than expectations, and it’s important to note that this was its second consecutive quarter of outperformance although continuing senior management exits at the firm remains a concern.
On the whole, though, the industry did fairly well. Analysts at Kotak Institutional Equities pointed out in a recent report that global technology companies such as International Business Machines Corp. (IBM) and Accenture Plc are struggling for growth, which implies that Indian IT companies are gaining market share.
Business segments that depend on discretionary spending by customers such as application development, enterprise resource planning (ERP), systems integration and consulting grew fairly well. Analysts at JP Morgan expect this pick-up in discretionary spending to be sustained. The commentary by almost all top-tier firms was positive, which also suggests the growth momentum should continue.
Another positive surprise was that most firms reported higher-than-expected margins, thanks to depreciation in the rupee and better employee utilization. With the rupee having appreciated recently, some gains may evaporate in the coming quarters. Nevertheless, growing volumes and a steady pricing environment bode well for both revenue and profit growth. However, valuations of leading IT stocks price in these factors. TCS is valued at 21 times estimated earnings for this fiscal. Having said that, the fact that industries dependent on the domestic economy are growing at much lower rates means that investor preference for IT stocks should continue. — Mobis Philipose
INFRASTRUCTURE: a quagmire of falling profits and rising interest costs
Infrastructure, especially construction, has been among the worst hit in the last three years. Expectations of government initiatives to boost infrastructure, which in turn had been expected to flood private sector firms with orders, hit a roadblock. A policy paralysis and the financial stress on companies due to delays in payments from clients, along with rising interest rates, led to falling profitability over the last eight quarters.
Infrastructure construction firms IRB Infrastructure Developers Ltd and Sadbhav Engineering Ltd registered flat or moderate revenue growth from a year ago. The primary reason is economic sluggishness, evident from the decline in growth of container and port traffic and road traffic over the last 12 quarters. Meanwhile, infrastructure projects being cash-guzzlers led to soaring interest costs. Operating margins in the quarter contracted by 100-250 basis points from a year ago, while the interest cover ratio (see chart) fell below 1, which is precarious because it shows profit isn’t enough to cover interest costs. One basis point is one-hundredth of a percentage point.
A study of nine key firms in the sector showed a 70% rise in absolute aggregate interest cost from September 2011 to 2013. This ate into the meagre operating profits and most firms posted losses or a hefty contraction in net profit. IVRCL Ltd, Simplex Infrastructure Ltd and NCC Ltd (Nagarjuna Construction Co. earlier) have disappointed over several quarters. Only the large-cap and diversified Larsen and Toubro Ltd (L&T) is a cut above its peers. Infrastructure is in a quagmire of poor order inflows, flat revenue growth and rising costs and interest expenses. For instance, in fiscal 2013, the National Highways Authority of India awarded 1,116km of road projects, as opposed to the targeted 9,300km. Worse, in the current year till date, only 551km has been awarded. Analysts do not expect any change in sentiment towards the sector as the fiscal deficit could see a cut in planned expenditure this year, as was the case in fiscal 2013. No wonder infrastructure stocks have continuously underperformed the benchmark indices. For investors, the key things to look for that will signal a change are order inflows and fresh awards by the government and industry, change in working capital and leverage levels and fall in inflation and interest costs. — Vatsala Kamat
METAL COMPANIES: margins hit by downturn
Metal firms have had a trying time navigating a global slowdown. China’s slowdown—though it was not as severe as feared—has been a big worry as it remains one of the biggest producers and consumers of most metals. Sluggish demand hurts volume growth but the bigger worry is falling prices.
On that front, the news was not all that bad. Compared with a year ago, non-ferrous metal prices were down in the September quarter, but compared with the June quarter they were either flat or marginally down. A similar trend was seen in flat steel prices. A weak rupee also meant more protection since domestic prices are linked to the landed price of imports.
So how did companies perform? The aggregate figures are distorted by Sesa Sterlite Ltd’s financials as its post-merger numbers are not comparable with the year-ago figures. Excluding this company’s numbers, the metal pack’s sales rose by 8.6%. But the increase in costs was higher, especially due to raw material costs rising at a faster rate and, as a result, the sector’s operating profit margin declined by nearly 2 percentage points sequentially.
Among non-ferrous metal firms, Hindalco Industries Ltd’s sales rose 8% while its operating profit rose 12.8%, helped by better performance of its copper unit. Hindustan Zinc Ltd’s performance, too, was good, helped by higher volumes. The firm’s mining operations in the earlier quarters had been affected, resulting in lower output.
Among steel firms, Tata Steel Ltd’s revenue rose 11.7% but its operating profit growth was flat. Though domestic and South-East Asian operations did well, Europe continued to be a drag. Steel Authority of India Ltd’s sales rose 12.3% but its operating profit fell 9.6%.
The outlook for metal firms depends on a few factors. One of them is metal prices. Prices have softened further in this quarter. That is not a good omen for profitability. But, globally, metal firms are eliminating capacity by temporarily closing plants that are unviable. That should give some support to prices.
In India, domestic demand is not showing signs of a revival, either from the infrastructure or industrial sectors. With elections dominating the scene, the implementation of new measures to kick-start growth can, perhaps, be expected only after a new government is in place. Thus, in the near to medium term, a revival in global conditions, especially in China, could trigger a revival in the sector’s fortunes.
— Ravi Ananthanarayanan
OIL FIRMS: weak gross refining margins, rupee take their toll
The expectations from refining companies were low during the September quarter as the operating environment remained muted with gross refining margins (GRMs) under pressure. In keeping with that, the performance of Indian refining companies was more or less on expected lines. GRMs, a measure of profitability, for both Reliance Industries Ltd (RIL) and Essar Oil Ltd (EOL), declined both on a year-on-year (y-o-y) basis and sequentially. EOL reports current price GRM, which includes certain adjustments. Note that the importance of RIL’s refining business for the firm has come down in the last two quarters, judging by the decline in the contribution of refining ebit (earnings before interest and tax) to the overall numbers.
Companies also benefited from the weak rupee.Net price realization of Oil and Natural Gas Corp. Ltd (ONGC) and Oil India Ltd (OIL) in rupee terms was stronger, boosting the financial performance of both firms, though they saw a y-o-y decline in gas and oil production.
The concerns on the subsidy burden continue. Oil marketing companies (OMCs)—Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd—posted a net profit for the last quarter, helped by government compensation and discounts from state-run upstream firms. Still, OMCs’ reported net profit for the quarter declined 81-86% on a y-o-y basis. That’s because last year’s September quarter government compensation included the June quarter’s government subsidy as well.
Meanwhile, Cairn India Ltd (CIL) delivered a slightly better than expected performance. CIL’s earnings were also helped by a weak rupee. The outlook for Indian oil stocks though continues to be muted. Improvement in gas output will be an important trigger for the RIL stock but that’s not going to happen overnight. Moreover, the operational environment for petrochemicals and refining, too, is lacklustre, keeping sharp upsides at bay in the near-term. For EOL, its high debt of about ₹ 23,000 crore is definitely a spoilsport. Sure, valuations of OMCs are attractive but a lot will depend on reforms. Investors in ONGC and OIL will do well to keep a tab on production numbers. For that, it will be important for CIL to meet production targets as well, but its strong balance sheet is a big positive. — Pallavi Pengonda
PHARMACEUTICALS: Indian firms on top
Overseas markets were the main growth engine, especially the US generic markets, for Indian firms in the September quarter. A weak rupee also aided growth in local currency terms. Slower growth in the domestic market meant that multinational companies (MNCs) did not do as well as their Indian counterparts. Most MNCs sell only in the domestic market and do not have a diversified geographical base. But the Indian pharmaceutical scenario is expected to return to normalcy gradually. Still, overseas markets are likely to dominate, as Indian firms are expected to continue to launch generic products in regulated markets such as the US and Europe.
The sector’s sales rose 14.8% in the September quarter against the year-ago period, with Sun Pharmaceutical Industries Ltd leading the pack with a 57.8% growth in sales—led by 74% growth in its US operations.
New launches and the effect of acquisitions have helped propel growth. Dr Reddy’s Laboratories Ltd, Lupin Ltd and Cipla Ltd saw slower growth rates, primarily because of slower growth in the domestic market. Ranbaxy Laboratories Ltd’s sales rose by only 3.1%, partly due to the domestic slowdown and also due to a high base effect (it earned exclusivity period revenues from selling generic cholesterol-lowering medicine Lipitor in the US market in the year-ago period).
The profitability of the industry is in good form, coming in at 20.9% against 22.1% a year ago. The decline is chiefly attributable to the slowdown in the domestic market and more specifically among the bigger companies to Ranbaxy and Cipla (partly due to a high base effect).
GlaxoSmithKline Pharmaceuticals Ltd’s sales declined by 7% and its operating profit margin declined by nearly 10 percentage points. Its performance and that of other MNCs should improve as the domestic market gets back on track. Indian firms have been investing significant sums in research and development in an attempt to bring complex generic products to the market. The advantage of such a strategy is that there will be limited competition for such products. The rupee’s volatility has had a positive effect on sales and profitability in 2013-14 so far, although it has led to higher mark-to-market provisions for some companies. If the rupee strengthens, it could have a short-term impact on performance. Otherwise, the prospects for pharmaceutical companies appear good in the medium- to long-term. — Ravi Ananthanarayanan
POWER: halfway to light
The September quarter earnings of the utilities sector were a mixed bag. Industry heavyweights NTPC Ltd, Reliance Power Ltd and Tata Power Ltd, which rely mostly on coal, reported profit gains from a year ago. As for gas-based power producers, the less said the better, given the sorry state of fuel supply.
But even the gains for coal-fired power producers were tempered by a number of factors. Although power generation increased 7.7% from a year ago, hydropower contributed a good chunk to this growth, owing to the good monsoon. An increase in coal supplies meant thermal power producers could show an increase in their plant availability factor, which means fixed charges get reimbursed and flow into the bottom line. That was the primary reason why the Mundra plant of Tata Power was able to show a reduction in losses. The increase in profits was also limited by the rupee’s depreciation. Adani Power Ltd, for instance, reported higher-than-expected losses owing to the high import cost of coal; this was despite coal prices falling globally. Some firms have foreign exchange loans and the interest burden on these loans also hit profitability.
More worryingly for power producers, there were some signs of waning demand, as seen from the fall in merchant rates. Merchant power prices declined to ₹ 2.4 per unit in the September quarter against ₹ 3.2 in the three months ended June.
The general economic sluggishness and contraction in manufacturing seems to have reduced the demand for power. In two of the last four months, total power requirement (as calculated by the Central Electricity Authority, or CEA) was lower than a year ago. Thus, power deficits, which had increased to as high as one-fifth in certain states last year, are down to 3% now. While that may seem artificially lower, note that demand is also being suppressed by state electricity boards, many of which prefer “load-shedding" rather than purchasing expensive power.
At the same time, capacity addition has been happening at a fast pace. Thus, plant load factors (PLF), or capacity utilization, of thermal power producers are declining. The September quarter PLF of coal-fired units was 58.3%, the lowest in three years. Given the depreciation costs on power plants, operating at this level of capacity utilization will tell on profitability. That said, there are some positives. The case-I bidding norms for state electricity boards to buy power have been finalized. Coal India Ltd has improved its supplies. More state distribution firms are also getting on board with the financial restructuring exercise. While these will benefit the industry in the long run, private producers have a tougher road ahead with tariff battles and money stuck in half-executed projects. — Ravi Krishnan
REAL ESTATE: time is the only healer
An eerie lull prevails in the realty space. The September-quarter performance of most listed realty firms had nothing to cheer investors, with subdued sales expansion and sticky costs and interest rates leading to severe profit contraction. Also, residential property prices in some regions have started showing cracks on the back of weak demand in the last few quarters.
In fact, pre-launches and new projects had taken a back-seat as most firms tried to clear the inventory pipeline. Large pan-India companies focused on cash flows rather than on net revenue. The largest private sector and listed realty firm DLF Ltd’s cash flow from operations jumped one-and-a-half times from a year ago, while net revenue contracted marginally. Sobha Developers Ltd and Prestige Estates and Projects Ltd stabilized cash flows, too.
However, rising costs have taken a toll on profitability. A Citi Research report says that the operating margins for 22 listed firms in the September quarter contracted by about 665 basis points from the year-ago period, after revenue inched lower. One basis point is one-hundredth of a percentage point.
Investor discomfort stems from the burgeoning debt of some players. Developers hold huge loans on their balance sheet and their interest costs continue to eat into profits. For instance, a MintAsia research analysis shows that average interest cost to sales of 13 firms continues to be sticky at year-ago levels.
The moot question is whether property prices that were holding out in the last two years will be sustained? The Citi report highlights that residential property absorption in key cities fell 39% in the September quarter, compared with a year ago. That is echoed in the Reserve Bank of India and National Housing Board Housing price indices, which show a slowdown in price expansion across major cities. Real estate agents say there is a slowdown in the number of transactions.
This could see revenue contraction for realty firms and also hinder asset monetization. One hopes that the companies don’t face the risk of default on borrowings.
The September quarter saw significant contraction in net profits for the sector. Broking firm Motilal Oswal’s report pointed to an average 31% contraction in net profit for the eight companies it covers in the sector. This trend is unlikely to reverse in the near term until broader trends like demand and prices for property improve steadily. The silver lining is that smaller regional firms with strong brand equity and lower debt on their books are likely to bounce back soon.
— Vatsala Kamat
TELCOS: connecting with investors
India’s top telecom operators managed to sustain the improvement in their operating performance in the September quarter. In the June quarter, the top three operators, Bharti Airtel Ltd, Vodafone India Ltd and Idea Cellular Ltd had reported double-digit growth in revenue from a year ago, for the first time in several quarters. Last quarter, they reported a cumulative increase of 14.1% in wireless revenue, according to data collated by Kotak Institutional Equities.
Other yardsticks, too, have improved, thanks to a sharp reduction in competitive pressure. Shares of Idea and Airtel have outperformed the market in the past six months, despite the headwinds related to the latter’s African operations.
As the chart alongside shows, non-voice revenue has grown at a healthy pace (thanks to a sharp jump in data revenue); and although the growth in volumes in the voice segment (network traffic) isn’t spectacular, the rise in revenue per minute more than made up. As analysts at Kotak point out in a results review note, “Consumers have absorbed the inflation in wireless voice tariffs fairly well, allaying elasticity concerns on this front, thus far." Typically, a rise in tariffs results in a drop in usage—which hasn’t been the case this time around. Additionally, unlike in the past, when attempts by the industry to raise tariffs flopped because of undercutting by some operators, the industry is now reaping the benefit of pricing discipline.
The weak numbers reported by Uninor (see chart), show to what extent competitive pressures have diminished. The company was one of the chief challengers to the incumbents, but has now considerably reduced its presence. All of this led to strong growth in operating profit margins as well, with Idea’s wireless margins improving by 440 basis points (bps) from a year earlier, and Bharti’s margins widening by 280 bps. One basis point is one-hundredth of a percentage point.
The September quarter is a seasonally weak quarter and, hence, a year-on-year comparison makes more sense. Nevertheless, it’s interesting to note that despite this, all firms reported a decent 1-2% improvement in voice revenue per minute over the June quarter. Volumes fell as expected, although it must be noted that the 5.8% sequential drop in Idea’s volumes were higher-than-expected. All told, the results were strong and reaffirm investors’ belief that the days of intense competition are over. Having said that, regulatory uncertainty, which has been a bugbear for the sector, remains, as the government is still to decide on issues such as spectrum pricing. Besides, investors should watch out for the sustainability of the industry’s good performance in the past two quarters, especially given the past experience of one or two large firms getting overtly aggressive with pricing to win market share.
— Mobis Philipose
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