Former US Federal Reserve chairman Alan Greenspan said recently that there’s a 50% chance the US economy will slip into a recession and the volatility in the equity markets worldwide reflects the high level of uncertainty among investors. The conservative attitude during such times is “to hope for the best, but prepare for the worst.”
So, how bad can it get for Indian markets? The last time the US had a mild recession was seven years back when the Sensex fell around 50% from its peak. UBS has now come out with a report titled “How would India fare in a global recession?” that explores the comparison with 2000-02 in detail.
The UBS note says that while there was a slowdown in the Indian economy during 2000-01, this was on account of a decline in agricultural production rather than because of the performance of sectors linked to the global economy. Moreover, investment demand was muted during the period and interest rates were much higher, which is why sectors such as autos and engineering languished. The note points out, “In 2000-2002, market’s earnings decline was caused by IT services, metals, petrochemicals, engineering, automobiles and telecommunications. These sectors contributed 44% to market’s earnings in early 2000.
Today, in contrast, risk to earnings appears significant only for IT, metals and petrochemicals—the export-oriented sectors and the global commodities. These sectors constitute 36% of market’s earnings today—implying that the risk to earnings is significantly lower today than in the past.” Moreover, sectors such as IT, autos and even metals are at lower price multiples today than they were in February 2000.
So what’s UBS’ worst-case scenario? The impact on commodity prices is likely to be less, simply because US demand as a proportion of global demand for commodities is lower now than in 2000. The firm’s estimate of worst case Sensex EPS (earnings per share) is Rs989 for FY09, compared with its current estimate of Rs1,027. What about P-E (price-earnings multiple) compression? That’s tough to estimate, but UBS believes the lowest point for the Sensex is at 16,500. To cut a long story short, the implication is that for the Indian markets, there’s no reason why things should get as bad as 2001.
The performance of both the economy and the corporate sector support that conclusion. It’s true that compared with 2001, we’re more integrated with the global economy. However, both economic growth and corporate earnings growth is much higher now. For instance, GDP growth was 6.4% in FY00, falling to 4.4% in FY01 and gross domestic capital formation was growing at 26%. Currently, GDP estimates are higher than 8%, while gross capital formation is in excess of 30%. Similarly, EPS for the Sensex firms grew by just 4.9% in FY01. During the last quarter, it grew?17%?year-on-year.?Interest rates, too, are now much lower than they were in 2000.
But as Donald Rumsfeld famously said, there are known unknowns and unknown unknowns. This recession is very different from the 2001 one, resembling more the Japanese meltdown of the late 1980s or the savings and loan crisis in the US. And unlike in 2001, each week seems to show the credit crisis spreading to new sectors. Till the extent of the crisis is known, it may be premature to compare it with what happened in 2001.
ABB: order intake improves in December quarter
ABB India’s earnings per share (EPS) improved to Rs8.53 in the December quarter, compared with Rs6.37 in the year-ago period, a 34% increase. For the full year 2007, EPS was Rs23.20, well below Bloomberg’s consensus estimate of Rs24.37. The stock fell 3.7% as a result.
Net sales rose 29% in the December quarter, while operating profit increased by 34%. Operating margins, however, were higher at 13.5%, compared with 13.1% during the year-ago period.
The good news is that order intake showed a growth of 42% year-on-year during the quarter, which indicates that the slowdown in order intake to 23% in the September quarter was a one-off. ABB’s order backlog stands at Rs5,026 crore compared with Rs4,900 crore at the end of the September quarter.
The company recently announced orders worth Rs330 crore from Powergrid Corp. of India Ltd. Given the substantial addition to generation capacity in the 11th Plan, order flow for transmission equipment is expected to remain strong and ABB’s strengths in this area ensure strong revenue visibility.
Moreover, the parent company has said that it will be investing $100 million (Rs399 crore) in the next two-three years, to ensure that India becomes a “key resource base”, and aims to double business volumes by 2010.
But while the business outlook for the company is buoyant, the stock is not cheap, even after the recent correction, and trades at 56 times CY07 earnings and 37.3 times CY08 consensus earnings. The December quarter is usually a weak one for ABB in terms of profit growth. But even if we take the full year numbers, growth in PAT was 56% in 2006 and it’s down to 44% in 2007. Order intake, too, saw 50% growth in 2006 and 42% in 2007.
If ABB has to justify its valuations, it’ll have to increase its growth momentum.
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