The reporting season for June quarter results has started against the backdrop of a slowing economy, high inflation, a weakening rupee and rising interest rates. How are companies tackling these headwinds? How vulnerable are they to the changed environment? Some of these questions will be answered when the quarterly results start trickling in. We have given below some of the key trends and data that investors should look out for in the corporate results:
Hard-hit: A file photo of a TVS Motor Co. plant at Hosur, south of Bangalore. For the automobile industry, revenue growth will be offset by declining margins as input costs are rising.
The sector is perhaps facing the maximum headwinds—higher steel and other input costs on the one hand and the pressure on demand on the other, thanks to increasing interest rates and higher fuel costs.
Still, most companies have done well to report decent volume growth. But the worry is that revenue growth will be offset by declining margins. The key ratios to look at are the operating margin and operating profit per vehicle.
In some cases, investors are keen to see how low margins could go. Bajaj Auto Ltd, which reported numbers last week, said operating margin fell 190 basis points and operating profit per vehicle fell 13% from a year ago. Though those were significant declines, markets were fearing worse and so the stock rose 10% after the announcement.
The positive spin about engineering companies and contractors has been that they are sitting on very large order backlogs and hence have strong earnings visibility, a great comfort during tough times. But, how soon will that order book be converted into revenue? A key concern about engineering companies has been their ability to execute projects, which has slowed revenue growth. A shortage of skilled manpower and components and the inability of vendors to ramp up capacities have contributed to the problem. Revenue growth will therefore have to be watched carefully to see how companies are tackling this issue.
The sector has been hit by a rise in raw material prices. As Motilal Oswal’s preview of first quarter earnings puts it, “The extent of impact would be a function of five factors: (1) steel as a percentage of raw material cost, since it has witnessed an exponential price increase, (2) fixed price contracts in the order backlog, (3) procurement strategy (in terms of long-term contracts with suppliers), (4) execution cycle (long/short), and (5) pricing power.” These metrics will need to be watched carefully and their impact on operating margins gauged. A recent survey of project developers (the clients of contractors and equipment makers) by Emkay Global Financial Services Ltd shows only 50% of those surveyed had price variation clauses, of which only 18% had a 100% pass-through clause. According to Emkay Research, the survey “highlights the risk of further scope for downward revision of Ebitda (earnings before interest, taxes, depreciation and amortization) margins”. Simply put, investors need to follow conference calls where managements are usually asked about what percentage of their billing is covered by price variation clauses, which tells you how much of the rise in input prices they can pass on to clients. Finally, we need to make sure companies continue to bag new orders. The proximity of the elections could hamper the inflow of orders from the government. Construction firms often have to raise resources frequently for new projects, which puts them at a disadvantage in the current environment. Interest costs also will have to be watched closely. And finally, the commodity hedging strategies will have to be monitored, to find out whether there’s a risk of such bets going wrong.
The consumer goods sector has been in the enviable position of passing on raw material cost pressures to consumers, through price increases in some cases, and by reducing the pack size of some others where prices were kept constant. As a result, margins of most firms can be expected to improve.
But it needs to be seen whether volume growth has been affected as a result. Also one needs to monitor if the entire increase in raw material expenses has been absorbed by price increases or whether companies have relied more on reducing overheads such as advertising and promotion expenses.
If raw material costs as a percentage of sales come down, it means that firms have been rather aggressive about taking price increases. This could affect volume growth or may result in a shift to cheaper products. In this regard, one needs to watch out for management comments on the impact of price increases taken so far on volume growth.
The environment of slowing credit growth and rising interest rates is very challenging. Investors will do well to see to what extent banks have been hit by the slowdown in credit growth, or whether growth has been achieved at the cost of too high a price paid for deposits. Growth in net interest income (interest earned less interest expended) will therefore need to be watched— while banks have raised lending rates, they have not been able to pass on the entire rise in their cost of funds. Net interest margins will show whether higher interest rates are squeezing profitability. Banks with a higher proportion of CASA (current and savings accounts) should do well, because they are low-cost deposits. Lower interest income and lower fee income usually go together, but fees and treasury income from capital market-related activities will see much lower growth. Another negative factor is higher mark-to-market provisions for their bond portfolio as a result of significantly higher bond yields. Public sector banks will also be hit by higher wage costs.
Investors will also look for signs that the slowdown in the economy is having an impact on asset quality, such as a rise in gross non-performing assets (NPAs). Banks may be forced to raise provisions for NPAs, which will keep net NPA ratios low but hurt earnings. The impact of the farm waiver must also be kept in mind. With the tighter Basel-II norms on capital adequacy coming into force and with the environment for raising capital deteriorating, the capital adequacy position needs to be monitored. Mark-to-market losses on credit derivatives and legal complications arising out of forex derivatives losses of clients also need to be tracked.
With substantial capacity addition looming and the economy slowing, this is not a sector that investors are fond of. Companies heavily reliant on imported coal, the price of which has almost doubled in the past year, will be severely affected, although all cement companies will be hurt by the rise in input and freight costs. An export ban and government action has kept prices in check. And, as Motilal Oswal points out, the industry’s capacity utilization is expected to decline on year-on-year basis for the first time in five years.
In this scenario, companies would differentiate themselves by changing their market mix, apart from managing costs. Companies that are the earliest to set up fresh capacity will reap the rewards of higher volumes.
Subscriber additions have been strong, but the key factor is if tariff cuts have led to increased usage. Another would be losses on derivatives transactions, as this could offset a large part of the rise in operating profit.
Investors would also be keen on hearing management comments on capital expenditure plans. But considering that some large players have either concluded large merger and acquisition transactions or are in the midst of due diligence, investors are likely to be focused on management comments on the implications of these moves.
Like Infosys Technologies Ltd’s results showed, wage hikes, visa costs and losses on forex hedges will more than offset gains from the depreciation of the rupee. Of course, for some companies such as Satyam Computer Services Ltd, wage hikes are granted later in the year, so there may not be as high an impact in the June quarter. But also note that Infosys had among the lowest forex hedges and still it saw much of the gains from the rupee depreciation being offset by losses on forex hedges. Investors would be keen to see the losses on this reported by Wipro Ltd and Tata Consultancy Services Ltd, both of which had hedges of more than $3 billion (Rs12,810 crore). HCL Technologies Ltd has said it will take a big hit.
The markets are likely to focus on management comments on demand from US clients and the situation with respect to pricing. Some of the numbers to look for are net employee additions and whether there’s a shift in work away from the US.
Although most retailers are likely to report strong year-on-year growth in revenues, margins are likely to be under pressure due to higher lease rentals and manpower costs. It needs to be seen what proportion of the growth is coming from stores that are open for at least a year (same stores), or if the growth is because of new stores. Stagnant same-store sales, caused by the increase in competition, can lead to lower return on investment and lower overall margins.
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