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September quarter results: Indian economy hinges on hope

The markets are trading near all-time highs on expectations that the new government’s reforms will eventually show results. Photo: Hemant Mishra/MintPremium
The markets are trading near all-time highs on expectations that the new government’s reforms will eventually show results. Photo: Hemant Mishra/Mint

An incipient recovery in the economy and reforms put in place by the six-month-old government are yet to translate into a turnaround in corporate earnings, an analysis of company report cards for the September quarter shows

Mumbai: The sharp depreciation in the rupee in 2013 had camouflaged the anaemic growth at India’s top companies for four straight quarters. With this benefit out of the way in the September quarter, revenue growth slipped back to single-digit figures.

Revenue of BSE-100 companies, excluding finance companies and public sector oil and gas companies, grew by only 4.1% year-on-year (y-o-y) in the last quarter, data collated by Nomura Research shows. Growth had averaged 13.6% in the preceding four quarters, thanks largely to a favourable currency for exporters and companies that price their products based on import parity.

Last quarter’s results were also below expectations. Kotak Institutional Equities, for instance, said in a note to clients that the aggregate net profit of companies under its coverage was 5.7% below its expectations. This is after excluding oil and gas companies, which can skew aggregate numbers owing to large swings in provisions for subsidy, etc.

The Mumbai-based broker cut its fiscal 2015 earnings growth estimate for BSE Sensex companies (again, excluding oil and gas companies) to 11.7%, from 13.7% before the beginning of the results season.

Kotak’s head of research, Sanjeev Prasad, said in a note to clients, “Underlying parameters such as loan growth, credit quality for banks and volume growth for consumer and cement companies remained weak. It is perhaps too early to expect a structural economic recovery although the government is implementing reforms for higher growth."

The problem of bad loans continues to plague the banking sector; while public sector banks are the worst affected on this front, some others from the private sector such as ICICI Bank Ltd and Axis Bank Ltd also reported an increase in slippages. With power companies under pressure because of the low availability of coal, slippages may continue to be a problem for the banking sector.

Commercial vehicle sales continued to be under pressure, reflecting weakness in freight movement. And growth in cement volumes fell to the mid-single digits, from around 10% in the June quarter, reflecting the fact that construction activity remains low in the economy.

In the case of fast-moving consumer goods (FMCG) companies and those dependent on discretionary spending, the results were mixed; while some such as Asian Paints Ltd did well, growth at some others such as Hindustan Unilever Ltd declined, when compared with the June quarter.

Results of capital goods companies were also weak because of the macroeconomic weakness as well as poor execution on account of financial/resource constraints.

And while a pick-up in order inflows at these companies suggests that things are likely to improve in the future, the recovery is not expected to happen soon. Prasad says in the note, “The confidence of companies expecting a recovery in the second half of the current financial year seems to have waned, with many companies now painting a more muted outlook for the next few quarters. This is not surprising as the underlying constraints in several sectors (power, mining, railways) may take time to resolve."

Even so, the markets are trading near all-time highs on expectations that the new government’s reforms will eventually show results. At current levels, the S&P BSE Sensex trades at over 18 times estimated earnings for the year till March 2015, higher than earnings growth estimates for the following two years. While it’s true that consensus earnings estimates have continued to rise in the past two months, this appears to be more of an attempt to justify the continued rise in share prices. As Kotak’s analysts point out, the September quarter results provide no reason for earnings upgrades. — Mobis Philipose

AGRICULTURAL INPUTS: uneven rains hit agrochemical sales, trading perks up complex fertilizer margins

A delayed monsoon and an uneven distribution of rainfall have hit the sales of agrochemical companies. Late rains led to farmers skipping the first round of pesticide application. And although the monsoon picked up towards the end of the season, excess and heavy rains in some regions made pesticide application unfeasible. As a result, the usually busy July-September quarter was lacklustre.

Rallis India Ltd’s stand-alone sales increased by a tepid 2%. PI Industries Ltd saw its sales drop almost 8%. Dhanuka Agritech Ltd was able to increase revenue by 12%, but unfavourable business conditions means the performance lagged some estimates. According to Nirmal Bang Securities Pvt. Ltd, after the relatively poor monsoon, the management lowered its sales growth guidance from 15-20% to 10-15%. Emkay Global Financial Services Ltd lowered its revenue estimate for Dhanuka by 8%.

The erratic rains, however, had limited impact on the fertilizer makers.

Total complex fertilizer sales increased 12% in the September quarter. Growth was driven by imported fertilizers, sales of which are up 24%.

With the companies sourcing goods at favourable rates, realizations improved. Consequently, Coromandel International Ltd and Chambal Fertilisers and Chemicals Ltd reported better-than-expected margins.

The performance of GSFC Ltd and Deepak Fertilisers and Petrochemicals Corp. Ltd, on the other hand, was weighed down by limited availability of raw materials and feedstock. Overall, the quarter was encouraging for most complex fertilizer makers.

An analysis of 20 fertilizer companies by Care Ratings found that sales and profitability improved in the first half of the current fiscal.

While agrochemical companies expect sales to recover in the second half of the year, aided by healthy water levels in reservoirs, normalization of excess inventories augur well for complex fertilizer makers.

The normalized inventory scenario has made companies discontinue the discounts offered to farmers and reduce dealer margins.

While this can give a fillip to fertilizer companies’ margins, the recent rupee depreciation and the increase in raw material prices can offset some margin gains.

Due to supply constraints, the price of ammonia has risen sharply in the international market. Many Indian companies import ammonia for complex fertilizer production.

“While margins should benefit from a reduction in farmer discounts and dealer discounts, we believe a part of the margin improvement will be offset by increase in raw material costs," B and K Securities India Pvt. Ltd said in a note.— R. Sree Ram

AUTO: sales recover as consumer sentiment improves

With the exception of light commercial vehicles (LCVs), the auto sector posted healthy growth in sales volumes in the September quarter. Backed by positive consumer sentiment, the low base of the year-ago period and the earlier onset of the festive season, along with pent-up demand, translated into robust sales growth in most segments. Average sales of the top seven listed entities grew by about 11% from the low base a year ago.

The best revenue and realization improvement came from trucks, while the worst show was put up by LCVs, whose sales declined for the sixth consecutive quarter. Two-wheeler and passenger vehicle sales improved. But Mahindra and Mahindra Ltd was the laggard, with rising diesel prices hurting sales as most of its vehicles are diesel-powered. Besides, tractor sales were weak on account of a poor monsoon.

Higher sales resulted in better operating leverage and profitability for some. But there was no clear trend. For instance, among two-wheelers, Bajaj Auto Ltd’s margin dipped while market leader Hero MotoCorp Ltd fared better than in the year-ago period. In commercial vehicles, Ashok Leyland Ltd posted a strong 510 basis points (bps) jump in margin even as Tata Motors Ltd’s domestic business slipped at the operating level.

Competition ate into margins during the quarter as most companies incurred high advertising and marketing costs. Discounts prevailed to push sales. This partially negated the benefits of lower raw material costs, which came on the back of softer commodity prices. In some cases like Maruti Suzuki India Ltd, sales continued to grow robustly although adverse foreign exchange impact hurt margins.

On average however, the sector is clearly on the road to recovery. September quarter’s earnings-per-share trend indicates better times ahead. A report by UBS Research says headwinds like high interest rates, tight credit standards and high fuel prices are all turning favourable.

Two-wheeler sales, therefore, will continue to do well, while passenger vehicle sales will see better recovery after a couple of years of slowdown. Although commercial vehicles are already showing green shoots of recovery, the pace of growth would depend on economic recovery.

That said, October sales volumes showed a dip after the festive season euphoria subsided. Earnings growth in the segment hinges on volume expansion. The BSE Auto index, however, mirrors investor optimism, given that its rise has beaten the Sensex and most other sectoral indices over the last one year. — Vatsala Kamat

AVIATION: lower oil prices and expenses help, but worries remain

SpiceJet Ltd and Jet Airways (India) Ltd—India’s two listed operational airlines—had reported post-tax losses in the June quarter. But Jet has had a good landing this time around, helped by an exceptional item (surplus from the slump sale of its “Jet Privilege" frequent flyer programme) and strong other income growth. Accordingly, Jet posted a stand-alone net profit of around 70 crore against a 891 crore loss in the September quarter last year. But SpiceJet had no such luck. Last quarter, its net loss was 310 crore. Thankfully, SpiceJet’s loss in the September quarter has narrowed compared with the same period a year ago, when its net loss was 559 crore.

Moreover, the fact that overall operating costs increased at a comparatively slower pace than revenue growth, supported the operating profit performance for both firms. For instance, fuel costs as a percentage of revenue for the September quarter declined for both firms, compared with the same period last year. SpiceJet’s aircraft lease rentals, aircraft maintenance and other expenses declined on a year-on-year basis. On the other hand, Jet’s other expenses declined marginally while lease rentals increased a bit. The outcome: both companies saw a substantial decline in their operating loss, compared with the year-ago period.

The operating environment for aviation firms in general has improved to some extent, thanks to lower crude oil prices. The current quarter is a seasonally stronger one and that should reflect in the numbers. Still, so far this year, shares of both firms have underperformed the benchmark Sensex. Weak balance sheets offer less scope for sentiment to improve from these levels.

According to ICICI Securities Ltd, given SpiceJet’s negative net worth of over 1,000 crore and a loan liability of 1,500 crore, funding future operations would remain a key cause of concern for the company.

Jet has a negative net worth, too, but analysts perceive the prospects of the firm to be relatively brighter than that of SpiceJet. “Despite ongoing challenges on domestic operations and negative net-worth, Jet is still in a better position to withstand the slowdown with sufficient funds from Etihad Airways," said a results update note from ICICI Securities. — Pallavi Pengonda

BANKING: stocks run ahead of fundamentals

Banking stocks have rallied strongly in the past three months. The key reason seems to be the expectation that the Reserve Bank of India (RBI) would cut interest rates sooner rather than later, given the improving trends in inflation. A rate cut would not only boost credit growth, but also help banks notch up some mark-to-market gains on their bond portfolios. Most public sector banks are holding government bonds far in excess of that required by law owing to poor loan growth.

But that seems to be the only bright spot in the sector’s short- to medium-term outlook. Yes, earnings have grown, but that is partially explained by the base effect. Many banks have also reported strong growth in non-interest income, which again has come about owing to upward revisions in fees and trading profits.

Net interest income grew only 7.3% from a year ago for state-owned banks, the poorest performance in five quarters. Most banks have struggled to expand loan books with combined advances growing only 9%. Private-sector banks have done better with an 18% growth in net interest income, primarily because some of them are trying to rebuild their corporate loan books. But the upshot is that a nascent economic recovery has not done much for boosting the core business of banks.

Secondly, asset quality woes persist. The aggregate bad loan of public sector banks rose 7% from a quarter ago; that’s the worst in a year. For private banks, bad loans rose 4.3% sequentially, confirming the economic environment is hitting even loan books previously considered safe.

Slippages, or fresh additions to bad loans, continue to grow almost unabated. Slippages for 25 banks whose data is collected by Emkay Global Financial Services amounted to 39,746 crore. While it is a sequential improvement, it is higher than the 36,037 crore average of the last three quarters of the previous fiscal.

There is also not much let up in restructured loans. Fresh loan recasts (for 14 state-owned banks, collated by Emkay) increased to 21,005 crore against 19,187 crore in the preceding three months. The outstanding pile of restructured assets (for a larger 25 bank grouping) stood at 2.89 trillion against 2.78 trillion three months ago. Thus, for state-owned banks, overall stressed assets (gross bad loans plus recast loans) continued to remain close to one-tenth of advances. An economic recovery remains the only hope for banks to see a pick-up in loan growth and slow impairment trends. — Ravi Krishnan

CAPITAL GOODS: outlook for investment activity muted

Capital goods stocks are regaining their mojo. After losing steam midway through the June quarter, these stocks are again climbing as investors hope for a recovery in the investment cycle. Since mid-October when the September quarter earnings started trickling in, the BSE Capital Goods index has gained 15%, almost double the broader market.

It is easy to see what is driving those gains—a bounce in order flows. For the top seven capital goods makers, domestic order inflows increased 84% from a year ago in the September quarter, according to Kodak Institutional Equities. This follows a 33% fall in the three months to June and a 20% decline in the March quarter.

It is too early to hail this increase in order inflows as a recovery of the capital expenditure cycle. Analysts say ordering by the government and state-owned enterprises is one of the key reasons for the increase seen in the September quarter. The increase is also off a relatively low base; order inflows in the last two September quarters didn’t show much traction for this set of companies. A revival in private sector ordering remains critical for a sustainable increase in order inflows, but that may well take some time since capacity utilization in many key industries is still at low levels.

While a low base also meant that domestic revenue for some firms increased on a year-on-year basis, it was not broad-based. Some firms such as Bharat Heavy Electricals Ltd (Bhel) reported a sharp drop in net revenue owing to slow-moving orders and execution challenges.

These execution problems are not new. Weak financials of client firms and stumbling blocks such as land acquisition or fuel shortage in certain projects would have hurt revenue growth. With continuing problems in many sectors such as power, mining and railways, not only is the outlook for investment activity muted, but revenue increases will also be subdued.

Moreover, a pile-up of receivables, along with higher interest rates, has led to stretched working capital costs. That clouds the profit outlook. There is also the danger that companies will bid aggressively to boost order inflows and in the process sacrifice operating margins. Some of this can already be seen in the margins of firms such as Larsen and Toubro Ltd and Bhel.

“The confidence of firms expecting a recovery in (second half of FY) 15 seems to have waned with many now painting a muted outlook for next few quarters,"said Kodak Institutional Equities. The corollary is that valuations are looking stretched.— Ravi Krishnan

CEMENT: volume growth will continue for north-based companies

The cement sector benefits from an economic recovery as construction activity lifts demand. Cement despatches for north-based firms may be around 9-10% higher in the December quarter, barring Ambuja Cements Ltd and ACC Ltd, buoyed by seasonal demand pick-up and momentum in construction, according to analysts. However, Ambuja and ACC have not added capacity in the past few years, which may crimp their ability to grab market share as demand revives.

South-based firms India Cements Ltd and Ramco Cements Ltd may continue to see a decline in volume growth as government projects have not seen the light of the day. Shrenik Gujrathi, cement analyst at Angel Broking Ltd, said, “Volume-led recovery will lead to around 2-3% growth in realizations in the December quarter," although prices have remained soft so far due to weak demand and labour shortage because of the festival season. The earnings were a mixed bag with north-based firms clocking double-digit volume growth, barring Ambuja and ACC, while South-based firms saw a drop in volume. Overall, net sales grew 14.7% for the top 10 cement makers by market capitalization, according to Mint Research, but this was mainly led by price increases. Operating profit grew 41%, the best in around two years, although it was on a low base as prices and volume growth were weak during the same period last year. While the operating profit margin dropped sequentially, it went up by 263 basis points (bps) to 14.3% against a year ago, helped by price hikes. One basis point is one-hundredth of a percentage point.

Cost pressures continued as power and fuel costs as a percentage of sales rose 64 bps to 22.5% sequentially on costlier e-auctioned coal and pet coke. Even freight costs as a percentage of sales were high due to elevated diesel and freight prices.

Cement firms have outperformed the broader markets in the last six months, barring Ambuja and ACC. A demand-led recovery and commissioning of new plants will help stock performance of north-based firms although some of them are trading at rich valuations like UltraTech Cement Ltd and Shree Cements Ltd. The share prices of south-based firms may be capped unless demand improves. — Krishna Merchant

CONSTRUCTION: companies languish under interest burden

The performance of construction firms in the September quarter paints a rather gloomy picture. The 10 firms listed in the BSE-500 index posted a marginal improvement in operating margin, although as expected, interest costs dragged net profit down.

The low base of the year-ago period, better management of cash flows to projects and stronger performance by road developers helped improve the average operating margin by about 140 basis points (bps). One basis point is one-hundredth of a percentage point. Companies like Sadbhav Engineering Ltd, Ashoka Buildcon Ltd, J Kumar Infrastructure Ltd and NCC Ltd clocked strong revenue growth, although the 10-company average showed a year-on-year dip.

Some firms like Hindustan Construction Co. Ltd and IL&FS Transportation Networks Ltd had a bump-up in revenue and margin on account of some claims that were settled in their favour. But then, there were also some laggards like IVRCL Ltd that posted an operating loss.

Like in most other infrastructure development businesses, construction firms, too, continued to face the burden of rising interest costs. Unsettled claims, lower advances and cost overruns on account of delayed projects led to a larger working capital requirement, which in turn increased interest cost as a percentage of sales. It was up by 400 bps during the quarter from a year ago.

What could attract investor fancy in the near term is order inflows. Analysts say there is a line-up of 50,000 crore worth of road projects, besides some trickles seen in the water, ports and energy sectors, too. Yet, domestic ordering activity is yet to see momentum enough to prop up the sector’s revenue.

Only firms such as Larsen and Toubro Ltd have been able to manage costs, given that their diversified nature of business helps tap opportunities across segments and also globally. Even then, the company moderated the revenue guidance for fiscal 2015 after the September quarter.

To sum up, while well-managed firms are struggling to hold their head above water through these challenging times, a turnaround in robust profits is still some quarters away. — Vatsala Kamat

CONSUMER GOODS:companies will benefit from improving sentiment

India’s consumer confidence index has been rising in recent months. But that confidence is not yet spilling over into shopping aisles for packaged consumer goods makers. The past quarter showed consumer companies continued to face growth pressures. Slow economic growth and high inflation have been major bugbears for the industry and consumers.

In the September quarter, sales rose by 11.6% over the year ago period, which is relatively low when compared with June quarter’s 15.8%. Year-on-year inflation in material costs continues to be a problem. Firms reported that it seemed like the worst was behind them, but they anticipated a delayed and more gradual recovery.

Volume growth was relatively low and price hikes to combat input cost inflation helped sales grow. But the dull consumer market made it difficult to pass on price hikes in full. Thus, material costs rose ahead of sales growth, pulling down gross margins from a year ago. But margins improved compared with the June quarter. Though companies cannot control inflation, they have reined in employee costs, kept advertising and promotion costs under check and also “other expenses".

This ensured that operating profit margin remained almost at the same level as a year ago, and improved by 89 basis points from the June quarter. Still, the year-on-year growth in net profit was just 10%. That is meagre growth for a sector that has a relatively expensive price-to-earnings valuation of 41 times. One basis point is one-hundredth of a percentage point.

The outlook seems to be on the mend. Inflation—both retail and wholesale—has been falling steadily, and that augurs well both for the purchasing power of consumers and material costs for companies. If this continues for a longer period, it should bring considerable savings for consumer companies. They could plough back savings into marketing efforts to spur growth. Another factor is the expectation of a gradual but steady recovery in the economy. If that takes hold, then consumer disposable incomes should get a further boost. That sets the stage for higher growth rates in the packaged consumer goods sector, in the medium to long term, especially in urban markets. The main risk is of the economic recovery being weaker than expected or inflation starting to rise again. — Ravi Ananthanarayanan

ELECTRICITY: Another dim quarter for power producers

Electricity generators had a dim September quarter. NTPC Ltd’s profits missed Street estimates due to low coal plant utilization and incentive income. The miss stoked fears that the new tariff norms regime may have a stronger-than-expected impact on the firm, leading to cuts in earnings estimates. “The overall return on equity (RoE) for the quarter came in at 3.7% below our expectation of 4.2%. We revise our FY15/16 earnings downwards based on quarterly performance (reduce core RoE by 0.5%)," Emkay Global Financial Services Ltd said in the results review note.

Private electricity producers did not do well either. Adani Power Ltd reported higher-than-estimated losses due to high fuel and finance costs. According to Edelweiss Securities Ltd, plant utilization or the load factor was subdued due to low coal supplies and a drop in off-take by Haryana state utilities. Tata Power Co. Ltd also reported losses. Performance was dented by a plant outage and a sharp drop in profitability at the coal subsidiary. With the power plant at Mundra, Gujarat, continuing to lose money and international coal demand remaining muted, analysts fear Tata Power’s performance will remain subdued for rest of the fiscal. “We have revised our earning estimate downward for FY15E to factor in the fall in coal realization, lower margin and delay in finalization of Coastal Gujarat Power Ltd (Mundra power plant) tariff," ICICI Securities Ltd said.

Reliance Power Ltd reported healthy operating performance. But two broking firms lowered their earnings estimates citing high capital (interest) costs. According to Emkay, the capital cost of the Sasan “ultra mega" power project has been revised up from 22,500 crore to 25,000 crore. Volumes at state-owned hydro electricity producers SJVN Ltd and NHPC Ltd grew at a healthy pace as new plants got added. From a year ago, they are up in the range of 19-24%. NHPC’s performance, however, was masked by provisions. Overall, earnings of most listed firms continue to be weighed down.

An analysis of 10 utilities by UBS Securities India Pvt. Ltd found profitability declined in the first half of FY15. That is due to the headwinds—unavailability of affordable fuel, unfavourable tariffs and sub-par utilization levels. Adani and Tata Power will need favourable compensation orders for their large plants to be economically viable. NTPC needs greater purchases from financially troubled state-owned distribution firms. The government is trying to address the problems. But, as can be seen from recent quarterly results, the benefits will take time to be reflected in the bottomline. — R. Sree Ram

IT SERVICES: commoditization, high base hit growth

The September quarter results of Indian information technology (IT) services companies should have had a sobering effect on the valuations of the sector. Instead, the valuations of IT stocks have reached a three-year high.

Much has been said about the apparent disconnect between the positive commentary of IT firms and their actual performance. Now, it’s also evident investors have preferred to go with the view that demand for IT services is strong, ignoring the warning signs in the reported results.

Last quarter, year-on-year (y-o-y) revenue growth of top-tier IT firms slipped to around 12% on an aggregate basis, from around 14-15% just a few quarters ago. Growth rates fell even for top-performing companies such as Tata Consultancy Services Ltd (TCS) and Cognizant Technology Solutions Corp. In TCS’ case, although the firm doesn’t give formal revenue guidance, it had made a statement that organic revenue growth this fiscal will be higher than the previous year. After the weaker-than-expected performance, it’s highly unlikely the company’s target will be achieved. TCS shares fell sharply soon after the results announcement, but have now recouped nearly two-thirds of those losses.

The September-quarter results also highlighted the fact that nearly every top-tier firm is facing some issue or the other that crimped revenue growth. In the June quarter results season it had seemed that only Cognizant was facing company-specific issues and that other firms such as TCS were doing well.

Analysts at Citigroup Research said in a note to clients, “Despite the macro uplift, revenue growth continues to slow (around 12% growth y-o-y for top five firms). Ebitda growth was even slower at around 7%, partly impacted by some appreciation in the rupee y-o-y—materially slower than the recent quarter trends. Our view remains that commoditization in some parts of the business as well as challenges in enterprise solutions are impacting growth. Global peers have also reported moderation in bookings in the recent past." Besides, as Cognizant has pointed out in the past, maintaining percentage growth rates is a challenge on the back of a very high base of revenues.

While analysts have resigned to the fact that growth will be lower, compared with FY14, some are now pinning their hopes on growth picking up in FY16. But it’s worthwhile noting that such hopes have helped valuations of IT stocks surpass three-year highs. Investors may not see sharp corrections ahead, if the disconnect between hopes and reality continues. — Mobis Philipose

METALS: sector loses its shine

The list of troubles facing the metals sector is long: in the domestic market, demand is down, the mining sector is stuck in a policy logjam and, abroad, the European Union’s economy is faltering. The biggest worry is China’s economic slowdown. On the positive side, energy costs are down due to falling coal and crude oil prices and the Indian economy is set to rebound.

The problems facing the sector were reflected in the financial results as well. In the September quarter, for example, Tata Steel Ltd’s global steel deliveries were flat sequentially, while sales fell 1.8% in value terms. Lower input costs could not prevent the decline in profitability—operating profit margin fell 1.5 percentage points—as expenses on other items rose significantly. Steel realizations were under pressure in the quarter due to weak global steel prices.

The situation for non-ferrous metals was a bit different as prices of zinc and aluminium were higher sequentially. Curtailments in capacity have resulted in a tighter supply situation, lending support to prices. This saw companies such as Sesa Sterlite Ltd and Hindalco Industries Ltd report decent operating results. Metal stocks had risen sharply in early 2014, especially after the election results became apparent. The promise of a new reform-oriented, business-friendly government gave hope to investors. But the reality that a recovery will take time and issues such as cancellation of coal mine allocations are weighing on the investors’ minds. The BSE Metal Index is about one-fifth off its high levels in June.

But it is not just local factors that are at play. China’s slowing economy spells bad news. Its low appetite will mean more supply in global markets. Also, low domestic appetite may see Chinese producers ship products to other markets. That can put pressure on prices. But for Indian metal producers, at this point, the local market offers hope.

There is a gradual increase in economic growth and that should eventually lead to better demand for metals. Price will depend on global factors, but a pick-up in domestic demand should be the first
sign to watch for a turnaround in the sector’s health, especially for steel companies.
— Ravi Ananthanarayanan

PHARMA: profitability improvement offsets slow sales growth

Indian pharmaceutical firms benefited from a healthy recovery in the local market, even as some companies faced slower sales growth in the US. US sales growth was slower partly due to a high base effect, but also due to competition and consolidation of firms in the distribution chain. On the bright side, profitability remained firmly in the pink of health.

The sector’s revenue rose 14.9% over the year ago, with sales rising 14.3% and other operating income by 81.3%, mainly due to a lump-sum licensing income earned by Cipla Ltd. The sector’s sales growth was lower than the preceding quarter’s 17.5% growth and 16% in the March quarter.

Large firms such as Sun Pharmaceutical Industries Ltd and Dr Reddy’s Laboratories Ltd saw relatively slow sales growth, at 13.3% and 6.9%, respectively. Their US market growth was subdued, mainly due to a high base effect and channel consolidation. Cipla’s export sales were very low due to several reasons. Most firms are expecting a pick-up in the second half. Not all companies suffered, with companies such as Lupin Ltd, Ranbaxy Laboratories Ltd, Aurobindo Pharma Ltd, Cadila Healthcare Ltd and GlaxoSmithKline Pharmaceuticals Ltd posting healthier sales growth.

The local market grew 12.3% over a year ago, according to market research agency AIOCD Pharmasofttech AWACS. Drugs exempt from price control and even those under price control saw good growth. In the last fiscal, sales growth had been affected due to teething troubles related to a new drug price control policy. In the US, apart from the problems mentioned earlier, the pace of new generic approvals has been relatively slow. Russia and some emerging markets, too, faced problems, causing slower sales growth.

Where sales growth failed to excite, profitability filled the gap. The sector’s operating profit margin rose 2.9 percentage points over a year ago and by 2.2 percentage points sequentially. The jump in other operating income was one reason, sure. But it was also a healthy product mix that brought down input costs as a percentage of sales, while a lower increase in other expenses also helped. The sector’s reported profit after tax rose by 28.4% during the quarter. A pick-up in drug approvals in the US and a continued recovery locally is what the industry needs. The sectoral index has risen 8.6% in the past three months against a 7.5% increase in the broad market. — Ravi Ananthanarayanan

OIL AND GAS: realization pressure for sector

One of the most happening sectors this year has been oil and gas. Anticipation of reforms and positive news flow has kept these stocks in demand, especially the state-run firms in the sector. But the financial results of companies in the industry for the September quarter have been nothing to write home about. Here are some reasons why:

Even as the falling crude oil price is a positive as it leads to a fall in overall sector under-recoveries (or losses on selling fuel below cost), companies such as Cairn India Ltd saw a dip in realizations due to softer oil prices. In the September quarter, Cairn India’s average price realization declined 4% over the same period last year to $91.3 per barrel of oil equivalent. Prices are lower sequentially, too. Further, higher expenses and a decline in revenue led to a substantial decline in operating profit margin. Thus, Cairn India’s net profit last quarter fell by one-third, compared with last year.

Net price realizations of state-run upstream oil companies—Oil and Natural Gas Corp. Ltd (ONGC) and Oil India Ltd (OIL)—were disappointing as well, thanks to a high subsidy burden and lower gross realizations. ONGC and OIL’s net realization for the September quarter is lower than that seen in the June quarter. Among the oil marketing companies (OMCs), Hindustan Petroleum Corp. Ltd (HPCL) fared better on the gross refining margin (GRM)—the difference between the per-barrel cost of crude oil and the value of products distilled from it—than Bharat Petroleum Corp. Ltd (BPCL) and Indian Oil Corp. Ltd (IOC), reckon analysts. On a positive note, “interest cost declined substantially by 67% year-to-date to 2,600 crore for all three OMCs in tandem with decline on debt levels which declined by 27% year-to-date to 96,300 crore," Emkay Global Financial Services Ltd wrote in a research note. In FY14, interest costs of all OMCs was 7,948 crore and debt was at 1.36 trillion, said analyst Dhaval Joshi of Emkay.

Meanwhile, Reliance Industries Ltd’s (RIL) consolidated refining revenue declined 6% on a year-on-year (y-o-y) basis due to softer crude oil prices and lower crude oil processing. Yet again, the refining business emerged as a saviour, as a strong GRM of $8.3 a barrel for the quarter helped refining segment Ebit (earnings before interest and tax) y-o-y growth of 18.5%. Note that Singapore complex refining margin had dropped to $4.8 per barrel last quarter. RIL’s petrochemicals business performed well. The firm was able to beat stand-alone net profit estimates. Shares of OMCs have performed better than others during the quarter. Clarity on subsidy sharing is a key trigger to watch out for. — Pallavi Pengonda

REALTY: No respite for real estate companies yet

In spite of a marginal uptrend in sales, real estate companies did not see a substantial improvement in financial health during the September quarter. The BSE Realty index also reflected weak investor sentiment as the hype associated with real estate following the new government’s commitment to low-cost housing died down. Investors realized that even reforms like real estate investment trusts and relaxing of foreign direct investment limits would take time to fructify into gains for real estate firms. So, realty stocks fell after gains posted until the June quarter.

During the September quarter, the only respite came from some sporadic new launches. But there was no drastic turnaround in the performance of companies. Regional disparities continued, with southern markets like Bengaluru clocking better sales when compared with Mumbai and the National Capital Region (NCR). Therefore, some companies like Sobha Developers Ltd, Prestige Estates and Projects Ltd and Purvankara Projects Ltd, with a greater presence in the south, reported better revenue growth. Commercial lease rentals, which had shown some improvement in the earlier quarters, were flat, too.

But high property prices in the residential market and interest rates are a deterrent and investors are still postponing buying decisions, hopeful of a price correction. A UBS Research report says the property market is still weak, inventories are at a seven-year high and approval delays, along with cash-flow constraints, have led to construction backlogs and cost overruns.

Hence, improvement in operating margin (in the last three successive quarters) through stringent cost cutting was negated by rising interest costs. The quarter did not bring much relief on debt, as there was hardly any asset monetizing. For instance, Sobha Developers’ interest costs rose year-on-year and so did those of DLF Ltd. A Motilal Oswal Financial Services Ltd report says that the overall gearing (debt to equity) rose across the sector on the back of negative free cash flows due to construction spending, business development activities and interest outgo. Besides, some like DLF are also stuck with legal tussles.

Until economic revival to boost residential property sales goes hand-in-hand with debt reduction for realty companies, they will remain unattractive for investors. — Vatsala Kamat

RETAIL: results a mixed bag

The results of Indian retail companies for the quarter ending September were a mixed bag, influenced by a variety of factors. What is encouraging, however, is that Shoppers Stop Ltd and Future Retail Ltd both reported better like-to-like or same store sales growth. Same store sales growth, or like-to-like sales growth, refers to comparable sales growth from stores that have had operations for over a year and does not take into account growth coming from new stores.

Like-to-like sales growth for Shoppers Stop department stores in the September quarter increased by 11%, comparing quite favourably with 3.7% like-to-like sales growth seen in the June quarter. Moreover, like-to-like sales growth in the September quarter last year was 15.5%. A longer (discount) sale period helped Shoppers Stop’s sales. Another positive factor is that the company’s subsidiary HyperCity’s performance showed an improvement for the second quarter in a row. Shoppers Stop reported consolidated post-tax profit of 3.78 crore last quarter as against a post-tax loss of 3.18 crore in the same period last year.

For Future Retail, same store sales growth for home and consumer durables chains Home Town and eZone was 7.8% while that of the value business primarily from Big Bazaar was 14.1%. “Early onset of the festive season, improved mix and higher electronics sales led to healthy same store sales growth," said a note by JP Morgan. However, higher depreciation and finance costs meant that the company posted a pre-tax loss of 28 crore. Importantly, balance sheet concerns remain. According to JP Morgan, net debt-to-equity ratio at about 1.9 times and net debt-to-Ebitda ratio at around 6 times remain high. Ebitda refers to earnings before interest, tax, depreciation and amortization.

Meanwhile, winding up of the Golden Harvest scheme—under which consumers deposited a fixed amount every month and bought gold worth the deposited amount at the end of 12 months–meant that Titan Co. Ltd delivered a spectacular 65% year-on-year revenue growth in its jewellery business. The company’s watch business, too, performed well. As a result, Titan’s year-on-year net profit growth was the strongest in at least six quarters.

Shoppers Stop shares performed better than those of the other two companies during the September quarter. — Pallavi Pengonda

TELECOMMUNICATION: volume-led growth makes telcos shine

India’s largest telecom companies continue to impress with strong growth on the back of reduced competition. Wireless revenues of the top three—Bharti Airtel Ltd, Vodafone India Ltd and Idea Cellular Ltd—grew 13% year-on-year in the September quarter, data collated by Kotak Institutional Equities show. In the June quarter, aggregate revenue of the three companies had grown by 11%.

What’s more, earnings before interest, tax, depreciation and amortization (Ebitda) of Bharti and Idea rose by an impressive 22.6% and 25.9%, respectively. Both managed this growth without a meaningful push from price realization. Voice tariffs had been on an uptrend since last year, but fell sequentially for both companies in the September quarter.

While competition has decreased considerably, firms are still being nimble-footed as far as pricing strategies go. And although price realizations haven’t risen, this has been more than compensated for through growth in volumes in the voice segment. Meanwhile, data traffic has continued to grow at a healthy pace. Analysts at Kotak wrote in a note to clients that data has become a growth driver, accounting for 14.4% of revenue for the top three, versus 9.2% a year ago. So, despite softness as far as voice tariffs go, revenue and profit have grown at a healthy pace, and there’s hardly any reason to complain.

In Bharti’s case, its African operations marred the show. Volumes in the region grew by only 4% year-on-year, while voice average revenue per user (Arpu) fell by 12% in dollar terms. Ebitda of the African business fell 11% in dollar terms. With the business accounting for one-fifth of total profit, the company’s earnings turned out to be lower than street expectations.

Reliance Communications Ltd, which typically runs an altogether different course, reported a 3.2% decline in Ebitda, after profit grew at a healthy pace in the preceding four quarters. While the drop in profit growth was largely owing to the company’s global operations, even its Indian operations lagged behind peers. — Mobis Philipose

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