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Q4 Causes Concern

Monday, April 15, 2013
By Manik Kumar Malakar

Revenue growth of Nifty companies is expected at a 13-quarter low of just 6% year-on-year

The linkage between the corporate sector and the Indian economy in the latest quarter is a little complicated. The India corporate sector in the latest quarter (read Q4FY13) is expected to post a lackluster performance. The economy though has probably bottomed out. Equity wise, the political uncertainty is taking its toll on the markets, but this means that equities are now trading at a discount to valuations.

“We expect a lacklustre Q4 (Fourth Quarter) with Sensex ex-oil sales expected to grow at a relatively better 12% year-on-year (yoy), but profits to fall by 2.4% led by Autos, Metals and Telecom and SBIN (State Bank of India),” says Dr. Tirthankar Patnaik, Director, India Strategist and Chief Economist, Religare Capital Markets in a Q4 FY13 Earnings Preview.

Q4 FY13 is expected to be flat to negative in terms of earnings and growth. “We expect 4Q FY13 earnings of our Karvy universe to exhibit a profit growth of 4% yoy,” says Murali Krishnan of Karvy Stock Broking in a Quarterly Preview. The Karvy Universe would be the companies that the brokerage tracks. On a quarterly basis  earnings are expected to grow by 12%.

“Revenue growth of Nifty companies is expected at a 13-quarter low of just 6% year-onyear,” says Ajay Bodke of Prabhudas Lilladher. The revenue growth of these companies; after excluding Oil & Gas companies; would be a just 6.3% yoy which is a 12 quarter low.

So what is the outlook for the various sectors that comprise/constitute the Indian economy? ‘We expect stocks under our coverage; excluding banking / NBFCs; to report revenue growth of about 7% on a YoY basis,’ says the research team at Kotak Securities in their Q4 Preview. Thus, amongst the various sectors, IT and Oil & Gas are expected to predominantly propel this growth, apart from Power and FMCG.

The revenues of the IT companies are expected to be driven by the near 8% rupee depreciation YoY. Higher capacities and realisations should lead to increase in revenues of power and Oil & Gas companies. Sustained demand should support growth for FMCG companies. ‘We will watch out for the order bookings and order execution issues, if any, in Construction and Capital Goods sectors,’ the Kotak team notes.

So what are the major reasons for the corporate number’s slump? It is mostly economic related. And here lies a dichotomy. Economic numbers (for now) are bad as are corporate numbers. But the economy, at the very least, is expected to recover from here, going forward.

“The sharp deceleration in top-line growth of India’s bellwether mega-cap companies is mirroring the slump in the overall aggregate demand in the Indian economy as evident in the multi-year low GDP growth numbers,” says Bodke.

So if it is the economy that has played such a damper on corporate earnings thus far, it is the economy that may yet play the role of a saviour.

“Whilst 3Q FY13 GDP growth hit a four-year low (of 4.5%), historical patterns suggest that the Indian economy is currently exhibiting the classical signs of being in the early phase of a recovery,” says Saurabh Mukherjea, of Ambit Capital.

What are the pointers for this assumption? First, in line with historical recovery patterns, the drop in GDP growth rates in India has stopped since 4Q FY12; (stabilising at approximately 5.4%YoY.

Secondly, in line with historical recovery episodes, specific components of GDP have begun to improve. These would include government expenditure and investment.

“Whilst history suggests that such a ’drop stop phase‘ is often characterised by a one-off drop in GDP growth rates; such as the drop in Q3 FY13;, historical evidence suggests that the GDP stabilisation phase eventually gives way to secular GDP growth acceleration,” says Mukherjea.

As such, the Indian economy finds itself at growth crossroads as the slide in growth indicators continues though the flow of reform announcement does raise hopes of economic growth bottoming out soon, says Centrum. “However, there are a few green shoots visible,” they say. So IIP growth has seen continued improvement, i.e. 1.8% growth for last 6 months versus 0.1%growth for preceding 6 months.

Also PMI (services & manufacturing) remains in expansion zone. ‘This, along with Cabinet Committee on Investments getting back into action, should pave the way for a gradual recovery in economic activity,’ says Centrum.

SECTORS LEADING PROFIT GROWTH

  • NBFC – healthy retail demand,
  • FMCG – margin expansion led by soft input prices and lower A&P Spends
  • IT – Rupee depreciation YoY,
  • Power – better PLFs and coal availability
  • Energy – led by refiners on better margins, weak quarter
  • Realty
  • Retail

SECTORS DRAGGING PROFIT GROWTH

  • Autos - lower prices and margin decline
  • Cap Goods – soft execution, declining order-book
  • Cement – lower volumes, higher costs hurting margins
  • Metals – lower realizations, albeit marginally better QoQ, and higher input costs impacting profits
  • Telecom – lower wire-less revenue growth.

REPO RATE CUT FAILS TO CHEER MARKETS
In its Mid Quarter Monetary Policy Review on March 19, the Reserve Bank of India (RBI) eased the repo rate by 25 bps (basis points – one basis point is one hundredth of a percentage point) from 7.75% to 7.50%, in line with market expectations, says Angel Broking in their Q4 preview. This move takes the repo rate 100 bps lower since April 2012.

‘We believe that the RBI's policy stance has shifted from a rather hawkish tone to a more balanced approach in the growth-inflation dynamic, owing largely to slower-than-expected pace of economic growth, recent moderation in WPI inflation (particularly core inflation) and the government's positive action on fiscal consolidation,’ says Angel Broking.

The monetary policy stance going forward in FY 2014 would continue to be determined by the Current Account Deficit, inflation and growth scenario. ‘We expect repo rate cuts amounting to 50-75 bps for FY 2014,’ says Angel Broking.

The reduction in RBI's key policy rate failed to impress the market as political concerns surfaced immediately after the policy review.

Equities
The equity markets have been very volatile in 2013. While 2012 was good for equities (with 26% returns), 2013 has not, so far. In the Q1 CY13 period equities fell by 3%..

Within the broader markets, certain sectors like mid-caps fell by 14%. Domestic investors were net sellers throughout the last 12 months, whereas FIIs were big buyers. ‘The Sensex return in FY13 at 8% has very closely tracked the EPS growth of 5%, keeping the valuation multiples unchanged,’ says Motilal Oswal in their Q4FY13 preview.

Weak macro and political concerns have had an impact,” says Dipen Shah, Head of Research with Kotak Securities.

The budget did provide support to the markets but the Government now needs to walk the talk and control the fiscal deficit while improving the investment climate.
“Valuations are slightly lower than the long term average though, based on consensus estimates for the Sensex companies,” says Shah.

So what are the triggers that will drive markets going forward?

“We opine that, if the markets have to sustain the current levels and move up, it will need to have more confidence in the medium to- long term growth rates of Corporate India,” says Shah. Growth rates will move up once there is a more-enabling investment climate and a lower-interest rate regime.

Conversely, disappointment in earnings or on future outlook may result in corresponding specific corrections. So how would the Sensex fare going forward? ‘We expect Sensex EPS (Earnings per Share) to grow by 14.9 % to Rs 1,366 in FY 2014 and by a stronger 15.5% to Rs 1,578 in FY 2015, implying a CAGR (Compounded Annual Growth Rate) of 15.2% over FY 2013-15,’ says Angel Broking.

Thus, the brokerage arrives at a 12 month Sensex target of 22,000, with a conservative target multiple of 14 times FY 2015E earnings; as against the 5-year average of 16 times and 15-year average of 14.4 times.

‘Our target implies an upside of 16.8% from the present levels and is likely to be backended,’ Angel Broking concludes.

SOME PICKS
Are there any stocks that look good to analysts? “Going into the results season we recommend investment in DRL, Sun Pharma, Lupin, Power Grid, BHEL, Bajaj Auto, Maruti, Ultratech, ICICI Bank, Union Bank, Oil India and ITC,” says Murali Krishnan of Karvy.

“Amongst mid caps we prefer Torrent Pharma, Shree Cement, Jyothy Labs, Dabur, J K Lakshmi, Syndicate Bank, CESC, NCC, Sadbhav and IL&FS Transportation,” he continues.

“Our high-conviction buys include L&T, Bharti, Maruti Suzuki, ONGC, Sobha Developers, TTK Prestige and Federal Bank,” says Saurabh Mukherjea of Ambit.

“Our high-conviction sells include Axis Bank, Infosys, Jubilant Foodworks and BHEL,” Mukherjea continues.

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