Feeling the Pressure

Except for defensive sectors such as IT and pharma, India Inc's first-quarter numbers show it is in a bad shape.
Tanvi Varma/Money Today        Print Edition: September 2013

The verdict is out. India Inc's performance in the first quarter of 2013-14 is not good. Although not all companies have declared results yet, based on the past trend, that is, Sensex earnings growth of just 6.8% in 2011-12 and 6.2% in 2012-13, and the results so far, double-digit growth looks difficult, says Pankaj Pandey, head, research, ICICI Securities.

"So far, 1,787 companies have declared their first-quarter results. The average top-line growth has been just 5.6% while bottom line has risen 6.7%," says AK Prabhakar, senior vice president & head, Equity Research Retail, Anand Rathi.

"Though the results are not encouraging, pharmaceutical, information technology and textiles sectors have gained from rupee fall," says Prabhakar. However, cement, capital goods and metals have done poorly due to low demand and high raw material costs. Automobile sales have fallen sharply while banks have been hit by poor asset quality and low deposit growth.


Pandey says almost all Tier-I IT companies reported better-than-estimated earnings, led by an average 3.9% volume growth on a sequential basis, though realisations took taken a dip. Even though the rupee fell sharply during the quarter, most of this fall was in June; the average decline for the quarter was just 3%.

Infosys, for instance, beat analysts' expectations, posting 2.7% dollar revenue growth as against the expectation of 1%. The company expects 13-17% revenue growth in 2013-14 in rupee terms and 6-10% in dollar terms. Despite uncertainty about the macro environment, changing regulatory regime and volatile currency, the company reported an operating profit margin of 26.5%.

TCS registered stellar volume growth of 6.1% (above analysts' estimates of 4%). Its dollar revenue grew 4.1%. But rupee fall ensured a 9.5% rise in rupee revenue to Rs 18,000 crore. The hallmark of TCS' performance over the past quarters has been growth across segments. "A rising dollar led to 8-10% revenue growth for most Tier-I IT companies barring Wipro," says Pandey.

Rupee fall has benefited pharmaceutical companies in the range of 3-5% of export revenues as most of them have hedged their net exposure. "While foreign markets provided support, problems in Brazil and concerns over domestic demand had a strong impact," says Prabhakar. In fact, most frontline companies missed estimates, mainly due to slowdown in the domestic formulation industry and delays in product approvals in the US and Brazil. The uncertainty created by the new drug pricing policy also created shortages in distribution channels.

Contrary to expectation that pharmaceutical companies will report exceptional results due to rupee depreciation as they are big exporters, the fact remains that the impact of rupee fall on a sector is decided by the extent of foreign currency debt, export surplus and hedging. While pharmaceutical companies are safe on the foreign exchange debt front, the impact of higher export earnings will be seen in the coming quarters.

Sun Pharma's adjusted net profit, for instance, rose 56% to Rs 1,240 crore, but after providing for provisioning the company reported a consolidated net loss of Rs 1,276 crore (it wrote off Rs 2,517 crore to settle a patent litigation with US-based Pfizer). Analysts say the performance is because of 32% growth in the US formulations business.

The company benefits from rupee fall as its net foreign exchange exposure is 50% of sales. Also, it has no foreign exchange debt on its balance sheet.


Though the results are not encouraging, pharmaceutical, information technology and textiles sectors have gained from rupee fall"

AK Prabhakar

Senior Vice President & Head, Equity Research Retail, Anand Rathi

Lupin's sales grew 9.9%. It reported a 43% rise in net profit to Rs 400 crore; however, adjusted for a foreign exchange gain of $960 million, adjusted profit after tax grew 20.7%. According to a report by Anand Rathi, Lupin's growth was less than expected mainly due to fall in the domestic formulations business and higher taxes. The company is looking at a three-fold rise in revenue to $5 billion by 2018.

Cipla also posted decent results backed by a strong 21% growth in exports and 17% in the domestic formulations business. The management is confident about double-digit growth in 2013-14. According to an IIFL report, Cipla's recent bout of large investments is likely to show results in the next two-three years.

The fast moving consumer goods, or FMCG, sector has been doing well for the last couple of years. The first quarter of 2013-14 was a bit different. "After several quarters of double-digit growth, almost all FMCG companies reported slowdown," says Pandey of ICICI. On the positive side, though, lower commodity prices aided margin expansion. Hindustan Unilever's (HUL's) numbers, for instance, show lower volume growth, though margin expansion provided some solace.

However, with raw material prices rising marginally, slowdown in demand for premium products and rise in media spending, margin expansion is unlikely in the coming three-four quarters.

According to ICICI Securities, earnings are expected to grow at 10% a year over 2012-13 and 2014-15, as against 26% between 2010-11 and 2012-13. Also, stiffer competition in the soaps and detergents space may put pressure on leading FMCG companies.


Looking at Sensex earnings growth of just 6.8% in 2011-12 and 6.2% in 2012-13, and the results so far, double-digit growth looks difficult"

Pankaj Pandey

Head of Research, ICICI Securities

Nestle's results were in line with analysts' expectations, aided by strong domestic revenue growth of 9.2% compared to 7.7% in the first quarter of 2012-13. Export revenue grew by 46.9%. According to a report by Edelweiss, the company's premiumisation strategy and introduction of products from the international portfolio are expected to support margins and drive sales. A good monsoon may lower prices of raw materials, particularly milk, and aid margin expansion. Higher rural disposable incomes as a result of a good monsoon will also push up sales.

According to Suruchi Jain, equity research analyst, Morningstar India, ITC's revenue growth this quarter was muted as higher excise duties hit cigarette sales, which grew only 13.5%. However, margins were buoyant. Full-year revenue growth is expected to be 15%.

Britannia also surprised the market by delivering 100% growth in net profit to Rs 86 crore led by higher gross margins and lower other expenses. "EBIDTA, or operating, margins rose 300 basis points, or bps, to 8.3% despite a 90 bps increase in ad spend and a 40 bps increase in employee costs," says Rakesh Tarway, assistant vice president, Research, Motilal Oswal Securities. EBIDTA is earnings before interest, depreciation, taxation and amortisation.

Banks sent mixed signals. "Though private banks reported good numbers and asset quality, government banks struggled due to poor asset quality and the central bank's liquidity tightening measures," says Prabhakar of Anand Rathi.

State Bank of India's net profit fell 14% to Rs 3,240 crore, primarily due to higher-than-expected operating expenses and provisioning. The net interest income, or NII, showed 3% growth. "There has been pressure on asset quality, which is demonstrated by a 19% sequential increase in gross non-performing assets to Rs 60,900 crore," says Tarway.

Further, with a sharp rise in bond yields, the bank could face significant mark-to-market provisioning. This holds true for a large number of public sector banks.

Punjab National Bank's asset quality also remained under pressure (4.7% gross slippages). Despite that, the bank's net interest margins, or NIMs, remained stable at 3.5% as the cost of deposits saw a marked decline. Bank of Baroda's loan growth decelerated to 12% from 23% in the year-ago period. NIMs fell 10 bps and are likely to remain under pressure due to spike in short-term borrowing costs. The bank's asset quality deteriorated for the sixth consecutive quarter with gross non-performing loans rising 22% quarter-on-quarter.

On the other hand, private sector banks such as HDFC Bank, Kotak Mahindra and Yes Bank reported superior performance. According to Jain of Morningstar, HDFC Bank is the best in class and has been able to maintain superior NIMs of 4.5% on an average over the last decade. Despite remarkable loan growth, which has averaged 40% a year for the past 10 years, HDFC has managed to expand its deposit base at nearly the same clip, maintaining a low cost of funds and upholding profitability. On a risk-adjusted basis, the bank's NIMs were 3%, much higher than that of peers.

"In spite of the bank being expensive, such high multiples are warranted given the company's superior track record and consistent growth trajectory," she adds.

India's second-largest lender by assets, ICICI Bank, also posted a decent 25.3% growth in net profit led by loan growth and income from fees and commissions. NIMs were 3.27% compared to 3.01% a year ago.


High interest rates and slowdown in economic activity were clearly reflected in the quarterly results of capital-intensive sectors such as capital goods, infrastructure and engineering. "While high rates have brought the capital investment cycle to a grinding halt, the overall economic slowdown is visible in slow growth or even shrinkage in order books of companies," says Pandey. "Stiff competition from foreign players, low-ticket transactions and shrinking margins are the key issues for the sector," says Prabhakar, who prefers stocks like Thermax, Havells India and L&T in this sector.

The current slowdown is not a quarterly phenomenon. It seems these sectors will continue to face the heat in the foreseeable future. Though most of these stocks look extremely cheap and may generate significant returns, the wait for restarting of the capital expenditure cycle may be painfully slow. In fact, Pandey recommends a switch to defensive sectors. The situation looks grim, says a report by Nomura Securities.

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