Beating the street

Corporate results are worse than before but better than expected. Best of all, despite the definitive slowdown, stocks remain the best investment.

R Sree Ram | Print Edition: May 29, 2008

Results tell us...

?• Winning stocks and sectors keep changing.so always diversify

• Stock prices won?ft rise as fast in the coming months as they did in the past few years.so temper down your expectations

• Inflation, interest rates and exchange rate affect returns on equity investment.so understand the economic environment

• Though lower than past few years, returns on equity will still beat all other asset classes.so rely on equity to get high returns

• The days of rising tide (investment) lifting all boats (stocks) are gone.so pick your stock and fund investments carefully

How to make a poor result look good? Create a doomsday scenario before the results are actually out. Something like this happened with the fourth quarter results of companies. Economists and businessmen seem to be more concerned about the fall in growth rates of sales and profits than stock markets are. Or so it seems. In the six weeks since 1 April—when fourth quarter results started coming in—Sensex had gone up by 11%. “The fourth quarter results were not as bad as they were perceived to be,” says Ajay Parmar, research head at Emkay Share and Stock Brokers.

Apparently, stock markets, usually a fairly accurate harbinger of future, were off the mark while estimating the extent of slowdown in corporate earnings. Share prices went into a tailspin in March fearing, among other things, that India Inc’s average sales growth rate would fall to 16-18%, but the fourth quarter results have proved them wrong. BSE-500 companies on an average have seen their revenues grow at over 29%, though their profit growth were subdued at 21% compared to 42% in the previous quarter.

The services industries, especially banking and telecom, were among those that outperformed the expectations on the street. Banking did slow down a bit in the fourth quarter, but it is the only sector which has reported consistent growth in revenues and profits in the past few years. Most of this is due to the robust results posted by private sector banks. The 18 banks which had declared results till the first week of May reported an average 33% rise in revenues and profits in 2007-8 compared to 23% in the previous year. Cellular companies, whose average profit growth had fallen to 28% in the October-December quarter, have seen profits rise by over 36% in the fourth quarter, largely driven by a spectacular 108% rise in net profits of Idea Cellular.

On the other hand, the sales and profit growth of manufacturing industries dipped as rising input costs put pressure on profit margins. Given the competition and government’s strict watch on inflation rate, most industries could not pass on the higher cost to consumers. At least not fully. “Rising input costs are hurting the automobile, cement, steel and FMCG sectors,” says Amitabh Chakraborty, president (equity), at Religare Securities. Not all companies and sectors were badly affected. FMCG companies passed on the rise in costs to customers by hiking prices by 8-10%.

Steel companies managed to protect their margins because of the substantial rise in steel prices. However, some of the price gains are likely to be diluted following the industry’s 7 May agreement to cut prices. In case of cement, per bag sales price could not absorb the total cost push, resulting in lower margin. High input costs surely benefitted companies manufacturing and supplying those inputs. For instance mining companies Gujarat NRE and Sesa Goa reported a whopping 70% rise in net profit, thanks largely to the rise in prices of coking coal and iron ore.

Click here to see quarterly performance of different sectors A
Click here to see quarterly performance of different sectors B

A Chakraborty
High input costs are hurting auto, steel, cement and FMCG sectors

—A Chakraborty, President (equity), Religare Securities


Sonam H. Udasi
Companies should be able to sustain 18% plus growth in profits in 2008-9

—Sonam H. Udasi, Director (research), Prime Broking

While most manufacturing sectors are slowing down, there are islands of fast-track growth. The pharma sector, which has been out of favour for most of the bull run in 2007, was one such exception. The sector showed definite signs of recovery in the final quarter of 2007-8, registering a profit growth of over 70% in the past two quarters.

In addition to rising costs, the pressure on earnings has also come from capacity constraints. “India is not facing any demand side constraints. The real issue is with supply side and that is being corrected,” says Parmar. With the current demand expected to sustain at least for the next 12-18 months, most companies are in the midst of capacity expansion. Emkay foresees a huge capacity build up in manufacturing and infrastructure. It expects the cement capacity to rise by 50% and the steel capacity to double in the next three years.

But the current slowdown would continue for a couple of quarters before new capacities come on board. IT companies, which saw profits shrink due to the rise in the rupee value, were able to sustain earnings growth in 2007-8. The sector’s revenues grew by 25% and profits by 16% in 2007-8. “IT companies’ earnings were in line with market expectations barring a few disappointments. Whether the same would continue needs to be seen on how the external events shape up,” says Himanshu Varia, senior manager, institutional sales, Asit C Mehta. Considering the unfavourable factors in the current situation, frontline IT companies estimate annual growth of 15% in 2008-9.

So, how will India Inc fare this year? Experts are unanimous that 2008-9 will not see a spurt in earnings growth given the rise in input costs and the high base effect. “Companies should be able to sustain 18% plus earnings growth in 2008-9. The RBI’s expectation of 8-8.5% GDP growth further ratifies this expectation,” says Sonam H. Udasi, Director of Research at Prime Broking Company. While most analysts expect companies to consolidate for the first two quarters, fixing raw material issues and adding more capacities, they expect a notable upside in earnings to emerge only in the second half of 2008-9. So you will have to wait till Diwali to see if the fireworks return to the market.

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