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Top sectors & stocks to look out for
Priya Kansara | April 16, 2007
The markets may seem unconvinced about the ability of corporate India to maintain its growth momentum but analysts are not predicting doomsday yet. Despite serious challenges in the form of crude price hitting a six-month high of $68, inflation climbing to a high of 6.49 per cent and rising interest rates, analysts are expecting that corporate earnings for the March 2007 quarter would end on a healthy note.
Besides strong growth in revenues, Indian corporates are expected to post improved profitability (read margins) with operating and net profit growing at a faster clip.
However, according to Motilal Oswal Securities' report, the year-on-year (y-o-y) growth in Q4FY07 is expected to be lower compared to the earlier quarters. However, Amitabh Chakraborty, president-equity, Religare Securities expects earnings growth to be better than the third quarter.
Sectors like cement, pharma, metals, information technology and telecom are expected to be star performers. On the other hand, sectors like auto, banks and sugar are likely to disappoint investors owing to unfavourable industry dynamics.
However according to analysts, most expectations, positive or negative, are priced into the stock prices and market is waiting for fresh triggers. Earnings guidance by the companies for the coming fiscal may provide some impetus. Read to find out in detail how the pillars of India's growth story are likely to perform in Q4FY07.
The performance of auto companies, barring two-wheelers, is expected to be satisfactory in Q4FY07. Revenue growth is likely to be around 20 per cent y-o-y led by strong growth in volumes and realisation though margins are likely to be under pressure. Volume growth of 22 per cent and 27 per cent is expected in commercial vehicles and passenger cars respectively while two-wheelers are likely to report a marginal growth of six per cent.
Intense competition especially in the two wheeler segment and rising input costs are expected to dent operating profit margins. A foreign broking firm expects passenger car and two-wheeler margins to nose-dive in the range of 200 and 450 basis points.
ASK Raymond James expects four-wheeler margins to decline by 100 basis points. Further, overall net profit growth is expected to be around 7-8 per cent largely due to profit growth of four-wheeler majors like Mahindra and Mahindra and Tata Motors even as two-wheeler companies are expected to report substantial decline in profit.
Besides, M&M will entrench its presence further in tractors by acquiring stake in Punjab Tractors. Also the company will be entering a new orbit as it has now entered into the largest auto segment - passenger cars- with the launch of Logan.
Further, the company could see some value being unlocked in future thanks to its investment in subsidiaries like Tech Mahindra and M&M Financial Services.
On the other hand, Tata Motor's commercial vehicle business is reaping the benefits of higher economic activity in the country. Its passenger car segment is also doing well. Tata's dream project -- the 100,000 car -- is also in progress.
Banks may surprise investors with robust growth of 30 per cent and 20 per cent y-o-y in credit and deposit respectively. But net interest margins could come under pressure on a sequential basis due to faster growth in deposit costs though they are expected to be maintained on a y-o-y basis.
The 75 basis points hike in the cash reserve ratio by the RBI during the quarter would also drag down the margins and profitability of banks since the prevailing interest on deposits with RBI at 0.5 per cent currently is far lower than the lending rate.
Moreover private sector banks would face additional pressure due to higher general provisions (up at 2 per cent from 1 per cent earlier) required on specified categories of loans - real estate, personal loans, credit cards. Edelweiss Securities expects an overall growth of 40 per cent in net profit. Private banks are expected to outperform public sector banks on most parameters.
Despite the fact that analysts expect better numbers from private banks, they recommend public sector banks as top picks. They prefer large banks like PNB, SBI and Bank of India with wide network and a higher CASA ratio while they are wary of private sector banks, especially ICICI Bank.
PNB's higher proportion of low cost deposits (CASA ratio) of about 50 per cent and net interest margins of over 3.5 per cent makes it a safe investment bet. SBI's biggest advantage lies in its large distribution network with over 9000 branches, high CASA ratio, value in its associate banks and non-banking subsidiaries like life insurance, mutual funds and credit cards.
FY07 has been a record year for cement companies, which have seen their profits soar consistently in every quarter. Q4FY07 is expected to be no different. Revenues of cement companies are expected to grow more than 30 per cent thanks to almost similar growth in realisations y-o-y and about 5-7 per cent growth in volumes.
Operating profit margins are likely to expand substantially as growth in realisations appears to have outpaced that of costs. Net profits are expected to jump over 70 per cent y-o-y.
Frontline companies like Gujarat Ambuja, ACC, Ultra Tech Cement, Grasim, India Cement and Shree Cement are the most preferred bets. Higher volumes and substantial improvement in realisations will drive these stocks.
Besides, some analysts recommend Gujarat Ambuja as a safe bet considering its cash rich position. During the quarter, Gujarat Ambuja sold its 11 per cent stake out of total 33 per cent holding in Ambuja Cements Eastern to Holcim for Rs 527 crore (Rs 5.27 billion) and its two acre land in Mumbai to Orbit Corporation for Rs 330 crore (Rs 3.3 billion), which it expects to complete by the second quarter of this calendar year.
With robust infrastructure spending and huge order book positions, the revenue growth of frontline construction companies is expected to be robust at 30-40 per cent. Operating profit growth is expected to be even higher. Net profit is expected to be a notch lower in the range of 20-40 per cent, thanks to the withdrawal of Section 80IA benefit in the Union Budget 2007-08 wherein construction companies earlier paying MAT (minimum alternate tax) are expected to pay full tax with retrospective effect from 2001.
However this is a one-time settlement and analysts are still positive on construction companies thanks to the long-term visibility rendered by robust infrastructure spending by the government.
Analysts prefer frontline construction companies like NCC, HCC, Gammon, IVRCL, Patel Engineering, Madhucon Projects and Punj Lloyd for their long term earnings visibility. Most of them boast of an order book to sales ratio of 3.5-4x.
IVRCL is preferred owing to its exposure to real estate through its subsidiary namely IVR Prime Urban which has a land bank of 2,298 acre, representing a development area of 56.63 m sq ft in the cities of Hyderabad, Chennai, Bangalore, Pune and Noida. Several other companies including NCC and HCC are also foraying into real estate business.
Riding on the industrial capex boom and robust infrastructure spending, analysts expect engineering and capital goods companies to report robust growth in revenues and profits with huge order book inflows in Q4FY07. Moreover, unlike in the past, margins are expected to improve due to the benefits of lower cost of inputs like steel, aluminium caused by the reduction in import duties in January 2007.
Most of the companies are sitting on huge order book positions. Order backlog for most companies is up about 50 per cent y-o-y. Further companies like Thermax and Siemens are on a massive expansion spree, diversifying into related but new businesses, which will fuel their already high growth.
Though concerns of US slowdown and the appreciating rupee loom large over IT companies, as far as Q4FY07 is concerned, investors will not see any slowdown in the performance of IT companies.
In Q4FY07, Infosys' net sales grew 3 per cent q-o-q to Rs 3555 crore (Rs 35.55 billion), while operating profit growth was flat at Rs 1268 crore (Rs 12.68 billion). Net profit jumped 17 per cent to Rs 1124 crore (Rs 11.24 billion) due to lower tax provisions. With the announcement of Infosys results, which were in line with analysts expectations, analysts expect others to follow suit.
Apart from the biggies, select mid-cap players like Sasken Communication, Mphasis BFL and Infotech Enterprises are expected to keep up their performance. While revenues are expected to grow over 6-8 per cent quarter-on-quarter (q-o-q) largely led by volume growth and stable pricing, operating margins are expected to be maintained and net profit is expected to rise by over 5-6 per cent.
However, Religare Securities expects operating profit margins to be under pressure (declining by 50 basis points except TCS) due to the appreciating rupee. ASK Raymond James argues that the impact of rupee appreciation will be offset by higher utilisation of fresh graduates recruited in the previous quarters.
Unlike in the past few quarters, investors can expect better results from steel companies compared with non-ferrous metal players in Q4FY07. While steel companies are expected to post double digit growth in revenues and profits riding on better realisations, strong volumes and low base effect of last year, non-ferrous players are expected to report minimal growth or decline in profits.
While hot rolled prices increased by more than 25 per cent in the quarter, prices of non-ferrous metals like zinc and copper declined 16 per cent each. The halving of TC/RC (treatment and refining charges) was a further blow to copper smelters. Aluminium prices, however, managed to be in the positive zone with an increase of 3 per cent.
While Tata Steel's buyout of Corus is expected to reap benefits in the long run, SAIL's Rs 37, 000 crore capex for raising the current capacity of saleable steel from 13 million tonnes per anum (mtpa) to 20mtpa by 2010 will boost its volumes and revenues. Further, JSW Steel is also expected to benefit from its brownfield expansions and cost advantages due to its location in iron ore rich belt of Bellary-Hospet.
Pharma companies are expected to report robust top line growth in the range of 20-30 per cent led by bigger Indian pharma companies like Dr Reddy's Laboratories, Sun Pharma and Wockhardt. The main reasons: the low base effect of last year, strong growth in unregulated markets including India and benefits of inorganic growth initiatives.
However, pricing pressure in the generics market continues to be challenging. Operating profit margins are expected to expand for Dr Reddy's and Ranbaxy as synergies relating to the acquisitions they made last year will start kicking in. The impact of rupee appreciation is something investors need to watch out for. Net profit margins for few select companies like Cipla and Shasun Chemicals are expected to be under pressure.
Analysts have a buy recommendation on almost all the large companies including Ranbaxy, Dr Reddy's Laboratories, Cipla and Sun pharma. While Ranbaxy and Sun Pharma will benefit from mark-to-market gains on their FCCBs because of the rupee appreciation, Dr Reddy's will benefit from Ondansetron exclusivity, though Betapharm may disappoint given worsening dynamics in the German generic market.
Riding on increasing consumerism, analysts expect FMCG players to better their performance in Q4FY07. Top line growth is likely to be in double digits though this may not be true for HLL and ITC due to their higher base. Operating and net profit margins are likely to expand for companies like HLL, ITC and Colgate due to price hikes.
Companies had raised prices in the range of 3-5 per cent in some large product categories to counter rising costs in the past quarter. Motilal Oswal Securities and Kotak Institutional Equities feel that companies like Godrej and Nestle (to some extent) could face some margin pressure due to the sharp rise in prices of raw materials like palm oil and wheat, which have shot up about 40 per cent and 30 per cent respectively y-o-y.
Though valuation of FMCG still seem to be on the higher side, HLL, ITC, Godrej Consumer and Britannia are the preferred bets. While Godrej Consumer is preferred for its recent initiatives like the 50:50 joint venture with SCA for baby diapers and feminine care, ITC is preferred due to its growing cigarettes business despite implementation of VAT.