Five Stars of India Inc.

December 2011 was an eventful quarter for India Inc. Be it on the global front or on the domestic front, every now and then certain events kept investors busy. On the global front, the European debt crisis and slower-than-expected growth in the US markets kept everyone on their toes. On the domestic side, the sharp depreciation of the rupee (eight per cent) against the US dollar, inflation worries and the worst-ever IIP numbers (negative 5.10 per cent in October 2011) made sure that India Inc. did not get any respite. What added to the woes was the government inefficiency that led to policy paralysis. While these were the major negative factors, the biggest positive news came in when the RBI took a pause on the rate hike front.

All in all, it was a mixed quarter, and the corporate results too were on similar lines. Expectations on the corporate performance front were already low from the December 2011 quarter on account of the negative factors mentioned above, even after considering the higher base of the corresponding quarter (QE December 2010).

If we take a look at the results for the December 2011 quarter, they appear to be neither good nor bad. Rather, they are very much as they were expected to be. We analysed the results of 3706 companies, and at the gross level the outcome suggests that the for QE December 2011, topline growth came in at around 26 per cent while bottomline growth was around 43 per cent as compared to the December 2010 quarter.

The 43 per cent bottomline growth may look surprising to many, particularly because we mentioned right at the outset that the results appear to be neither good nor bad. However, a deeper scrutiny of the data reveals that the profits were skewed due to higher earnings from Oil Marketing Companies and also on account of extraordinary income; aberrations that need to be considered while looking at the growth that came in at the bottomline level.

As a standard practice, we adjusted for both these factors and arrived at the true picture after doing so. This shows a topline growth of 23 per cent and a decline in net profit by around 7.20 per cent as compared to the December 2010 quarter. On a sequential basis, the topline grew by six per cent and there was a marginal increase of 1.50 per cent on the bottomline front.

If we take a look at the results, a few factors emerge straight away. First, the raw material prices remained firm despite many expecting some amount of easing in December 2011. Higher raw material prices that could not be passed on to customers impacted the operating margins, which witnessed a decline of around 150 basis points and stood at 25.40 per cent. We are of the opinion that the high cost inventories that were carried forward might be the reason behind the same, and we may witness some improvement on the margins front in the coming quarters.

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The rupee depreciation (eight per cent in the December 2011 quarter) also impacted many companies, as many of them had taken foreign currency loans and reported mark-to-market losses. A few export-oriented sectors like IT and Pharma benefited, but Textiles could not get anything as the demand itself was impacted.

The continuously higher rate of inflation resulted in the RBI maintaining a hawkish stance, keeping interest rates on the higher side. The impact of higher interest cost is clearly seen from the fact that the interest cost of India Inc. has gone up by more than 44 per cent to Rs 33187 crore on a YoY basis after adjusting for the interest cost of Banks and financial   institutions. To quantify this, the interest cost as a percentage of sales stood at 2.70 per cent as against just 2.33 per cent in December 2010. Although this is lower than that of 2.82 per cent in September 2011, it is still above the comfort zone.

Rising interest costs resulted in higher cost of capital, which in turn impacted the capex cycle. Naturally, depreciation cost has been lower in the first three quarters of FY12. Rather, the data provided by a recent report from Morgan Stanley suggests that depreciation as a percentage of sales was at around 3.50 per cent in the December 2011 quarter, and has continuously witnessed a decline since the September 2010 quarter. This is an alarming sign.

The impact of higher raw material and interest costs is also clearly seen from the fact that while the sales of 2143 companies witnessed an up-move on a YoY basis, those for 1211 companies declined and were stagnant for 352 companies. Only 1572 companies showed an increase in net profit, while 1921 of them reported a decline. Profits for around 213 companies remained stagnant.

The story was no different when we analysed the figures for the ‘A’ group companies. Companies in the ‘A’ group form an important part of the overall results – though there are only 189 companies in the group, they contribute around 85 per cent of India Inc.’s bottomline. Data for these companies indicates that for QE December 2011, the topline growth stood at 25 per cent but the bottomline increase was a minimal 0.36 per cent.

The Sensex-based companies too showed a similar trend. For the QE December 2011, their topline growth stood at 25 per cent, while the bottomline growth was a marginal 2.46 per cent. In case of the Sensex, we feel that a 13 per cent decline in net profit for RIL, that too after a substantial rise in its Other Income, was what dampened the sentiment.

All in all, the results are in line with the expectation. Looking at the adverse macro economic factors and a higher base of the 19 per cent net profit growth for QE December 2010, the results are surely not great. However, sectors like IT, Pharma, Cement and FMCG kept their neck high above the water even in a difficult scenario.

So, what can we expect in the next quarter? As of now, there are many ‘ifs’ and ‘buts’ about the expectations from the March 2012 quarter. While the March quarter results are usually good, a higher base of a 23 per cent topline growth and 16 per cent bottomline growth will make it a bit difficult for India to post a spectacular performance in March 2012.

It is true that some positive factors like the decline in inflation and the expected action by the RBI to reduce key interest rates may provide much-needed impetus to the Indian economy. The news emanating on the global front also seems to be positive. What will decide the course of events though, will be the policy actions taken by the UPA government. Unless and until the government takes some positive steps to control the rising fiscal deficit and clears the related pending bills, it will not be possible to attain a higher GDP growth. If no policy action is taken, we feel that India Inc. may put in another dismal show for the March 2012 quarter. Certain sectors like Cement, IT, Pharma, Banking and Infra may put in a better performance, but overall growth may remain muted.

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Automobiles

Two Wheelers

The domestic sales of two-wheelers in the December 2011 quarter grew by only 11 per cent, bringing the YTD growth for the segment down to 15.32 per cent. Our sense is that this growth may reduce to the higher single digits going forward, thereby impacting the margins and sales growth for the companies. A brisk growth in exports, driven by motorcycles, has been a strong point for the segment. Export sales were up by 30 per cent, helping companies to report decent financials.

Hero MotoCorp, the leading player in this segment, reported a topline growth of 17 per cent but its bottomline hardly grew. However, Bajaj Auto reported a topline growth of 21 per cent and its bottomline grew by 10 per cent. We expect a similar kind of growth in Net Profit for the quarter ended March 2012 too.

Passenger Cars

The journey of the Indian passenger car industry has been one from high growth to no growth. In the first nine months of the current year, the domestic car sales have declined by 2.28 per cent. Going by the trend, car sales growth would in all probability be in the negative zone for the current financial year too. Readers may recollect that we had predicted the
same while analysing the September quarter numbers, despite the fact that car sales growth was in the positives at that time.

The industry dynamics are also changing, with the demand for super compact cars (Dezire, Etios and Verito) and mid-sized cars (like Verna and Vento) being much better. Due to some smart growth, these two segments now account for as much as 20 per cent of the overall car market as against 15.6 per cent last year.

So, how do we see the financial numbers for car companies in the next couple of quarters? Well, we are of the opinion that the car market would become more competitive in the months to come, as many players are launching new models at competitive prices in the coming months. Also, the Union Budget may be nasty for car players, as the government may increase excise duty (more likely on diesel cars), which would make cars costly and result in lesser demand. At the same time, a petrol price hike is on the cards and this may also dampen sentiments. India is likely to sign a Free Trade Agreement with Europe, Automobiles and cars imported from Europe would become cheaper due to a cut in import duty, which would further squeeze the margins of the Indian players.

Our sense is that one should avoid car companies from an investment point of view for the time being and look for other sectors to create an alpha on one’s stock portfolio. 

Commercial Vehicles

The performance of commercial vehicles in the domestic market was a mixed bag, with the Medium and Heavy Commercial Vehicles’ sales growing in single digits and the Light Commercial Vehicles segment growing at a handsome 28 per cent. In fact, a boom for LCVs continues even in the export market, where sales increased by 46 per cent in the first nine months, where M&HCV saw a negative growth of seven per cent in the same period.

We believe that the sector’s growth should improve in next six months due to the softening interest rates and also due to the government’s thrust on infrastructure development, which will push up the demand for commercial vehicles. We have been bearish on this sub-segment but we feel slightly bullish about it now. As far as exposure to auto stocks is concerned, we continue to believe that these companies may not offer exciting returns in the short term. Hence, we suggest that investors should play their cards cautiously. 

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Banking

As mentioned in our second quarter review, the BSE Bankex ended up underperforming the broader indices in the December 2011 quarter. The Bankex was down by 15.64 per cent, while the Sensex declined by six per cent during the same period.

In the third quarter of 2011, the RBI had assessed the monetary situation of the economy on two occasions. While it raised the repo rate by 25 basis points in its October 2011 review, the rates remain unchanged during the December 2011 review. This rise in rates further impacted the Net Interest Margin (NIM) of banks. In its January 2012 review, the central bank went a step ahead and slashed the CRR by 50 basis points to 5.50 per cent, hinting at an interest rate reversal in the coming quarters.

During the quarter, we also saw the deregulation of interest rates on savings bank accounts. Some private sector banks immediately increased the rates offered to customers, which in turn increased their saving deposits during the quarter. The deregulation of interest rates for NRIs came in during mid-December, the effect of which would be seen in the next quarter results.

Deposit growth outpaced credit growth in this period. As on 31st December, 2011, banks’ aggregate deposits grew by 16.2 per cent. On the back of higher interest rates offered, time deposits (Fixed Deposits) grew by 18.9 per cent during the period, while demand deposits (Current Account and Savings Account deposits) witnessed de-growth of 1.4 per cent on a YoY basis. On the other hand, as a result of the slowdown in the economy, banks’ advances grew by 15.9 per cent on a YoY basis as of 31st December, 2011, lower than the growth of 19.3 per cent recorded as on 7th October, 2011.

Of the 39 banks which we analysed, private sector banks (15) continued to outperform the public sector banks (24). The Net Profit of private banks increased by 26 per cent during the quarter, while that of the public sector banks grew marginally by just about one per cent. One of the reasons for PSU banks reporting lower profit growth was higher provisioning, which increased by 45 per cent.

Asset quality continues to be the key concern for the sector. SBI’s Net NPAs increased by 61 basis points on a YoY basis to 2.22 per cent. Other banks like Punjab National Bank, IDBI Bank, etc. have also seen deterioration in their asset quality. On the contrary, ICICI Bank’s asset quality improved significantly on a YoY basis, which is highly commendable.

In a rising interest rate environment, the Net Interest Margin (NIM) for banks is usually affected. Most of the banks saw a decline in their NIM, except for SBI, which saw its NIM go up by 26 basis points sequentially and by 44 basis points to 4.05 per cent on a YoY basis.

The deregulation of interest rates on savings bank accounts also helped some of the banks to mobilise more funds. Yes Bank was the first mover to hike its interest rates on saving bank  accounts and the result of this was clearly seen in the December quarter numbers. Its saving account deposits grew by 99 per cent on a YoY basis and by 40 per cent on a QoQ basis.

A major concern that still persists for the banking sector is the asset quality. This is particularly because of the pressure that sectors like Aviation, Power and Metals are exerting on it. With the IIP growing at a marginal rate and inflation showing signs of cooling off, we expect the interest rates to reverse, which may benefit the banking space. The NIM of banks may improve and the bond portfolio show a mark-to-market profit going ahead. We believe that the worst is almost over for the banking sector, and it may regain investors’ confidence and perform well on the bourses.

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Cement

The cement sector, which was languishing in the previous two quarters, has emerged with strong topline and bottomline growth in the December 2011 quarter. As per the dispatch numbers released by the Cement Manufacturing Association

(CMA), the said quarter has witnessed the highest growth in dispatches in the last nine months – a growth of 10.2 per cent YoY to 44.22 million tonnes, which takes the nine month growth to 5.13 per cent YoY.

Companies which have a pan-India presence reported a decent growth in their dispatches and realisations, which resulted in strong bottomline growth. The following table shows that the realisations of ACC have gone up by 21 per cent on a YoY basis, while those of other players went up between 12-17 per cent YoY. On the volumes front, Ambuja Cement reported 11 per cent YoY growth, and others saw a volume growth of around six per cent YoY. This is also reflected in the stock price  movement of these companies (ACC up by 20 per cent, UltraTech up by 21 per cent and Ambuja Cement up by 13 per cent) between October 2011 and Feb 2012.

The results reported by 39 cement  companies illustrate a similar picture, with aggregate sales having gone up 28 per cent and operating profits up by 44 per cent on a YoY basis during the December 2011 quarter. Net profits grew by 79 per cent YoY.

The major reasons for the cement sector doing well was the hike in the cement prices and some pickup in demand that happened during the December 2011 quarter. From October 2011 onwards, the cement players started hiking product prices in anticipation of a rise in demand and to offset higher input costs. In December 2011, the companies raised prices in the average range of Rs 20 to Rs 280 per 50 kg bag.

Overall, cement companies faced a very challenging time in the first half of the FY2012. The high interest rate regime led to a tighter liquidity situation, which hurt the investment cycle and new capex plans of various infrastructure and construction companies. Major input costs such as coal, power & fuel and freight were high due to supply shortages, which led to price hikes by various suppliers.

From December 2011 onwards though, the situation started appearing more conducive for these players as the RBI cut the CRR by 50 basis points, indicating that the interest rate cycle has peaked out and we may not see further rate hikes going forward. Also, cement is a cyclical business and the second half of the fiscal tends to remain better than the first half due to the monsoon and some lag effect post the monsoon.

Keeping this scenario in view, we believe that cement companies will see good volume growth and a subsequently hike in cement prices ahead. Both these factors will result in decent overall growth for cement players in the coming quarter.

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FMCG

The BSE FMCG Index outpaced the broader markets in the December 2011 quarter. It witnessed a rise of 3.19 per cent against the Sensex, which closed down six per cent. FMCG companies have seen a robust bottomline growth of 31 per cent, beating our expectations of 15-17 per cent growth. This was due to a decline in the prices of the key raw material components of the sector. The prices of palm oil (a major input for Hindustan Unilever) decreased approximately by three per cent and those of copra (a major input for Marico) saw a decline of around four per cent from December 2010 to December 2011. Thanks to this, the companies in the sector posted a rise in their EBIDTA margins, which was up by 103 basis points to 15.87 per cent.

The sector performed extremely well during the quarter. For the 12 companies that we have analysed, the overall topline growth increased by 21.65 per cent while the bottomline grew by 31.57 per cent on a YoY basis. Product price hikes by companies enabled December 2011 quarter sales growth, driven by a combination of volumes as well as prices. For instance, the sales of Hindustan Unilever grew at 16.5 per cent (of which 9.1 per cent growth was volume driven and the rest came in from price hikes). The sales of Britannia Industries grew at 15 per cent (six per cent was volume driven), while those of Marico grew at 29 per cent (enabled by volume growth of 20 per cent).

The overall raw material expenses increased by 17.71 per cent, but if you compare the raw material expenses to sales, the ratio declined by 138 basis points to 41.38 per cent. Britannia was one of the companies that witnessed a significant lowering of raw material costs in the December 2011 quarter. Its raw materials to sales ratio declined by 375 basis points to 52.73 per cent.

FMCG companies continued to spend lower on advertising during the quarter, which to some extent, helped them to show better profits. Overall, the advertisement expenses contracted by 269 basis points to 11.11 per cent as a percentage of sales. The ratio of advertising expense to sales for HUL and Godrej Consumer Products showed a contraction of 287 and 243 basis points, while that for Dabur and Marico showed an upmove.

Lower advertisement expenses and the other cost effective techniques used by the companies have yielded better results for them. With the cooling off in input prices coupled with the rupee appreciation, companies are likely to witness moderation in costs in the coming quarters. The question now is, what will be the growth strategy for FMCG companies from here on? Will it be volume driven or price driven? Will companies roll back the higher costs that were passed on to customers, or will they continue with the existing price structures, which will help them to have better margins going ahead?

We believe that the sector will continue to perform well even in the fourth quarter. Investors are focussing on aggressive bets that could give them additional returns over the defensive FMCG companies. However, one should hold the stocks in this sector until a clear macro picture emerges. Defensive bets that allow risk mitigation are a must in one’s portfolio.

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Information Technology

Despite not-so-encouraging guidance from Infosys for the March 2012 quarter, the BSE IT Index has done exceptionally well with its surge from the September 2011 close of 4771 to 5700 by mid-February, moving by 21 per cent. We believe that this outperformance would continue in the coming months, as the IT sector would continue to perform better on the financial front.

For the quarter ended December 2011, IT companies reported aggregate sales growth of 27.6 per cent and bottomline growth of 19.6 per cent. This is one of the best performances in the recent past (refer to table: IT – YoY Growth In The Last Five Quarters). Among the leading players, Infosys came out with a good set of numbers, with the bottomline growing by 33.3 per cent, while TCS saw its bottomline grow by 18.3 per cent. Wipro saw a modest bottomline growth, which was up 11.2 per cent.

While going through the transcript of the conference call of Infosys and TCS, we get a sense that Infosys should perform better despite a not-so-rosy guidance provided by the management, as the company added more active clients as compared to TCS in the quarter ended December 2011. The number of active clients for Infosys as of December 2011 stands at 665 against 647 as of September 2011. This is a net addition of 18 clients. TCS, on the other hand, showed a marginal decline in its net addition, from 1010 as of September 2011 to 1003 as of December 2011.

We believe that Infosys should outperform as compared to TCS, at least for the next one quarter.

Assuming that the prices would continue to remain stable and the demand reasonable, IT companies should report numbers in line with those reported in the December 2011 quarter. The only area of concern is the rupee volatility. The rupee has appreciated sharply since December 2011, and none of the IT companies seem to have anticipated this. Nonetheless, we remain bullish on IT companies, especially Infosys, and suggest that investors remain invested in the same. The Greek bailout package is another positive for the industry, as worries on the European front would subside,  giving more opportunity to IT companies in this part of the world.

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Infrastructure & Realty

If we take a look at the performance of infrastructure companies for the December 2011 quarter, it has posted results exactly like what we had predicted at the time of reviewing the September 2011 results. We had mentioned that factors like the slower reforms process, higher inflation leading to a higher interest cost regime and higher costs leading to slower capex will impact the performance of infrastructure companies. An unfavourable macroeconomic situation on the global

as well as the domestic front has added to the woes. As expected, while the topline for the December 2011 quarter increased by around 16.50 per cent on a YoY basis after adjusting for extraordinary items, the bottomline improved marginally by 0.24 per cent. Sequentially, the topline increased by 17 per cent and the bottomline was up by 19.50 per cent.

If we further analyse the results of leading infrastructure companies, it is clearly seen that their EBITDA margins were impacted due to a highly competitive scenario. Further, the full impact of declining commodity prices was not seen in the December quarter. A sharp rise in the interest costs (up 37 per cent on a YoY basis) also added to the woes. The scenario was so competitive that the largest players like L&T also lowered the new order intake guidance for FY12. In case of L&T, the EBITDA margins for the December 2011 quarter declined to 9.60 per cent from levels of 10.80
per cent in December 2010. Also, the liquidity situation was so bad that certain players had to opt for stake sales in the SPVs to raise funds. A combination of all these factors resulted in marginal growth in the bottomline.

Going forward, the scenario seems to be improving. Inflation has started to cool off and expectations about softening interest rates are taking wing. The government is also making some positive moves on the reforms front. The March 2012 quarter results are expected to be good for infra companies owing to better order flows. With a decline in commodity prices being witnessed, we expect better performance from the infra sector in the March 2012 quarter.

While this was the scenario on the infrastructure front, real estate companies continued to struggle through the December 2011 quarter as well, with seemingly no end to their woes. The interest rates continued to be higher, impacting the quarter’s performance. With no major improvement on the realisation front as well as lower volumes, the topline declined by 15 per cent on a YoY basis. Due to higher interest outgo, the bottomline declined by 46 per cent.

The sector continues to face problems on account of the slowdown in the economy. Higher interest rates have seen EMIs go up and buyers postponing buying activity in the housing segment. Tier II and Tier III cities witnessed some traction, but this was only in certain pockets, and realisations were not robust. Some improvement was seen in the commercial segment, but volume growth is marginal here. Although the scenario is getting better, we do not see much immediate improvement and hence, expect a similar performance in the March 2012 quarter as well.

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Oil & Gas

The December 2011 quarter results for the oil & gas sector are a complete contrast to those in the previous two quarters. While oil marketing companies (OMCs) were laggards in the June and September 2011 quarters, the stupendous topline and bottomline growth (YoY) of 38 per cent and 28 per cent respectively this time around for the 17 companies analysed by us has been majorly fuelled by them. In fact, if we exclude OMCs, the sector has reported a six per cent YoY decline in the bottomline.

Despite a massive spurt in interest costs and lower gross refining margins (GRMs), all three domestic refiners – IOCL, BPCL and HPCL – have reported a better-than-expected December 2011 quarter performance due to a significant jump in budgetary support and increased discounts from the upstream companies. IOCL had to provide for a one-time exceptional provision of Rs 6168 crore on account of payment of entry tax in Uttar Pradesh on crude oil and gas imported for use at the Mathura refinery. Despite this, the company managed to report a 52 per cent rise in profits on a YoY basis.

The quarterly financial performance of upstream majors, ONGC and Oil India, came under pressure as the government directed them to foot a larger share of the fuel subsidy bill. While ONGC’s net realisations fell by 31 per cent to USD 44.96 per barrel, Oil India saw its net realisations fall by 15 per cent to USD 57.02 per barrel. Despite receiving a one-time exceptional royalty payment of Rs 3142 crore from Cairn India, ONGC reported a five per cent decline in its bottomline. In a bid to boost liquidity and reward its shareholders, Oil India announced a bonus issue (3:2) and a second interim dividend of Rs 10 per share at the time of announcing its December 2011 quarter results.

In the case of private companies, Reliance Industries saw its net profits decline by 22 per cent (QoQ) on the back of sluggishness seen in all three business segments – refining, petrochemicals and oil & gas. While the KG-D6 basin woes continue to haunt the company, the recent fall in GRMs (QoQ), which came below the Singapore Reuters benchmark for the first time in years, has spurred fresh concerns. In a bid to shift focus from the dismal quarterly performance and create investor fancy, the company recently announced a share buyback program to the tune of Rs 10440 crore.

On the global front, despite the International Energy Agency (IEA) lowering its demand forecast for CY12, Brent crude oil prices have spurted up by 10 per cent on a YTD basis to USD 118 per barrel as a result of the escalating tensions in Iran. However, the strengthening of the Indian rupee against the US dollar has limited its negative impact on domestic refiners.

Going forward, we expect the upstream companies to share a higher portion of the subsidy bill, which will surely impact their financial performance. As for the domestic refiners, we believe that the government would make good all their losses by allowing them to hike retail petrol prices post the elections in UP. However, with the Union Budget 2012-13 slated to be announced shortly, we strongly believe that the long term benefit of the sector would lie in the government’s ability to initiate key reforms and policies.

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Pharma

Those who parked their money in the pharma sector have not witnessed any major wealth erosion in 2011. This is evident from the performance of the BSE Healthcare Index, which remained flat during the turbulent period of September-December, 2011, compared to a fall of six per cent in the Sensex. The topline growth of 23 per cent during the quarter indicates that growth drivers are well in place. Even though growth was a moderate eight per cent on the bottomline front, the sustained operating profit levels indicate that earnings opportunities still lie ahead.

Domestic business was normal, with no major baffles. The branded formulations business in the country grew in double digits. As the disease profile of the country is changing towards lifestyle diseases, the speciality segment related with Diabetes, Cardio Vascular ailments and Central Nervous System disesases etc. boosted the topline of many companies. Other segments such as dermatology, ophthalmology, gynecology, etc. have also continued to grow. Companies were seen launching products across all categories, which will yield results from the next quarter onwards.

A strong growth in the exports business was bettered by a weakened rupee. Indian Pharma companies are working towards significant value addition, as more and more drugs in the US market are going off patent. In the December 2011 quarter, Dr. Reddy’s Laboratories (DRL) launched Generic Zyprexa, while Ranbaxy launched Generic Lipitor in the US market. Both the products are gaining a significantly high market share, and with few months of exclusivity still remaining, we expect further growth in the market share as well as revenues. ANDA activity, which indicates preparedness for generic opportunities in the USA, continued in the quarter, with many companies filing for product approvals.

In the other export markets, the business was healthy. Higher revenues were recorded in the quarter from regulated markets (Japan and Europe). In the emerging markets too, companies have reported good growth in revenues. Although a slow approval process (over about two-three years) was recorded in Brazil, revenue growth was in double digits. In the Russian market, growth was flat as winter impacted the off take of products.

Though the rupee depreciation boosted export revenues, it also caused forex losses for some companies. Aurobindo Pharma, Jubilant Life Sciences, Glenmark Pharma, etc. reported a high quantum of forex losses, due to which their profits were impacted.

Mergers and acquisition activity gained momentum in the quarter, as we expected. Lupin bought Japanese company, I’rom Pharmaceutical, while Sun Pharma bought a stake in Natco Pharma and increased its holding in its Israeli subsidiary, Taro Pharma. In the domestic space too, Cadila Healthcare bought pharma company, Biochem, for an undisclosed amount.

Going ahead, we expect the pharma growth story to continue, and domestic companies are likely to put in good numbers. With the markets currently witnessing a rally and pharma being a defensive sector, investors should go in for stocks like Lupin, DRL, Sun Pharma, Strides Arcolab etc., which have high growth drivers in place.

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Power

Though the overall IIP numbers have not been encouraging, those for the power sector have been decent over the past one year or so. There has also been a good amount of incremental capacity addition by companies. However, the power sector as a whole has disappointed again, with the aggregate bottomline declining by 21 per cent despite topline growth of 27 per cent in the December 2011 quarter. Of the 24 companies that we analysed, 13 reported a decline in profits, and five reported losses. The BSE Power Index shrunk by 16 per cent in the quarter, indicating weakness in investor sentiment with respect to the sector.

4309 MW of new capacity was added in the country during the December 2011 quarter. The total generation rose by nine per cent on a YoY basis, but the peak demand deficit remained at 13 per cent, indicating a slower pace of capacity addition.

While the key problems remain unanswered as yet, there is an added misery related with gas supply. Gas-based generation declined by two per cent YoY, with the share coming down from 15 per cent to 13 per cent in the same period.

On the coal front, Coal India reported flat production numbers. A depreciating rupee coupled with high international coal prices and the Indonesian regulation of benchmark pricing kept the margins of power companies dependent on the prices of imported coal under tight pressure. In fact, companies like Adani Power and JSW Energy reported losses in their books, as they meet most of their fuel demand through imports.

Amid all the negatives, the government has provided some respite to the sector. The Shunglu Committee has recommended the creation of a Special Purpose Vehicle backed by the RBI to purchase the loans of the SEBs. Besides this, the committee also suggested the practicing of a franchisee model in more towns. The recent direction by the Prime Minister to Coal India to sign longterm fuel supply agreements with power companies which have long-term power off take agreements in place looks to be a positive for the sector. This would change the sentiment for the sector, and investors may take this opportunity to unlock their capital by selling some of the non-performing scrips.

It should be noted that coal production would not rise overnight. It is also a well-known fact that power companies are unable to pass on prices, and their profitability will remain under stress if tariffs are not increased. We believe that both the recommendations are meritorious, but the execution remains a key factor. Until that is seen, it would not be a good idea to take substantial exposure to the power sector.

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Steel

After the steel sector faced strong headwinds such as the high input cost of coking coal, the depreciating rupee and a slowdown in demand in the last one quarter, has anything changed for it in Q3 FY12 at all?

Well, the scenario has remained the same in the December 2011 quarter, as the sector that forms an integral part of the economy, which is driven by its overall development, underperformed on the bourses between October-December 2011. The BSE Metals Index was down by 15.47 per cent, while the Sensex fell by six per cent during the same period. This gives us some indication that the sector was struggling throughout the quarter due to lower demand, high input costs and a depreciating rupee.

The muted performance of the companies in the sector can be seen from the industry aggregate figures, which are not very encouraging. The aggregate sales of the 88 companies that we have analysed grew by 15 per cent on a YoY basis, while the operating profit has declined by 11 per cent YoY. The weak quarterly numbers are mainly on account of a slowdown in consumption due to high interest  rates, and a tight liquidity situation that impacted the investment cycle
and new capex plans. These factors were coupled with higher raw material and power & fuel costs, which made the situation worse.

However, the realisations of these companies witnessed a jump due to rupee depreciation, which insulated the domestic steel prices from the fall seen in the international prices. Realisations of major companies have remained quite firm (see table), but the volumes have gone down. The volumes of major steel makers were muted, except for JSW Steel, which saw a jump because of the new capacity addition undertaken in 2011-12.

Although a sharp rupee depreciation has helped steel companies to keep the steel prices firm, it has impacted the bottomline of the industry, which has fallen by 73 per cent on a YoY basis. Rupee depreciation led to expensive imports of coking coal, one of the major raw materials used in steel production. Moreover, companies which had exposure to foreign exchange, reported huge forex losses. The consolidated net profit of these companies came down drastically, with JSW Steel (down by 67 per cent) and SAIL (down by 42 per cent) being the worst hit. The net profit of Tata Steel was down by 172 per cent due inventory write off on the back of sluggish demand in its European operations.

Going forward though, with inflation slowing down and the interest rates peaking out (as is indicated by the RBI’s CRR cut of 50 basis points) we believe that a pickup in demand is likely in the coming quarter. Moreover, with the rupee appreciating from its peak level of Rs 53 per USD to levels of around Rs 49, we can expect some respite for the major steel companies on the forex losses front, as also lower coking coal costs. Considering these factors, steel companies will see decent growth in the fourth quarter of 2012.

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Telecom

A look into the performance of the listed Indian telecom service providers in the December 2011 quarter shows a mixed picture. While Idea Cellular emerged a clear winner as its net profits soared by a whopping 90 per cent (QoQ), Bharti Airtel reported a flat QoQ net profit growth and Reliance Communications (RComm) saw its profits dip by 25 per cent.

On the bourses, all three major counters – Bharti (-10 per cent), Idea (-16 per cent) and RComm (-3 per cent) ended the quarter in the red. On a YTD basis though, they have swung back into the black. RComm has led by posting hefty 45 per cent returns and continues to trade on non-fundamental drivers.

Network traffic has improved for all three telecom players, though the pace of growth was slower for Bharti and RComm. While RComm suffered on account of lower volumes from its wireless business, Bharti’s traffic growth was impacted due to the company’s strategy of holding on to its current tariff levels. Idea continued its robust pace in traffic growth, buoyed by strong volumes growth as the company focussed more on rural areas where competition is lower.

The key performance indicators like Rate Per Minute (RPM) and Average Revenue Per User (ARPU) improved for Bharti Airtel and Idea Cellular, while RComm continued to lag behind. Bharti continues to command the highest RPM and ARPU in the Indian telecom Industry at Rs 0.446 per minute and Rs 187 per user. RComm continues to lose on its ARPU, from Rs 112 per user in December 2010 to Rs 100 per user in December 2011. On a broader analysis, all three listed telecom majors have seen their respective ARPUs drop on a YoY basis on account of higher subscriber additions.

Minutes of Usage (MOU) have moderated and dipped lower for all three players on a YoY basis, as the telcos rationalised their offerings and cut down the free minutes they offered. On a quarterly basis, the MOU improved for Idea Cellular, while Bharti Airtel and RComm continued to show de-growth.

The quarter also saw a major development, where the Supreme Court (SC) cancelled 122 2G spectrum licenses granted in January 2008 on the grounds that the licenses were granted in a “totally arbitrary and unconstitutional manner”. This development has worked completely in favour of old timer Bharti Airtel, as the reduced competitive intensity in the industry will help it gain market share.

Going forward, we expect the ARPU to continue to decline, as new subscribers are added but at a slower pace. As for the RPM, we expect it to be stable over the coming quarters on account of the full effect of price hikes undertaken by telcos and an uptick in 3G services. However, the major driver for the industry would be the positive rollout of the new telecom policy, which envisages bringing transparency and clarity into the telecom sector.

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Textile

While analysing the quarterly results for September 2011, we had mentioned that “with the sector’s profit dipping for the second consecutive quarter, the textile story seems to be fading off, for there are clear signs of the sector heading for a deep downturn yet again”. We have been proved right, as is evident from the fact that the sector’s profits for the December 2011 quarter have taken a severe beating. Around 172 companies have announced their results till date. What emerges clearly is that, after adjusting for extraordinary income, textile companies on an aggregate have posted a loss of Rs 104.14 crore as against a minimal profit of Rs 13.18 crore in December 2010. The topline showed some resilience though, with marginal growth of just two per cent.

The deterioration in the performance can also been seen from the fact that out of the 172 textile companies, around 92 failed to show any improvement on the sales front, 12 remained unchanged and the rest have shown marginal appreciation. Similarly, on the profitability front, 82 companies witnessed a decline in profits and 12 could not show any improvement. For the rest that showed marginal improvement, it was more of a case of decline in losses.

So, what were the reasons behind such a poor showing? Well, this was a combination of various factors. A weak macro environment thanks to the European debt worries that cast a shadow of gloom on the overall economy, along with slower-than-estimated growth in the US markets impacted exports growth for the sector. A dull demand scenario combined with high costs of production left little incentive for the textile industry to boost production, with many preferring to idle operations until a more favourable environment returns.

With a persistently downward production trend in all downstream segments of the textile sector including apparel since April 2011, the full year textile output across India was anyway expected to contract in 2011-12. What added to the woes was the higher cost of raw material. Although cotton prices have declined significantly, manufacturers suffered due to the high cost of inventory.

The depreciating rupee against the US dollar would have been of help on the exports front. However, that was only a short-term phenomenon. To top that, the poor macroeconomic situation only resulted in lowering demand.

Going ahead, the demand from leading markets like Europe and US is not expected to improve immediately. Further, it will take at least another quarter for the companies to clear their high cost inventories. All in all, it does not make for a pretty picture. Considering the fact that there aren’t any positive triggers for the sector, we would suggest that investors should stay away from the same for the time being.