Q1 FY-14: Another Bleak Quarter For India Inc.

The equity markets are always driven by expectations. In fact, the equity indices are said to be the leading indicators of expected economic activity. In case of markets, while at times the developments happen in line with the expectations, at others, they turn out in the exactly opposite direction.

The results for the June 2013 quarter are an example of the latter scenario. When the March 2013 quarter results were announced, most on the street had expected the June 2013 quarter results to be better. The positive factors that were expected in the June quarter were contracting inflationary pressure, a fall in commodity prices, and last but not the least, easing out on the interest rate front.

Rising interest costs was the primary factor that was hurting growth, the prime reason being halted capex due to higher interest costs, which made most of the projects financially unviable. With the RBI going ahead with two consecutive repo rate cuts, many had expected India Inc. to get benefited. However, the environment was not as conducive as it was hoped to be.

There was a series of events that transpired, such that a quarter earlier expected to be a base for India Inc.’s turnaround actually turned out to be a disappointing one. A series of events like the continued policy paralysis, slower GDP growth, higher inflation and dismal IIP numbers, along with the weakness of India Inc. in terms of pricing power made the June quarter a tepid one.

As if this were not enough, the depreciating rupee added fuel to an already blazing fire. In just the June quarter, the rupee witnessed a decline of around 9.59 per cent from the levels of 54.32 per USD to 59.53 per USD. The slide continued thereafter too, as the rupee touched an all-time low by breaching the 64 per USD level mark. The currency comes into special focus is as it is a known fact that India Inc. has been heavily debt laden, especially in foreign currency terms. With mounting forex losses, it comes as no surprise that the bottomlines of India Inc. were impacted negatively.

Another Disappointing Quarter

When we take a superficial look at the overall results of India Inc., the picture seems pleasant enough, with a topline growth of 6.37 per cent and bottomline growth of over 39 per cent on a YoY basis. However, adjusted for the results of public sector refiners, the figures change dramatically. In this case, the topline growth is at just 3.83 per cent YoY, while the bottomline takes a nosedive, declining by more than 25.84 per cent.

After putting in a dismal performance in the March 2013 quarter, the June 2013 numbers have pushed India Inc. to another low. The breadth of the companies that have posted topline and bottomline growth clearly hints at this. As regards sales growth, there were around 58.40 per cent companies that moved upwards in March 2013 but this declined to 56.80 per cent in June 2013. Similarly, on the bottomline front, while around 52 per cent companies had seen growth, this declined marginally to 49.42 per cent in June 2013. So, the breadth has actually contracted.

The performance has been disappointing on a sequential basis too, with the topline falling by around four per cent and the bottomline declining by over 33 per cent. However, it would help to remember here that the March and June quarters are not comparable, as March is usually the time of yearly closure Still, the drop is much more than what India Inc. had witnessed in 2013.

Operating Margins Decline

While sales growth has been quite weak, India Inc. also failed to sustain its margins during the quarter. The margins have declined by more than 255 basis points on sequential basis (See Chart: Operating Profit Margins). Interestingly, Corporate India failed to improve on the margins front despite a fall in commodity prices. This factor clearly indicates that the companies have no pricing power. Thus, we do not expect the things to improve in this regard any time soon.[PAGE BREAK]

Despite Rate Cuts, Interest Costs Higher

Interest cost has been the major factor that has impacted the bottomline of India Inc. in the past two years. We had continuously mentioned that in our previous few quarterly results analysis stories. The worrisome factor, the rise in interest cost has occurred despite the deliberate efforts of RBI to reduce the Interest cost. However, the interest costs (excluding Banking and Financial Services) have increased by 15.26 per cent on a YoY basis and around 6.96 per cent on sequential basis. Just to simplify the impact of interest cost as a per cent of sales for the June 2013 quarter has increased to 3.33 per cent from the levels of just 3.05 per cent in June 2012 (See Chart: Interest Cost As A % Of Sales). One noticeable factor here is the Banks have not passed on the benefits of repo rate cut to the end users. This was despite government and RBI requesting for it consistently.

Rupee Plays Spoilsport

While other factors have contributed to the dismal performance of India Inc., the depreciating rupee has been at the core of it. To quantify this, forex losses stood at Rs 12660 crore for the June 2013 quarter as against Rs 3801 crore in June 2012. There is also a counter view about exports getting a push from the depreciating rupee. However, the overall impact on India Inc. is negative as the gains in IT and pharma are much lower than the losses in other sectors.

About the future course of the rupee, we still stand by our call of the currency continuing its southward movement going ahead too. Rather, a few of the leading economists are expecting the rupee to touch the level of around 67-68 per USD. We second the possibility of this happening unless and until some stern action is taken by the RBI and the government.

Expectations From September Quarter

As regards the expectations, one needs to tone them down again. The depreciating rupee is expected to be a worrisome factor along with other issues like policy paralysis, rising inflation and the increasing Current Account Deficit. We are already half- way through the September quarter, and the rupee has depreciated to a new low of 64 per USD as we go to press. What is adding to the woes is the intensity of the fall, which is making it difficult for the companies even to hedge their positions.

Further, the debt burden in foreign currency has increased significantly to the tune of USD 390 billion as on March 31, 2013 (up 13 per cent). A Crisil report has stated that half of India Inc.’s debt is un-hedged, and this factor is expected to be another worry in the September quarter as well. With the forex losses directly being included to the P&L according to the new rule, the impact on the bottomline would surely be negative.

Another key factor is inflation. While the WPI has remained under the RBI’s tolerance levels for the past few months, food inflation is increasing and the issues are more from the supply side. Apart from that, the RBI is not keeping any stone unturned to curb excess liquidity. So, while most of the market participants are expecting a cut in the repo rate, there is another lot which feels that the regulator may instead increase this rate. If that happens, growth would be stalled, or rather one can expect a downgrade on the GDP growth front.

We expect the margins to stabilise going ahead, but do not foresee any improvement. As mentioned earlier, India Inc. lacks pricing power and hence, passing on costs is not a possibility.

Until the March 2013 quarter, there were no downgrades by the fund houses and broking houses. However, after the June quarter results, most of the fund houses have gone ahead with a downgrade for FY14 and a few for FY15 too. Though the downgrades are not significant, the consensus EPS estimates for FY14 now stand at Rs 1340- 1350 from the earlier expectations of Rs 1475. What is more worrisome is that this could be reworked downwards if the scenario does not improve. So, there is certainly a downside risk on the earnings front.

While this was on the negative side, there are three factors that may turn the tide – stemming the rupee’s fall, controlling inflation (especially food inflation) or a positive impetus from the government in terms of reforms work. Needless to say, actual ground- work is needed rather than merely hollow promises. Else the scenario may worsen further.[PAGE BREAK]

Automobile

Q1FY14 spelled yet another dismal quarter for the Indian automobile industry. According to the Society of Indian Automobile Manufacturers (SIAM), the overall domestic auto sales declined by 2.10 per cent in the June 2013 quarter over that in the corresponding quarter in 2012.

The issues of weak consumer sentiment, high inflation and rising fuel prices continue to plague the demand for passenger vehicles and two-wheelers, the sales of which declined by 7.24 per cent and 0.82 per cent respectively. At the same time, lower industrial production, mining and construction activity have been weighing down the demand for commercial vehicles, whose sales have declined by 8.12 per cent in the quarter. This has resulted in subdued financials for most players.

Maruti Suzuki (MSIL) saw a 5.02 per cent decline in revenues. However, the company’s EBITDA and net profit shot up by 48.31 per cent and 49.05 per cent respectively. Lower material costs, re-distribution of expenses owing to the Suzuki Powertrain India (SPIL) merger, cost reduction efforts and a favourable impact of foreign exchange resulted in this boost in profitability.

In the case of Tata Motors (TML), its standalone performance continued to be a drag on the overall financials. A reduction of 19.33 per cent in the domestic sales of TML resulted in a 14 per cent decline in revenues to Rs 9104.5 crore. The EBITDA declined by a massive 84.97 per cent to Rs 105.19 crore. However, the outperformance of JLR (Jaguar Land Rover) reversed the situation for the company.

While M&M witnessed a flattish trend in its numbers, it saw robust growth in farm equipment sales. A good monsoon resulted in a 25 per cent increase in the sales of tractors. Overall, the company’s financials saw good revenue growth coupled with improvement in profitability.

The situation was more uniform across the two-wheeler players. The three largest listed players, viz. Hero MotoCorp (HMCL), Bajaj Auto (BAL) and TVS Motor (TVS) all witnessed a decline in sales. The volumes decreased by 5.05 per cent, 9.24 per cent and 4.75 per cent respectively.

While HMCL and TVS registered a decline in both revenue and profitability terms, BAL showed some buoyancy. As the latter has a higher export component, rupee depreciation aided its performance. Moreover, BAL has not resorted to offering huge discounts to enhance sales, thus maintaining its realisations.

Overall, sales continue to dip across segments. The only manufacturers who have seen some cheer in the overall sales have been those whose new models have met with widespread success among consumers. Companies like Honda, Renault and Ford are good examples of this trend. These have seen an upswing following the launch of their models Jazz, Duster and EcoSport respectively. Manufacturers that launch such big bang models will continue to see higher growth. In the past, M&M’s launch of XUV500 and MSIL’s launch of Ertiga are known to have pepped up the companies’ overall performance.

Also, upbeat are companies that are dependent on their segments/subsidiaries for overall performance, like TML and M&M. This trend is expected to continue and the performance of TML and M&M would remain robust owing to the good traction seen in JLR and FES respectively.

However, we reckon it would take time for the overall industry performance to improve. The health of the auto sector is directly dependent on the wellbeing of the economy. Until there are structural improvements in the economy, we do not expect the industry to come to a decisive turning point. The upcoming festive season, though, is expected to provide temporary relief to the industry since the good monsoon will positively impact rural income and hence spur demand.

Read interview of R C Bhargava, Chairman, Maruti Suzuki India on www.DSIJ.in[PAGE BREAK]

Banking

After weathering the storm of the financial crisis so well, the Indian banking sector is succumbing to the overall slowdown in economic growth. Among the banks, it is the public sector players that are suffering more.

In fact, the divergence in the performance of public sector banks (PSBs) and private sector banks has widened in the quarter through June 2013, and nowhere is this more visible than the rise in the net interest income (NII). This has risen by seven per cent in the case of PSBs, whereas it is up by 24 per cent on a yearly basis for their private sector counterparts. Overall, 40 banks (including private and public sector) have clocked in NII growth of 11 per cent.

However, this did not translate into similar bottomline growth, and the net profits for these banks grew at a slower pace. Here again there was stark difference between PSBs and private sector banks. One of the reasons why the profits grew at a slower pace is the substantial rise in provisions & contingencies, which went up by 44 per cent on a yearly basis.

The slowdown in the economy has impacted the repaying capacities of borrowers. This has led to a substantial increase in the Gross and Net NPAs, both on a sequential as well as on a yearly basis. On a net interest margin front, PSBs saw a yearly decline while private sector banks registered a marginal increase.

The coming quarter threatens to be even worse for the banking sector. The steps taken by the RBI to curb the rupee fall will adversely impact the banks, and this will be fully reflected in the September 2013 quarter results. In the last one month, the RBI has taken steps to tighten liquidity. This will raise the cost of funds for banks, especially those that rely upon short-term funds to fulfil their long-term lending needs. The spike in bond yields will also lead to a loss in treasury income for the banks, and this will impact PSBs in a greater way. Credit growth is likely to dip further as we may see GDP growth below five per cent in the coming quarters. Although the RBI has taken steps to address some of these issues, they may not help banks in a major way.[PAGE BREAK]

Cement

Cement is one of the core sectors, which plays a vital role in the growth of the economy. Due to the general slowdown in the economy and reduced spends on infrastructure, the sector has been bleeding for the past few quarters. Owing to this, the sector was expected to be under pressure. Sure enough, the first quarter numbers have revealed a poor performance for the sector.

Apart from the economic slowdown, the early onset of the monsoon also dented the growth of the industry. None of the companies in the sector were able report good numbers in Q1. The only positive was that the recent IIP numbers indicated a 3.3 per cent year-on-year (YoY) rise in cement production during the quarter.

The aggregate topline of the 26 companies that we analysed has dipped by one per cent YoY in this period, but the aggregate bottomline has declined by as much as 37 per cent, indicating a major hit on their profitability. The top three players, i.e. UltraTech Cement, Ambuja Cements and ACC, which contribute 52 per cent of the total sales of the sector, have reported either flat or lower realisations. Ambuja’s realisations for the quarter dropped by six per cent on a YoY basis to Rs 4360, which is representative of the overall decline.

The decline in the topline and increase in input cost have had a negative impact on the operating profits, which went down by 21 per cent for the top 10 companies in the sector. The aggregate EBITDA margins of these 10 players have also deteriorated by 544 basis points YoY.

With regard to the recent issue of cement cartelisation, the companies which had come under the Competition Commission of India (CCI) scanner were able to get a stay order from the Competition Appellate Tribunal (COMPAT) by depositing 10 per cent of their penalty amount as bank fixed deposits. The matter is sub judice for now.

On the positive side, the monsoon has partially departed from a major part of the country, and hence, cement companies may breathe a sigh of relief. We may also see some rise in infrastructure spending due to the elections, which would improve the construction activity in the country. Cement companies have also passed on the increased costs (as a result of higher raw material prices) to the cus- tomers between Rs 15-30 per bag across the country.

The prospects of the sector in the next quarter have become grim due to the ban on some sand mines which were alleged to be illegal. Sand is an important ingredient for construction activity, and hence the cement volumes may come under pressure going ahead. The RBI has also increased the short- term interest rates to curb rupee depreciation. This is bound to impact India Inc., and hence, the cement sector as well. Considering all these factors, one can expect marginal improvement in the cement sector in the next quarter, but with no major surprises.[PAGE BREAK]

FMCG

Economic slowdown’ and ‘job cuts’ are words that have been in cur- rency in recent times, and have wreaked havoc in the lives of many. But have you ever felt the impact of these two words when you queue up in a hypermarket at the beginning of the month. Far from it, the length of the queue is as astounding as it is nerve-racking each time.

This is the Indian consumption story for you, which has so far remained untouched by the sting of recession or slowdown. This can be substantiated by the healthy financial numbers posted by FMCG companies in India. The strong performance continues in this quarter too.

Let’s take a quick look at how companies in the sector fared on an aggregate basis. For the 13 companies that we have analysed, the top- line witnessed a gain of 10.26 per cent and the bottomline was five per cent higher on a yearly basis. Among the highlights of the numbers were the EBITDA margins, which improved by 111 basis points to stand at 28.21 per cent on a YoY basis. One of the factors that helped companies to expand their margins was the drop in raw material expenses as a percentage of sales, which stood at 34.43 per cent of the topline (down by 164 basis points YoY).

In this quarter too, the companies have been able to garner in better volumes growth of around six-seven per cent. The better performance of the sector can be attributed to better price realisations which helped the companies to clock in better revenues.

The question that may arise here that if the performance has been good, then why is the bottomline growth in single digits. The reason for this is higher interest cost and deprecia- tion that the companies have incurred in this quarter. The finance cost has shot up by more than two per cent to Rs 77.46 crore, while the depreciation cost went up by 14 per cent on a YoY basis to stand at Rs 402 crore.

Now for the way forward. The weakening rupee has made crude oil, fertilisers, medicines and iron ore, which India imports in large quanti- ties and costlier. Fast moving consumer goods, like soaps, detergents, deodorants and shampoos, for all of which crude oil is an input, are likely to become more expensive. Of course, it must be remembered that FMCG companies have pricing power and they are in a position to pass on costs to the end consumers. This neutralises the impact of raw materials becoming dearer.

We have also seen a series of launches by companies in the sector, the impact of which is yet to be discounted in the prices. The full impact can be seen from the next quarter onwards, when brand visibility as well as acceptability with consumers increases.

One concern that remains an overhang on the sector is the higher valuations of the players. But this gets neutralised when we look at their earnings visibility, which is purely based on the consumption-led story of India. We also do not see any major impact here of the depreciating rupee. We remain bullish on this sector, and Dabur India, Emami and Godrej Consumer Products remain our top picks in the sector.[PAGE BREAK]

Infrastructure

With the Indian economy emerging on the global canvas, the infrastructure space has remained fairly vibrant. However, the sector has taken a sluggish turn over the past few quarters, bogged down by macroeconomic factors like slower GDP growth leading to an overall slowdown on the capex front. As if that were not enough, the rising commodity prices, tighter liquidity norms and shrinking margins on account of severe competition kept the infrastructure companies under stress. The June 2013 quarter results hint clearly towards these strains.

In the quarter, companies in the sector managed to put in topline growth of 1.41 per cent on a YoY basis. If we take a look at the bottomline, it appears to have almost doubled on a YoY basis. However if we scratch the surface and adjust for the exceptional results posted by GMR Infrastructure, we can see that the bottomline has actually dwindled by more than 11.18 per cent for the sector.

Except for L&T, all the other players have struggled on the order book front. Many infra players are of the opinion that rather than merely announcing measures the government needs to do more groundwork to revive the economy, and this lacuna is being clearly reflected in the order books of companies.

Infra companies also seem to be under margin pressures, which is clearly from the significant drop in operating profit margins despite a respite in commodity prices on a sequential basis. Another worrisome issue has been the rising interest costs. This has gone up by more than 23 per cent on a YoY basis and by five per cent on a sequential basis.

As regards the outlook for the next quarter, it seems unlikely that the scenario will change dramatically and the macroeconomic pains will wane right- away. As a result, we are quite sceptical about an immediate turnaround in the scenario. While the immediate measures being by the government are likely to provide some solace, these are short-term in nature and naturally, the results are also expected to be short- term. We expect the margins pressure to remain in the September 2013 quarter as well.

However, there are a few positives on the horizon too. From our conversations with some of the infrastructure players, we understand that even a minor improvement in the scenario would aid in margins improvement. During the past few quarters, when the scenario was difficult, many infra companies had increased their capacities but could not use the same to the fullest on account of the slowdown. If orders start flowing in, the margins would start improving as the fixed cost factor comes into play. With the general elections scheduled next year, we can expect many public sector projects to see a green flag soon, helping the infra players generate some cash flows in the next two quarters. However, a full-fledged recovery is still some time away.[PAGE BREAK]

IT & ITES

The IT industry has been in a tricky position lately. On one hand, it has been witnessing secular changes that have been leading companies to change the way in which they operate. At the same time, the industry has been facing the pressures arising from delayed decision making, tight client budgets and subdued discretionary spending, leading to demand pressures.

To cope with these changes, companies are consistently looking at providing solutions rather than services, engaging with customers on an end-to-end basis, capturing the transformation caused by disruptive technologies in the traditional landscape, leveraging capabilities to optimise current investments, shifting focus areas and investing in emerging technologies and emerging geographies. Those companies that have managed to build traction with solutions and execute them have managed to keep growth buoyant even in a difficult macro environment.

The Q1FY14 results of IT majors have been good. The revenues of the top five listed IT companies (TCS, Infosys, Wipro, HCL Tech and Tech Mahindra) grew on an aver- age by 2.77 per cent in USD terms on a sequential basis. The colossal depreciation in the rupee resulted in higher growth figures in INR terms. The revenues of the top five listed IT companies grew by 7.74 per cent on an average. On a constant currency basis, revenue growth averaged 3.54 per cent.

Geographically, North America turned out to be strong with the recovery in the US visibly favouring the performance of IT companies. TCS & Tech Mahindra saw 11 per cent plus growth from the US market. The European markets, however, fared differently and no firm trend emerged. While the European market accounted for a 12 per cent growth for TCS, Infosys saw a three per cent decline there.

The profitability of IT companies took a considerable impact on account of wage hikes and visa costs. However, rupee depreciation and other factors managed to offset this impact. For example, in the case of TCS, wage raises and realisations caused a negative impact of 172 basis points and 35 basis points respectively. However, this was offset by rupee depreciation and the lack of one-off expenses (as were incurred last quarter), resulting in the operating profit going up by 50 basis points.

Overall, the quarter has been good for the IT industry. The managements of various companies seem optimistic about the outlook for the industry. A pick-up in discretionary spending is expected and demand is seen to be healthy. The order book of the companies validates the upward trend in various pockets.

The general positive outlook is also evident from the guidance provided by various companies. Infosys has maintained its yearly guidance of six to 10 per cent growth for FY14. At the same time, Cognizant raised its 2013 revenue guidance to at least USD 8.74 billion, which translates into an expectation of 19 per cent growth over 2012. For Q32013, the company is anticipating sequential growth of 4.1 per cent. Wipro too managed to cheer the markets, with its revenue guidance between 1.99-3.89 per cent for the next quarter.

With companies gearing up to make the most of the transformational trends and the pickup in demand, we expect the next quarter to be robust for the IT industry.

(Read interviews of Milind Kulkarni, CFO, Tech Mahindra and Rajeev Mehta, Group Chief Executive, Industries & Markets, Cognizant on www.DSIJ.in)[PAGE BREAK]

Oil & Gas

With an ever declining rupee against the dollar, core sectors like Oil & Gas are now in total disarray. India imports over 74 per cent of its crude requirements. This sector has always been known for the high levels of government interference, which impacts the performance of the companies.

In Q1FY14 too, the financial performance of oil & gas companies, especially PSUs, remained weak due to a declining rupee and a heavy burden of under-recoveries owing to costlier crude imports. The performance of state-run oil and gas powerhouse ONGC has gone haywire due to the subsidy burden (Rs 12622 crore in Q1, two per cent higher YoY), and its net profit dropped by 34 per cent to Rs 4061 crore as against Rs 6078 crore during the corresponding period in FY12.

The net realisations of the company also declined from 45.91 USD to 40.17 USD/barrel of crude as it gave discounts to OMCs on crude to share its subsidy burden. ONGC’s share of subsidy has increased despite the fact that the OMCs’ losses have declined by a whopping 43 per cent. This clearly shows the inability of the government to share the burden.

Oil India’s net profits also dropped by 34.5 per cent to Rs 609 crore and its total income fell 12.68 per cent to Rs 2449 crore during Q1 owing to a higher subsidy burden and declining realisations. During this time company subsidy burden reached Rs 1983.06 crore, a decline of 1.66 per cent.

At the same time, the rupee turmoil brings a silver lining for these companies. As they receive the payment for natural gas in USD, the rise in the dollar spells handsome profits for them. ONGC alone will gain more than Rs 300 crore in a quarter if the rupee continues its poor stint in the forex market. RIL and OIL are other companies that would gain from this decline. 

While PSU companies are reeling under the subsidy burden, India’s biggest private sector company Reliance Industries saw its net profits surge over the refining margins and other income. The company’s topline has dropped by around 4.5 per cent to Rs 87645 crore due to lower output from the KG basin fields, but its profitability shot up by 19 per cent to Rs 5352 crore following robust gross refining margins (GRM), up 8.4 USD/bbl as against 7.6/bbl in Q1FY13. Its revenue from exploration and production has increase by 43 per cent to Rs 1454 crore, while its EBIT margin declined from 38.8 per cent to 24.2 per cent. Refining and market- ing spurted by 4.6 per cent to Rs 81458 crore. The company’s petrochemicals revenue and profitability also headed northward, with the revenue touching Rs 21950 crore.

Cairn India’s profits declined by 18 per cent to Rs 3127 crore as against Rs 3826 crore in the corresponding quarter last year. The company’s revenues also declined by eight per cent to Rs 4063 crore. During this period, it has made up Rs 326 crore additional to the government as per the product sharing contract as the payout ratio increased from 20 per cent to 30 per cent.

IOCL posted a net loss of Rs 3093 crore during the quarter as against a loss of Rs 22450 crore suffered during Q1FY13. This is inspite of the deregulation of petroleum products as well as the Rs 8142 crore discount it received from upstream companies as per the scheme formulated by the government. In addition to this, IOCL received a cash subsidy of Rs 4261 crore from the government. Its income from operations went up from Rs 96861 crore to Rs 110467 crore during the period.

BPCL made a turnaround with a net profit of Rs 150.32 crore against a loss of Rs 8836.75 crore in the corresponding quarter last year. This was due to deregulation and the release of subsidies by the government. During this time, the company’s GRMs also improved from USD 2.62/bbl to USD 4.05/bbl.

If the rupee continues to decline, the oil companies’ problems can increase manifold, especially those of PSU companies. Upstream companies like ONGC, OIL and GAIL will be plagued by this factor in the coming quarter as well. Due to dearer imports, the margins of OMCs will also decline. In addition, the delay in subsidy recovery will push up the interest cost for these companies. Diesel prices are not fully deregulated so far, so it is a big concern for them. All in all, oil companies can expect the subdued performance to continue if the present scenario persists.[PAGE BREAK]

Pharma

The June 2013 quarter results have indicated that the pharma sector is still in good shape and has a lot of steam left. In the quarter, the aggregate topline of the sector has surged by 11 per cent. Adjusted for Ranbaxy’s results (one-time sales of the generic of Atorvastatin in Q1FY13), we get a topline growth figure of 15 per cent. At 30 per cent, the bottomline for the sector is also robust. Note that we have adjusted for Sun Pharma’s results, which made a provision of Rs 2517 crore for settlement for the generic of Protonix during the quarter.

The performance in the domestic market remained subdued due to the impact of the New Pharma Pricing Policy (NPPP). The government has announced a list of 348 formulations whose prices are to be capped as per the policy. This has impacted wholesale purchases of drugs and distributors also destocked their inventories, resulting in slower growth. According to the All India Organisation of Chemists & Druggists (AIOCD) the domestic pharma industry has seen 9.4 per cent growth in the quarter, which is well below its potential of 15-16 per cent.

Q2FY14 would be crucial for companies. MNCs have 100 per cent exposure to the domestic market and hence these companies would take the major hit of the NPPP. Companies like Cipla and Cadila Healthcare see around 50 per cent of their revenues coming in from the domestic markets, and hence would also get impacted.

On another note, the rupee’s lows seen during the quarter positively impacted exporters’ revenues. The top 10 players (representing about 70 per cent of the sector’s revenues), have reported 12 per cent growth in export revenues. Adjusted for Ranbaxy’s num- bers, this growth jumps to 20 per cent. The contribution of exports in the total sales for the top 10 players has also gone up by 100 basis points to 72 per cent. The growth in exports was primarily on account of the antiretrovirals, anti-asthma and anti-allergic segments. The generics boom has worked in favour of the sector.

On the regulatory front, Wockhardt has received a warning letter for its Waluj manufacturing facility.

According to AIOCD President Jagannath Shinde, pharma sales in the domestic markets would remain under pressure for at least two more quarters due to the NPPP. Exports should do well owing to rupee depreciation. Overall, we remain upbeat on the sector.

(Read an interview of Jagannath Shinde, President - AIOCD on www.DSIJ.in)[PAGE BREAK]

Steel

The slowdown in the Indian economy overall is clearly visible in the steel sector, one of the worst hit by the moderating economy. Steel demand in the country remained almost flat for the first quarter of FY14, growing by a mere 0.3 per cent on a yearly basis to stand at 17.8 million tonnes. On a standalone basis, the aggregate net sales of the 49 steel companies we analysed saw a decline of six per cent on a yearly basis. The fall is even more on a sequential basis.

Apart from the lower demand drop in the average realisation of steel for the quarter impacted the topline. For example, SAIL and Tata Steel saw their realisations dipping by 9.1 per cent and 13 per cent respectively on a yearly basis. Nonetheless, the fall in domestic steel prices was lower as compared to that in international prices due to the depreciating rupee. This also led to a decline of finished steel imports on a yearly basis to 1.33 million tonnes (down 34 per cent), while exports increased to 1.13 million tonnes (up 14 per cent).

The fall in topline also lead to a drop in the bottomline of companies. The net profit of the companies analysed saw even more of a decline than the sales.

The reasons for this were a rise in the interest burden and depreciation cost on both a sequential as well as yearly basis. Nonetheless, the fall in the commodity prices has arrested what could have been an ever greater fall in the net profit. The prices of key raw materials like coking coal and iron ore are down, which has helped bring down the overall raw material costs on a yearly basis.

Going forward, the headwinds still persist for the steel sector. The demand outlook remains bleak due to the slowdown in the infrastructure sector and automobile sales. The investment cycle too is not picking up. The problem is further compounded by higher interest rates. 

Although the raw material prices are expected to decline, a part of that effect will be set off by the depreciating rupee. Hence, we do not expect the next quarter’s result to show any growth either.[PAGE BREAK]

Telecom

The signals emanating from the telecom sector are largely on the positive side. In the recently concluded Q1FY14, the companies in the sector (especially Bharti Airtel and Idea Cellular) have been able to post impressive numbers. It can be said that after witnessing a lull for the past couple of years, the tides are turning in favour of the sector again. Only the results of Reliance Communications have been disappointing.

A quick look at the aggregate performance of the three main companies in the sector reveals that Bharti and Idea both posted a good set of numbers for the quarter, with the voice realisations seeing a growth of 4.5 per cent on a sequential basis. This was mainly due to the discount reduction process initiated in the month of December 2012.

The mobile businesses of Bharti and Idea recorded significant EBITDA margin expansion on a sequential basis by 185 basis points and 350 basis points respectively. The benefits arising out of operating leverage and moderated subscriber acquisition costs have resulted in significant benefits for both companies on the margins front. The expansion in EBITDA margins is likely to sustain given the relatively tempered competitive environment.

As far as the outlook for the companies goes, the realised revenue per minutes (RPMs) are slated to improve in Q2 and Q3 of this fiscal.

Both Bharti and Idea have reported strong growth in data revenues in the range of 18-22 per cent on a sequential basis for Q1. Nearly 25 per cent of the subscriber base of Bharti and Idea are data customers, and value added services (VAS) now contribute around eight per cent of mobile revenues for them. It can be said that data revenues are likely to be the significant growth drivers hereon, as higher usage per subscriber may lead to a switch to 3G services.

Moreover, given the sunk costs in spectrum and network on the companies’ balance sheets, acceleration in data revenues may lead to disproportionately higher growth in returns on capital. For Idea, the current data capacity utilisation is only five to 10 per cent, and hence, incremental investments in data are set to be outstripped by data revenue growth. Also, unlike RCom, providing 3G at lower tariffs is not sustainable, which emphasises this company’s focus on profitability.

Stronger revenue growth than the consensus expectations, associated expansion in EBITDA margins and increasing contribution from data services are likely to be the key highlights for the incumbents over this fiscal. These three factors, aided by a more benign regulatory environment, may also lead to an improvement in returns, thus resulting in material benefits for shareholders.