Sector Watch

THIRD QUARTER EARNINGS OUTLOOK

10855.20 67.90 7.90 SpiceJet640.40-70.70-2.801339.70-31.80-1.30 Data Compiled by BS Research Bureau  Currently, profitability is constrained heavily by costs thrust on the industry due to the inadequate infrastructure support.  While the airline industry is currently making losses, analysts expect a turnaround for the industry with the onset of rational pricing.  The move by a large number of international operators to offer improved connectivity to Indian cities opens up opportunities in the feeder segment.  Put simply, international flights discharge passengers at major hubs, who are thereafter flown by feeder airlines to smaller towns.  Rapid growth in the domestic passenger traffic has been quite remarkable with a clear contribution from low-cost carriers (LCCs). Of the total 9.48 million additional domestic passengers carried by local carriers from FY03 to FY06, 4.16 million (or 44 per cent) were carried by LCCs.  With the low-cost model finding favour with the price-sensitive Indian market, airlines are offering increasing air connectivity at low fares.  While actual yields have been more or less steady, inflation-adjusted yields have gone down by about 6 per cent in the last three years.  The airline industry has witnessed a spurt in consolidation in the form of recent mergers of Jet and Sahara, Kingfisher and Deccan Aviation and Air India and Indian Airlines.  Consolidation has meant that the top-three players (in terms of passengers carried) will have 88.5 per cent market share as against 71 per cent before the consolidation began.  The fallout of the consolidation process has already begun, with most of the airline operators hiking their fares from September 2007 by about Rs 200-250. This would lead to better average realisation per passenger, thereby improving their profitability.  CEMENT
Cement manufacturing companies are facing a tough time in the current quarter as cement prices move south, while the cost of power and coal moves north. Apart from the increase in the cost of production and little or negative rise in cement prices all over India, cement companies are also likely to face a glut in 2008-09 and 2009-10. 
 

Rs crore	Last year (FY07)			1Year forward (FY08)
	Sales	PAT	EPS	Sales	PAT	EPS
ACC	5803.50	1081.00	56.90	7128.40	1496.10	78.80
Grasim	13783.30	1956.60	213.40	15264.20	2421.00	264.00
Gujarat Ambuja	6268.30	1503.30	9.90	5578.70	1445.50	9.50
India Cements	2049.70	444.50	19.20	2839.50	805.90	29.70
Shree Cement	1423.60	155.50	44.60	2129.80	477.00	136.90
UltraTech	4910.80	782.30	62.80	5507.40	994.40	79.90
All companies except ACC, FY07 nos are provisional

 The cement pricing scenario is also benign and analysts do not expect a significant price increase in November or December. In fact, there have been reports of prices falling in some regions. Cement despatches for November 2007 grew at a slower rate of 3.4 per cent compared with 9 per cent in October 2007 in the absence of any major capacity addition in the industry and a lower offtake during the festival season.  The outlook for the Indian cement industry is buoyant. According to Sharekhan Research, the cement sector will witness a rise in volumes as construction activity gains full steam in December and continues its momentum in the fourth quarter as well. The rising cement demand will surely push up the prices gradually. The first such price hike was effected after the resumption of construction activity after the monsoon in Maharashtra, Andhra Pradesh and Tamil Nadu. Cement prices in Kerala are likely to firm up in the coming week.  According to the latest research report on the cement sector by Edelweiss Research, all-India utilisation levels are likely to correct to 94 per cent in FY09 (estimates) and 84 per cent in FY10 from 101 per cent in FY08.  The cement sector is estimated to move from a deficit of about 2 million tonnes in FY08 to an excess of 12 million tonnes in FY09. Price hikes are expected till the first quarter of FY09, but prices are likely to correct or stagnate thereafter.  The second quarter results for cement companies were a mixed bag, with Grasim, India Cements and Shree Cements beating expectations, while ACC, UltraTech and Ambuja Cement performing below expectations. The primary reason for lower-than-expected results was higher costs.  INFORMATION TECHNOLOGY
The slowing US economy, concerns over the rupee appreciation and the end of tax holidays, post-FY09, will hit Indian IT companies hard in the coming years. If the slowdown in the US is severe and widespread, apart from the banking, financial services and insurance (BFSI) sector, manufacturing, retail and telecom sectors may see a cut in IT spending.  According to CLSA, the rupee appreciation threatens to transform the cost structure of Indian IT, while benefits of the solution-based delivery are likely to remain restricted to a select few. 
 

Rs crore	Last year (FY07)			1Year forward (FY08)
	Sales	PAT	EPS	Sales	PAT	EPS
HCL Tech*	6033.60	1366.00	18.50	7542.50	1518.20	22.40
Infosys	13893.00	3856.00	69.80	16727.60	4575.50	80.80
Satyam Comp.	6485.10	1404.60	28.80	8003.50	1639.60	25.00
TCS	18633.20	4131.50	42.20	23017.20	5007.80	51.20
Tech Mahindra	2929.10	612.50	50.50	4001.50	791.10	65.20
Wipro	14943.10	2916.90	20.00	18861.70	3341.90	22.90
* Year end June

 The third quarter results will be in line with the Street's estimates, but the guidance for FY09 numbers will be crucial. According to Religare Research, Indian IT firms are operating at near-peak productivity levels and there is limited room for improvement on that front. Hence, margins would continue to remain under pressure. Overall, the 20 per cent growth in profit outlook for Indian IT is much lower than in the past.  According to an analyst at Lehman Brothers, the trend of falling operating profit margins is likely to accelerate in the next few years due to the appreciating rupee and continuing year-on-year salary hikes. The demand remains strong for tier-I companies, but the growth momentum and price hikes may get impacted negatively if there is a cut in the IT spending of the BFSI sector.  The earliest indicators of clients' IT budget will likely filter in only by January-end 2008 and hence the demand for frontline IT firms remains robust till that time. Pricing is likely to remain the main margin lever for tier-I vendors for the next two to three years, considering the continuing worldwide shortage of IT resources and the move towards vendor consolidation.  According to Kotak Securities, a sharp slowdown in the US led by the sub-prime crisis and reduced IT budget among large BSFI companies may lead to lower price realisation for IT and ITES companies. The pricing improvement has enabled the Indian frontline IT companies to manage the impact of the rupee appreciation and wage inflation on operating margins in the current year.  PHARMACEUTICALS
Pharmaceutical companies delivered a mixed performance in the second quarter ended September 2007, with Cipla, Orchid Chemicals, Aurobindo Pharmaceuticals, Lupin, Nicholas Piramal and Wockhardt performing better than expected, while Sun Pharmaceuticals and Cadila reported results, which were in line with expectations.  Net sales for major pharmaceutical companies grew by 23.1 per cent against the expected growth rate of around 19.3 per cent. Generics exports continue to be the main growth driver for most of the companies, while Wockhardt and Cadila also benefited from the consolidation of their acquisitions.  The appreciating rupee affected export revenues of some of the Indian companies, notable among them being Unichem, Ranbaxy and Torrent Pharmaceuticals. 
 

Rs crore	Last year (FY07)			1Year forward (FY08)
	Sales	PAT	EPS	Sales	PAT	EPS
Cipla	3572.10	660.70	8.50	4121.00	808.30	10.40
Dishman Pharma	578.70	91.70	11.40	791.30	129.60	15.90
GlaxoSmithKline *	1553.00	545.60	42.70	1636.00	619.60	50.40
B Chemicals	531.50	71.10	8.40	626.10	83.70	9.90
Pfizer**	688.50	105.70	43.30	604.00	591.10	38.40
Sun Pharma.	2266.40	774.10	37.40	2875.50	940.70	45.40
* Year end Dec  ** Year end Nov

 The proposed pharmaceuticals policy of 2007 intends to increase the number of drugs under the Drug Price Control Order, 1995, to 354 from the current 74. If the government proposes to implement the policy,it would affect the profitability of pharmaceutical companies.  The Indian market has seen a price decline in the past few years and which is why the market growth rate in terms of value has declined from 18 per cent in the CY06 to 12 per cent in the first nine month of the current calendar year.  The most important risk for the pharmaceuticals sector is regulatory in the form of price controls by the government. Pro-generics policies in Europe could lead to further price declines.  The increasing consolidation in the global generics industry is forcing Indian companies to merge or acquire at a higher price. The rupee has appreciated by over 8 per cent in the current year and companies with higher exports to the US market are likely to suffer.  TELECOMMUNICATIONS
The regulatory activity in the Indian telecom sector has been very high in the last three months starting with the Department of Telecommunication (DoT) accepting the Telecom Regulatory Authority of India's (Trai)recommendations of subscriber-linked spectrum allocation norms. The period after this has seen developments, which have largely been aimed at decreasing entry barriers for new players. These developments, although negative for the majority of existing operators, are positive for the Indian consumers as they will lead to higher competition and tele-density. 
 

Rs crore	Last year (FY07)			1Year forward (FY08)
	Sales	PAT	EPS	Sales	PAT	EPS
Bharti Airtel	18420.20	4062.10	21.40	26835.00	6466.30	34.10
Reliance Comm.	11761.91	3163.90	15.50	19269.20	4946.30	22.90
Consolidated

 According to Religare Research, the subscriber addition rate has been strong in the last 12 months, but the regulatory developments will increase competition and thus curtail the long-term growth rates of individual companies. All the private operators have been very consistent in their performance. The sector provides very strong revenue as well as earnings visibility over the next 12 months. Although the sector's growth will remain strong, analysts view the recent regulatory developments as negative for telecom companies as it will increase the number of operators per circle, which will intensify competition.  Kotak Securities expects the pricing environment in India to deteriorate further in 2008, enhance competition and curtail high return on invested capital (ROIC), which would lead to a further price reduction. The incumbent GSM operators are likely to become more aggressive on pricing and network expansion to accelerate their subscriber addition over the next 12 months, given the recent development regarding spectrum allocation, grant of GSM licences for CDMA and execution of mobile number portability.  Microcom Networking Protocol (MNP) would perhaps remove the last possible barrier to competition. Price competition will intensify, given that there is little differentiation among various service providers and hence pricing to quickly settle around the lowest price offered by a service provider. India is a very price-sensitive market and subscribers have very little hesitation about changing their service provider for a cheaper service as long as they can retain their numbers.  A telecom analyst at Crisil says that the new licence policy has made technology neutral, with the government permitting existing universal access service licensees to offer wireless services using either GSM or CDMA technology. This decision has paved the way for existing CDMA operators to provide GSM-based services and vice versa, subject to the availability of spectrum.