Small, midcap firms may do better

Sample preview shows margin pressure to continue, mixed picture across sectors, net sales growth up nearly 20%.

Small and midcap companies are expected to show moderate improvement in financial performance in the fourth quarter (January-March) of 2010-11, a preview of 202 companies suggests. The net profit of the midcap universe (150 companies) tracked by most broking houses may increase by 14 per cent and of smallcap (52 companies) may decline by around 5 per cent.

Midcap firms had reported a single-digit rise in net profit in the first and third quarters, and a significantly higher 15 per cent in the second quarter of financial year 2010-11. Smallcap companies are likely to report a decline in net profit for three quarters in a row.

Midcap firms may see net sales growing at a higher pace of 23.8 per cent in the fourth quarter, compared to 14 per cent in the first quarter, 20.5 per cent in the second and 18 per cent in the third. The net sales growth rate is expected to be around 15 per cent for smallcap companies, marginally lower than the 16 per cent reported in the second and third quarters. Smallcaps did well in the first quarter, posted 20 per rise in net sales and a 1.2 per cent rise in net profit.

The preview is based on the results estimates of 316 companies which accounted for 81 per cent of the market capitalisation of listed firms. The data has been sourced from a dozen foreign and Indian broking houses. The sample size accounts for 83 per cent of net profit and 72 per cent of net sales of the 3,700 companies on a quarterly basis. The consensus estimates in sales and profits is likely to be fairly accurate, with margins of error likely at one to two per cent.

The broad picture shows net sales growth rate of 19.6 per cent and operating profit expected to go up by 18 per cent. Net profit growth is likely to be around 13.3 per cent. The operating margins on revenue will be more or less unchanged or may decline marginally by 30-50 basis points.

The analysis of midcap companies hints at strong results from sectors such as banks, cement, fertilisers, fast moving consumer goods (FMCG), housing finance, and oil and gas. Weak results are expected from auto ancillaries, hotels, infrastructure, pharmaceuticals and textiles. Of the 150 midcap companies studied here, as many as 133 are expected to show a rise in net sales, of which 55 will report more than 25 per cent rise.

Net profit growth for the 92 best-performing midcap firms will be positive, with average growth of 36 per cent. Their net sales are expected to grow around 30 per cent, while profit margins are expected to be unchanged at 19 per cent. The remaining 58 midcap firms are expected to show a 15 per cent rise in net sales and a sharp 27 per cent decline in net profit. Among midcaps where significantly higher profit is expected are Chennai Petroleum, Indian Overseas Bank and Manappuram Finance.

Among 52 smallcap companies, as many as 43 will show increase in net sales. For 24 of these, the growth rate will be over 20 per cent. Net profit growth is expected to be up for 27 companies, at an average of 47 per cent; 10 of these are expected to post more than 50 per cent rise in net profit. TRF, Hexaware, Dhanlakshmi Bank, VIP Industries and KPR Mills are expected to report robust growth in net profit.(Click here for PERFORMANCE ESTIMATES)

MIX ON MARGINS, COSTS UP
Margins are expected to inch up around 10 bps for the midcap firms, while the smallcaps may see a decline in margins by 70-100 bps. Interestingly, more than half the Nifty firms (29) may decline in margins, while 80-odd midcap firms will likely show increase in margins. The 27 smallcap firms may see pressure on margins in the fourth quarter.

Overall, 60 per cent of companies – a level similar to that in the third quarter — will see year on year fall in margin. Sequentially, most banks face pressure on margins, while this pressure will be highest for media, pharma & steel companies. According to CLSA, there is room for negative surprises in autos, cement and midcaps, in general. With tight liquidity in the fourth quarter, the potential for negative surprises on interest cost is seen for smaller companies and big users of commodity inputs.

An analysis of margin expectations for the broader universe of BSE-100 companies suggests the consensus expects margin expansion in over 50 per cent of stocks between 2010-11 and 2011-12. However, it needs to be seen how much of these cost increases will be passed on to the end consumer, given high inflation.

The total sample of 316 companies analysed here are expected to post moderate performance in the fourth quarter, with net profit growth rate around 14 per cent. The net sales growth is likely to be maintained at around 20 per cent, while the rising input costs and lower price realisations are likely to hurt profit margins. According to Citigroup Global Research, this should be the lowest growth quarter in the last five years, excluding the financial crisis year.

The profit growth rate in the third (23.1 per cent), second (22.6) and first quarter (18.4) for the sample companies was moderately higher and driven by the strong performance of domestic companies having foreign subsidiaries, Tata Motors, Tata Steel and Hindalco. Tata Motors is expected to perform well in the fourth quarter, while Tata Steel and Hindalco may report subdued performance.

According to an analyst at ICICI Securities, banks’ earnings could spring a negative surprise if amortisation of pension/liability provisions for banks is disallowed. For the information technology services sector, there could be a positive surprise in both volumes and margins for front-line companies. Higher crude prices should hurt HPCL and BPCL. The FMCG sector could get hit by higher raw material costs, especially given that price rises have been minimal.

The Prabhudas Lilladher analyst hints at strong performance from capital goods companies but expects real estate, auto ancillaries, media and offshore services’ firms may show weak performance. IIFL Research indicates margin pressure to continue due to every item of a company’s profit & loss such as raw materials, labour, fuel and interest costs seeing significant jump in recent months.

Going ahead, the fourth quarter will be keenly watched for forming 2011-12 expectations, given the uncertainty on margins, full-year guidance on investments and the surprises that companies will throw out. According to an analyst at Merrill Lynch, the 2011-12 earnings estimate for the Sensex is expected to see more downgrades on account of rising interest rates and input costs.

For Edelweiss Research, the 2011-12 EPS consensus is still holding, on expectations of margin expansion in majority of stocks. In face of rising raw material prices, higher interest rates and higher salaries, cost pressures will increase. According to their estimates, costs have gone up by four-five per cent cumulatively, while earnings’ expectations for 2011-12 remain unchanged.