| Indian companies have once again beaten market expectations in the second quarter of FY2007 as unabated growth in top line and bottom line continues. That the growth was well-spread across sectors is even more heartening. |
| While the top line of 1574 companies (excluding banking, financial services, refineries and oil and gas) grew 28 per cent year on year (y-o-y), operating profit grew nearly 40 per cent and net profit rose even higher at 51 per cent. It is no surprise to see brokerage firms upgrade their price targets. |
| Amitabh Chakraborty, head-research, Privileged Clients Group, BRICS Securities, says, "In the first half of this fiscal, profit growth of Sensex stocks has been 45 per cent as against the consensus estimate of 25 per cent for the whole of FY07. So, there is a strong reason for earnings upgrade." Similarly many mid-cap companies have also done very well. |
| The stock market has cheered India Inc's Q2 performance as the Sensex trades at new highs, quoting at about 18 times and 16 times its estimated FY07E and FY08E earnings respectively, which seems high. |
| Can investors buy shares now and still make decent returns? Anup Maheshwari, head-equities and corporate strategy, DSP Merrill Lynch Mutual Fund, replies, "Just because the index is at higher levels doesn't mean that everything is expensive." |
| There are few voices of dissent like the the head of research of a leading broking firm, who feels that the risk is higher than the return at present. He adds that most companies are fully priced and stock prices are reflecting the future growth of at least the next 18 months (till FY08). |
| Overall, most experts are unanimously positive about the market as long as India Inc continues to deliver such robust growth in earnings. They also believe that if a medium to long term outlook is adopted, then there is more room for choosing stocks. |
| In a recent research report, stockbroking firm SSKI expects the Sensex to be range-bound and recommends select mid-cap stocks due to compelling valuations and strong earnings visibility. |
| India Inc continues to deliver The top line growth of about 28 per cent y-o-y was marginally higher than 25.2 per cent reported in June 2006 quarter. However, revenues of some sectors like the auto and auto ancillaries (excluding frontline), engineering and telecom declined marginally. |
| Construction and real estate companies ruled the roost with the highest growth of a whopping 63 per cent largely, powered by companies like Nagarjuna Construction (up 78 per cent), Unitech (193 per cent) and Subhash Projects (up 217 per cent). Some of the smaller companies like Peninsula Land, Lok Housing and D S Kulkarni Developers have grown phenomenally off a low base. |
| As construction and real estate sectors boomed, cement too did well. Sales of cement companies grew over 47 per cent. |
| Also, the metal sector witnessed a strong 35 per cent rise thanks to strong demand in auto, construction and consumer durables sector as well as higher metal prices. Even frontline IT (Infosys, Wipro, TCS, Satyam) and telecom (Bharti Airtel) beat market expectations. |
| The FMCG sector (which includes tea, coffee, cigarettes, detergents, food and dairy products) grew at 17 per cent, which is impressive considering that segments like soaps and shampoos are mature. Mid-size FMCG companies like Dabur and Marico grew at a higher growth of over 30 per cent. |
| Improved operational efficiency The operating profit margins expanded by a huge 153 basis points y-o-y to 17.52 per cent in the September 2006 quarter. However, the margin in the June quarter was slightly better at 17.68 per cent. Generally, companies have been able to control raw material and other expenses in Q2, though total expenditure inched up. |
| In terms of sectors, infrastructure related companies like cement, construction and metal companies reported fantastic margin expansion. The overall margins of cement companies stood at 28.4 per cent in Q2 FY07, as compared with 16 per cent a year ago, buoyed by strong volume growth coupled with pricing power amid the boom in the construction and housing activity in the country. |
| Cement prices shot up by 25-30 per cent y-o-y on an average in Q2. Mid-cap cement companies like Birla Corporation, India Cements and Madras Cements did better than large-caps like ACC and Gujarat Ambuja. |
| Metals showed a stellar improvement in operating margins growing by 400 basis points y-o-y in Q2 FY07 as against 51 basis points in the June quarter thanks to skyrocketing global non-ferrous metal prices like zinc, aluminum and copper as compared to last year. Some of the Indian metal companies Hindalco, Nalco, Hindustan Zinc and Tata Steel are among the lowest cost producers in the world. |
| Pharma companies surprised the markets with a marked improvement in operating margins, which rose a whopping 380 basis points y-o-y at 21 per cent unlike 6 basis points in the June 2006 quarter. |
| Companies like Dr Reddy's and Ranbaxy were the major contributors to the improvement in margins. Sandeep Nanda, head of research, Sharekhan, says, "While domestic demand was strong, past acquisitions by companies also delivered positive results." |
| Bulging bottom line While the operating profit grew by 40.58 per cent, the net profit growth was even more impressive at 51.22 per cent. Higher interest rates have not affected the bulk of corporate India (without considering banks, NBFCs, oil and refineries). Interest costs went up 22.46 per cent y-o-y in Q2 "� a smaller rate as compared to the rise in sales or operating profit. |
| While India Inc is on a capex drive, depreciation costs have not impacted companies either. Depreciation went up just 11.09 per cent. And though taxes went up 48.6 per cent, they didn't end up denting the net profit growth. As a result, net profit margin improved by 177 basis points to 11.7 per cent as compared to a 74 basis point rise in the June 2006 quarter to 11.15 per cent. |
| Cement companies were the best performers as their margins almost doubled to 17 per cent despite huge tax provisions and higher depreciation costs as many companies are ramping up capacities. |
| Mid-cap cement companies like Birla Corporation, India Cements and Madras Cements have reported better margins than large companies. However as compared to June 2006 quarter, the y-o-y rise in margins slowed down in the last quarter due to higher growth in expenditure especially raw materials in this quarter. |
| Construction companies, which disappointed in the June 2006 quarter with a sharp decline of over 600 basis points in net profit margins are back with a bang. While their net profits more than doubled despite an even higher growth rate in interest, depreciation and taxation, their margins improved by nearly 300 basis points. |
| Among real estate players, Unitech is the biggest gainer while Peninsula Land made a profit against a loss last year. Among the pure construction plays, Nagarjuna Construction and Patel Engineering fared better. |
| What looks good? Going ahead, market experts are tempering expectations and have accepted that growth rates will decelerate. However, they remain generally bullish on the stock market outlook as the managements of most companies have guided for improved margins in the near future. |
| But investing is not easy as valuations of most sectors look stretched, and there can't be any top-down sector picks. However over the next two-three years, there are many sectors which can deliver good returns. |
| Cement, engineering and construction continue to remain market favourites due to the strong infrastructure growth story. Even banking, FMCG, IT and telecom are emerging as top picks due to positive outlook. On the flip side, market players advise investors to be selective in autos, metals and oil and gas sectors. |
| Cement: Demand-supply mismatch, firm pricing, lower raw material prices especially coal prices (internationally) are expected to continue for a year. |
| Despite a sharp run-up on the bourses, select frontline stocks like ACC, Ultratech Cement and mid-caps like India Cements, Shree Cement and Kesoram Industries are still quoting at attractive valuations. |
| Engineering and Construction: There is strong visibility over the next three years due to bulging order books of many companies. Further, experts feel that any disappointment on the margins front (both BHEL and ABB saw their operating profit margin decline) was just a blip and many companies have guided for better margins in the coming quarters. |
| Though current valuations in the range of 20-30x for FY07 look stretched for leading construction companies, they look reasonable on FY08 basis quoting between 10-15x. |
| However the same is not true for engineering companies like ABB, Siemens and BHEL as the valuation of 25-30x for FY07E is not changing much for FY08 when they are still trading at 20-25x. |
| Banking: The improved performance in the September 2006 quarter saw banking stocks soaring on the bourses. Given the strong economic growth and high demand for credit (about 30 per cent) whether it is retail, agriculture, SME or corporates, the banking sector is expected to do well aided by a stable interest rate scenario. |
| The permission to raise hybrid capital and perpetual bonds is expected to improve return on equity. However, some analysts are wary of public sector banks despite cheap valuations, as growth in operating profits and net interest margins for most of them was not encouraging. |
| IT and telecom: With strong growth reported in the September 2006 quarter and the positive guidance given by frontline IT companies, market players are betting on IT stocks. |
| Also, though valuations for most IT and telecom companies are not cheap, the growth momentum of the companies is still strong which has kept the sentiments buoyant. |
| FMCG: FMCG, being a defensive sector, has not performed as well as other sectors. In September 2006 quarter, except Godrej and HLL, other companies reported strong growth. Going ahead market players feel that margins should be good due to better pricing power and the cooling in raw material costs on account of lower crude oil prices. |
| Auto: Two-wheeler companies like Bajaj Auto, Hero Honda and TVS Motors in the two wheeler segment, disappointed the street with a contraction in margins. |
| Analysts feel that margin pressure is expected to continue despite price hikes with intensifying pace of competition and high input costs. |
| Higher base effect has also started to affect top line growth. Valuations of four-wheelers are also getting stretched, and hence some market experts recommend that investors should avoid the sector for the time being. |
| Metals: Spiralling global non-ferrous prices are already reflected in the companies' stock prices, making non-ferrous stocks vulnerable to any shocks in a price decline. In case of steel stocks, there still a lack of clarity due to the increasing output in China. |
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