Q4FY08: Crunch time

Loss of momentum in sales and higher costs are expected to result in lower earnings growth.

The slowdown is finally happening. Leading brokerage CLSA expects only a 16.3 per cent growth in profits for the Sensex stocks (excluding DLF) in the March 2008 quarter.

That, says the brokerage, will be the lowest growth in the last eight quarters. Numbers for the larger universe of 75 stocks that the brokerage has under coverage are much better though: Profits should be up a smart 26.6 per cent.

The picture, however, changes dramatically if oil and gas stocks are excluded: CLSA's universe will then post only a 12 per cent growth, again the lowest increase in the last eight quarters with pharmaceuticals, cement and automobiles being the laggards.

The lower earnings growth, for the CLSA sample, is the result of a moderation in revenue growth, which could be just short of 18 per cent.

This together with higher raw material and other costs could crimp operating profit, allowing for a growth of just under 15 per cent. Very few companies have been able to pass on the entire cost increase to consumers in a difficult operating environment.

What's more, expenses on interest have risen and that will eat into the net profit margins. With some amount of provisioning expected for forex derivatives positions, there's a likelihood of some companies seeing far lower profits than anticipated.

As a Morgan Stanley report cautions, investors will need to watch for off balance sheet losses that have not yet been disclosed.

So far, the outlook for earnings growth has stayed robust: IBES consensus earnings, for instance, to a compounded annual growth of 20 per cent between FY08 and FY10 for the Sensex. The projected is higher at 22.7 per cent for the BSE 200.

However, if the fourth quarter numbers are disappointing, these estimates will need to be downgraded. At 15,700 levels, the Sensex trades at around 15.6 times forward earnings while the MSCI India Index trades at about 15.7 times forward. If profit numbers need to be revised downwards, these valuations might not appear so attractive any longer

Jubilant: Expensive deal

Jubilant Organosys' buyout of the Canada-based Draxis Health for an enterprise value(EV) of $255 million is expensive. That's because the drug firm, which does contract manufacturing and has a presence in specialised segments like radio pharma, posted an operating income of just $2.14 million for the 12-months to December 2007, a sharp decline from the $14.95 million in CY06.

Besides, the ratio of the EV to the trailing 12-month consolidated sales too is a fairly high 3.2 times. Some time back Biocon picked up a 70 per cent stake in Germany-based AxiCorp for 30 million euros at just 0.5 times EV/ trailing 12-month sales.

Two years ago Ranbaxy had acquired 96.7 per cent of Romania-based Terapia for $ 324 million, that translated into an EV/sales of about 4 times.

Even if it's costly, the deal makes sense for the Rs 1,810 crore Jubilant which itself takes on contract manufacturing""typically, it makes inputs or even the final medication for a customer. This it does for multinational firms like Syngenta earning fixed returns of between 14 and 16 per cent.

Moreover, Jubilant's cash flows and FCCBs worth $200 million, are sufficient to fund the deal. Draxis has said its volumes have been lower in segments related to Hectorol, a medication for chronic kidney diseases, which it made for Genzyme Corporation.  In addition, Draxis' radio pharma segment was also impacted by a shortage of inputs, like medical isotopes.  With Draxis, Jubilant can enter the high-margin and high-growth radio pharma business in North America. By leveraging the synergies of the Canadian firm, it claims it will improve Draxis' operating profits to $19 million by the end of CY08, on sales of around $80 million.  The management also claims the deal will add to the earnings per share (EPS) of Jubilant in the first year itself. At Rs 341, the stock trades at a reasonable 15.5 times estimated FY09 earnings (pre-acquisition).  Other large contract manufacturers like Divi's Lab trade at 18 times at the current price of Rs 1279.