 "What to look for this earnings season")
The earnings season is here again. This time, don't just look for stock-investing ideas but also at the overall health of corporate India.
The quarter ended September might not have been inspiring, as companies grappled with a volatile currency, which hit an all-time low of 68.83/dollar mid-quarter. Also, India Inc is fighting a demand slowdown and rising input costs, while rising interest rates are adding to increasing financing costs. Amid this environment, one shouldn't consider only revenue growth, margins, etc, but also a company's ability to grow in the face of mounting input costs and consumption patterns.
Analysts expect Sensex companies to report muted growth of one-two per cent in earnings - a far cry from the double-digit growth last year. Earnings of companies in the oil, metals and cement segments are expected to be very weak. Overall, growth could well be in the negative zone, if not for the double-digit growth in the information technology (IT) and export-driven sectors such as pharmaceuticals.
Investors should only look for companies that manage to stay ahead of the curve and spring surprises on the earnings front. So, keep an eye on a few key parameters to hold stock portfolios in good shape.
To begin with, foreign exchange risks surfaced in the September quarter, particularly for importers. Companies that have foreign-currency loans and are inadequately hedged are faced with higher risks. That's why analysts would scan un-hedged figures minutely. Mehraboon Irani, head (private client group), Nirmal Bang, says, "Quite a few companies are exposed to foreign currency and could be in trouble if most of it is un-hedged."
In the past few quarters, earnings growth has been steadily sliding and analysts say had it not been for the benefits of a rise in global earnings, front-line companies would barely match last year's profits. "Barring a few companies, the overall results will be disappointing. Growth will be high in the IT and pharmaceutical sectors and that would lift overall earnings growth to respectable figures. But it does not tell the whole story - that most sectors will be badly hit this quarter," Irani says.
He says the cement sector wouldn't fare well this year due to a slowing demand environment. UltraTech Cement saw a 52 per cent fall in profit in the September quarter.
Amid this environment, market watchers say the key aspect to look at is the quality of revenue growth. They add in a slowing environment, any upswing in revenue indicates the business concerned is well-entrenched. And, if a company manages to retain and maintain its revenue momentum, it would be superbly poised when economic growth resurfaces. Says S Krishna Kumar, head (equity), Sundaram Mutual: "A better part of the businesses are likely to show constrained growth. So, if any company shows better revenue growth than expected, it would be a real surprise and speak highly of the management." Look out for outliers such as Tata Consultancy Services. Despite its huge size, the company is posting growth rates of a company in its teens. In the September quarter, the company's net profit rose 34 per cent.
Investors should also look beyond the revenue growth say market watchers. For instance, volume growth of fast-moving consumer goods companies and order inflows to capital goods companies are being keenly watched. V Balasubramanian, fund manager (equity), IDBI Mutual Fund, says, "For companies able to show quality growth, expand their clientele and volume growth, it would reflect fundamentally on their ability to grow in the future."
From the September quarter, keep a close eye on operating margins. With the rupee having plunged to an all-time low and petroleum prices on the rise, margins are more likely to have been squeezed. Further, prices of commodities, by and large, were also on the rise.
Market watchers say companies that manage to expand margins in such a tough environment would show they still command pricing power and can pass on the rise in costs to customers. Says Irani: "Demand has not picked up and with a weak, local macroeconomy, it's not going to be very easy to pass on the increased costs to customers. It will be interesting to see whether companies would be able to, at the least, maintain their operating costs in these times, as before."
The inability to pass on costs would hit mid-cap companies more than larger ones - the latter can absorb some of the mounting costs. Therefore, mid-tier companies are at a slight disadvantage, and one should closely examine their operating margins. A couple of key operating parameters the market would be watching are leverage and whether companies are able to reduce borrowings. The Reserve Bank of India had increased the repo rate by 25 basis points to 7.5 per cent during the quarter. Experts are expecting another rate rise, which could increase borrowing costs of companies. When interest rates rise, infrastructure and capital-intensive companies are the worst hit. "If companies can show lower leverage, it would help improve earnings growth," Kumar says.
Investors should also look at companies' capital expenditure plans - this would signal whether the investment cycle in the economy is likely to pick up. Experts would be looking for signs of a revival at the grassroot level. Capital goods companies whose order books increase beyond expectations could come out with surprises. Even in a slowing environment, Larsen & Toubro managed to record an increase of 27 per cent in its order book in the September quarter.
But experts reckon a turnaround in the investment cycle is not on the cards. Defensives would still be the preferred investment choices for the next two-three quarters. "The investment cycle will kick off sometime and so, I will be looking for companies that show signs of beating the slowdown. At some point, people will have to move out from defensives into cyclicals for a kicker in returns," says Irani.
The quarter ended September might not have been inspiring, as companies grappled with a volatile currency, which hit an all-time low of 68.83/dollar mid-quarter. Also, India Inc is fighting a demand slowdown and rising input costs, while rising interest rates are adding to increasing financing costs. Amid this environment, one shouldn't consider only revenue growth, margins, etc, but also a company's ability to grow in the face of mounting input costs and consumption patterns.
Analysts expect Sensex companies to report muted growth of one-two per cent in earnings - a far cry from the double-digit growth last year. Earnings of companies in the oil, metals and cement segments are expected to be very weak. Overall, growth could well be in the negative zone, if not for the double-digit growth in the information technology (IT) and export-driven sectors such as pharmaceuticals.
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Investors should only look for companies that manage to stay ahead of the curve and spring surprises on the earnings front. So, keep an eye on a few key parameters to hold stock portfolios in good shape.
To begin with, foreign exchange risks surfaced in the September quarter, particularly for importers. Companies that have foreign-currency loans and are inadequately hedged are faced with higher risks. That's why analysts would scan un-hedged figures minutely. Mehraboon Irani, head (private client group), Nirmal Bang, says, "Quite a few companies are exposed to foreign currency and could be in trouble if most of it is un-hedged."
In the past few quarters, earnings growth has been steadily sliding and analysts say had it not been for the benefits of a rise in global earnings, front-line companies would barely match last year's profits. "Barring a few companies, the overall results will be disappointing. Growth will be high in the IT and pharmaceutical sectors and that would lift overall earnings growth to respectable figures. But it does not tell the whole story - that most sectors will be badly hit this quarter," Irani says.
He says the cement sector wouldn't fare well this year due to a slowing demand environment. UltraTech Cement saw a 52 per cent fall in profit in the September quarter.
Amid this environment, market watchers say the key aspect to look at is the quality of revenue growth. They add in a slowing environment, any upswing in revenue indicates the business concerned is well-entrenched. And, if a company manages to retain and maintain its revenue momentum, it would be superbly poised when economic growth resurfaces. Says S Krishna Kumar, head (equity), Sundaram Mutual: "A better part of the businesses are likely to show constrained growth. So, if any company shows better revenue growth than expected, it would be a real surprise and speak highly of the management." Look out for outliers such as Tata Consultancy Services. Despite its huge size, the company is posting growth rates of a company in its teens. In the September quarter, the company's net profit rose 34 per cent.
Investors should also look beyond the revenue growth say market watchers. For instance, volume growth of fast-moving consumer goods companies and order inflows to capital goods companies are being keenly watched. V Balasubramanian, fund manager (equity), IDBI Mutual Fund, says, "For companies able to show quality growth, expand their clientele and volume growth, it would reflect fundamentally on their ability to grow in the future."
From the September quarter, keep a close eye on operating margins. With the rupee having plunged to an all-time low and petroleum prices on the rise, margins are more likely to have been squeezed. Further, prices of commodities, by and large, were also on the rise.
Market watchers say companies that manage to expand margins in such a tough environment would show they still command pricing power and can pass on the rise in costs to customers. Says Irani: "Demand has not picked up and with a weak, local macroeconomy, it's not going to be very easy to pass on the increased costs to customers. It will be interesting to see whether companies would be able to, at the least, maintain their operating costs in these times, as before."
The inability to pass on costs would hit mid-cap companies more than larger ones - the latter can absorb some of the mounting costs. Therefore, mid-tier companies are at a slight disadvantage, and one should closely examine their operating margins. A couple of key operating parameters the market would be watching are leverage and whether companies are able to reduce borrowings. The Reserve Bank of India had increased the repo rate by 25 basis points to 7.5 per cent during the quarter. Experts are expecting another rate rise, which could increase borrowing costs of companies. When interest rates rise, infrastructure and capital-intensive companies are the worst hit. "If companies can show lower leverage, it would help improve earnings growth," Kumar says.
Investors should also look at companies' capital expenditure plans - this would signal whether the investment cycle in the economy is likely to pick up. Experts would be looking for signs of a revival at the grassroot level. Capital goods companies whose order books increase beyond expectations could come out with surprises. Even in a slowing environment, Larsen & Toubro managed to record an increase of 27 per cent in its order book in the September quarter.
But experts reckon a turnaround in the investment cycle is not on the cards. Defensives would still be the preferred investment choices for the next two-three quarters. "The investment cycle will kick off sometime and so, I will be looking for companies that show signs of beating the slowdown. At some point, people will have to move out from defensives into cyclicals for a kicker in returns," says Irani.