Down but not out

India Inc has slowed down in the June 2007 quarter. A sectoral analysis of Q1 FY08 results and what to expect.

After running at a breakneck speed for several quarters, India Inc's financials have taken a breather. In the June 2007 quarter, our universe of 942 companies, excluding banks, financial services, oil and gas companies, and with a turnover of more than Rs 25 crore have shown the slowest growth in terms of almost all parameters like net sales, operating profit and net profit.

Net sales and operating profit (excluding other income) have grown at 19.5 per cent and 18.8 per cent year-on-year respectively-the slowest since last four quarters starting June 2006 quarter (Click here to see table: Stocks in Focus).

As a result, operating profit margins declined marginally by 11 basis points year on year, thanks to a small rise in total expenditure. However, a growth of 32 per cent in net profit has been maintained on a year-on-year basis, thanks to higher other income, declining interest cost and lower increase in depreciation costs.

Companies in sectors like construction and real estate, media, telecom and lifestyle have been leaders in terms of the overall growth of the universe. On the other hand, companies in the sugar, textiles and auto spaces have been laggards.
 

CORPORATE SCORECARD
% chg (y-o-y)	Net sales	Operating profit	Net Profit
Overall	19.50	18.80	32.30
Cement	24.30	32.30	50.50
Construction	45.00	89.20	87.90
Engineering	30.40	26.00	44.80
Ferrous metals	21.20	17.40	44.00
FMCG and related	23.30	20.50	20.50
Income / Life style-based	28.70	50.90	49.20
IT	26.90	21.60	33.80
Media	32.70	81.80	95.70
Non-ferrous	11.80	-5.80	5.80
Pharma	12.90	10.00	34.00
Power and power equip	19.30	8.00	36.30
Telecom	31.10	47.10	90.60
Textiles	18.00	1.40	-7.00

So will this slowdown continue or is this just a blip? What is the outlook for the next few quarters and which sectors look positive? Market participants are unperturbed by the slight slowdown in the financial performance of Indian companies as they have been on the expected lines.

Both Prateek Agarwal, fund manager, ABN Amro Mutual Fund and Bharat Shah, CEO and managing partner, ASK Investment Managers, feel that the performance of Indian companies has been reasonable.

Going forward, investors can consider investments on declines in domestic growth stories like capital goods, construction, financial services (primarily public sector banks), media and telecom sectors.

However, with the global mayhem, market watchers feel that there may be more declines in the next few weeks, and some of these sectors and companies will become attractive.

Let's go deeper to find out what factors affected the leaders and the laggards in the June 2007 quarter and what your investment strategy should be.

THE LEADERS

Construction and real estate
The construction and real estate sector has once again emerged as the star performer in terms of overall growth. The sector has reported highest growth of 45 per cent in net sales and about 88-89 per cent each in operating profit and net profit growth, thanks to robust performance by companies like Unitech, Punj Lloyd, Simplex Infrastructures, IVRCL Infrastructure and Parsvnath.

India's infrastructure spending pegged at $350 billion for the next five years is leading to robust growth of over 50 per cent in order inflows of construction companies, whose order book to sales ratios now stand at a comfortable three times their FY07 sales. Further, skyrocketing growth in real estate prices, especially in last three years, has led to fantastic growth in the financials of real estate companies.

But despite the favourable macroeconomic factors, most of the construction and real stocks like Nagarjuna Construction, Simplex Infrastructures, Parsvnath and Akruti Nirman have remained underperformers since January 2007.

Hitesh Kuvelkar, associate director, First Global, is not that bullish on construction stocks as he thinks that companies are facing competition in the Indian market because of which margins are constrained. Agarwal of ABN Amro Mutual, is positive on the real estate sector and according to him, the peaking of interest rates will lead to a bounceback of sentiment.

Media
Higher economic activity led by robust growth in GDP is leading to higher spends on advertising benefiting media companies. The sector has recorded the next best growth of 32.7 per cent led by companies like UTV, TV Today, PVR, Deccan Chronicle and Zee Entertainment.

The operating profit and net profit have grown at a scorching pace of more than 80 per cent and 90 per cent respectively. Going forward, analysts expect advertising revenues of media companies to grow at 20 per cent a year over the next three years.

However, stock prices of media companies have ballooned over the last six months reflecting the positives. Almost all the media companies have outperformed the Sensex with a significant margin since January 2007. However, investors can consider investments in Jagran Prakashan and Deccan Chronicle on declines.

Telecom
Robust growth of more than 6 million subscribers to 181.1 million at the end of June 2007, rising teledensity and huge untapped potential in rural areas with teledensity as low as 2 per cent are driving skyrocketing growth of telecom companies.

While the sector's revenues have grown by 31.1 per cent, operating profits have jumped by 47 per cent and net profits have almost doubled. Companies like Bharti, Reliance Communications, Idea Cellular and Spice have contributed to this scorching pace of growth.

Analysts have a positive outlook on the sector but don't expect the stock performance to be as robust as in the past as ARPUs are falling and urban markets are saturating, leading to compressed margins. Kuvelkar of First Global feels that the growth expectation is already factored into the prices.

Lifestyle
In India, where approximately 50 per cent of population is under 25 years of age and 30-35 per cent of the total population is placed in the middle and upper middle class category, companies impacted by changes in lifestyle cannot be ignored.

Lifestyle companies are those whose revenue growth is driven by favourable changes in demographics skewed towards younger population, higher disposable incomes and rising aspiration levels. India is witnessing a boom in this business and the beneficiaries are sectors like retail, liquor, consumer durables, accessories, and jewellery.

Accordingly, the sector has seen a robust growth of 30 per cent in net sales and 50 per cent each in operating profit and net profit in this quarter led by robust growth in companies like Titan Industries, United Spirits and Gitanjali Gems. Though these stocks have had a sharp run-up since January 2007, the companies are expected to grab attention due to high earnings visibility.

Engineering
While the sector's revenues have grown at a robust pace of 30 per cent, operating profit growth has lagged behind growing 26 per cent due to rising input costs.

However, net profit growth has shown a robust growth of 45 per cent due to stable interest, depreciation and taxation. Companies like Larsen & Toubro, Bharat Earth Movers and Alstom Projects have been major gainers.

Kuvelkar is bullish on the sector for the next one year as capital goods companies are expected to see significant margin expansion due to demand-supply mismatch for the companies' products and services not only in the Indian market but also globally.

Cement
Cement companies have not reported a very robust top line growth like other infrastructure-related companies as increase in price realisations have happened the most only in the southern region. Net profit has grown at a robust pace of 50 per cent though operating profit has been subdued at 30 per cent.

The sector's performance has been largely led by India Cements, Shree Cements and Madras Cement. Agarwal feels that large cap cement companies are fairly valued while investors can look for an upside in midcap and smaller rung companies. Moreover he feels that prices are likely to remain at the current levels.

THE LAGGARDS

Auto and ancillaries
A substantial increase in interest rates on auto loans in the last six months by banks and other financial institutions led to a slowdown in the demand for automobiles, especially two-wheeler companies like Bajaj Auto, Hero Honda and TVS Motor.

However, four-wheelers including commercial vehicles have fared better reporting a growth of 10-20 per cent. The only exceptions are Maruti Udyog and Eicher Motors, whose revenues grew over 20 per cent.

As a result, the markets have punished the auto sector and most of the market players ask you stay away from the sector though some of them do not mind taking a contrarian call on cars and commercial vehicles. However, two-wheeler stocks will under-perform.

Sugar
A surplus of 7 million tonnes, domestic prices falling over 20 per cent, less lucrative exports market due to declining international sugar prices, appreciating rupee and unfavourable government policies have hit sugar players hard. The sector's revenues declined by 6.5 per cent led by companies like Balrampur Chini, Dhampur Sugars and Shree Renuka.

Almost all the big players have reported negative growth in operating profit and net profit caused by a double whammy of declining realisations and increase in expenditure. Analysts advice is to stay away from sugar stocks as the surplus production factor will continue for the next four-six quarters.

Textiles
The rupee appreciation of 8.7 per cent and 5.5 per cent against the dollar and euro respectively plus competitive global market conditions have taken a toll on the performance of textile companies.

While revenues have still grown by 18 per cent largely driven by volumes, operating profit inched up only 1.5 per cent and net profit declined by 7 per cent.

However companies like Bombay Rayon Fashions, Spentex Industries, JBF Industries, S Kumars are some of the few who have shown extraordinary performance and are good investment bets for those who want to have a textile company in their portfolio.

Non-ferrous metals
Companies in the non-ferrous metal space reported a lacklustre performance in Q1 FY08 led by a poor performance in the aluminium business of Hindalco and Nalco but supported by decent performance in copper and zinc players like Sterlite and Hindustan Zinc.

While the sector revenues grew 12 per cent, operating profit declined by 5.8 per cent. Aluminium prices were affected by rupee appreciation and customs duty cut, but TC/RC (treatment and refining costs) margins in the copper business did not grow substantially.

However, zinc prices rose 6 per cent. Net profits also increased by a similar magnitude as companies are on an expansionary mode. Investors need to be cautious about the sector as it is fraught with volatility and uncertainty due to the China factor. Analysts expect aluminium prices to decline and TC/RC margins to weaken in 2009.

Power and power equipment
Despite India being a power deficit country and the existence of a huge potential for power companies, especially in the generation space, the sector has not performed up to the mark barring exceptions in the transformer and distribution space.

Net sales grew only 19.3 per cent and operating profit was largely affected due to a decline witnessed by large companies such as Tata Power and CESC. Operating profit was lower at 8 per cent though net profit jumped 36 per cent due to higher other income.

Pharma
Pharma companies once again disappointed on the operational front due to poor performance by large companies like Ranbaxy, Cipla and Dr Reddy's. The sector reported a growth of just 13 per cent and 10 per cent in net sales and operating profit respectively, net profits jumped 34 per cent, thanks to doubling of over 100 per cent in other income. Companies that have had huge forex borrowings have gained due to rupee's appreciation.

Market participants feel that the stocks are under-owned but prefer to be stock specific as global generics and domestic business is competitive leading to pricing pressures. Companies in the CRAMs space are worth looking at if at all.