 "Earnings likely to recover to 15%-17% in FY17")
In the midst earnings season Prasad Koparkar, Senior Director, Crisil Research in an interview with Tulemino Antao says that modest improvement in operating profits will be driven by a handful of sectors on the back of higher gross margins aided by lower input prices: Edited excerpts:
What are your expectations on earnings growth (excluding financials and energy) for the fourth quarter in fiscal 2016?
CRISIL Research expects aggregate revenue growth of India Inc. to remain lacklustre at ~2% (excluding BFSI, and oil and gas) in Q4 2015-16. EBITDA is likely to grow by ~7% y-o-y, driven by higher gross margins fuelled by lower input prices. This modest improvement in performance is expected to be driven by a handful of sectors such as information technology, automobile, media, pharmaceuticals and certain consumption-driven sectors. On the other hand, sectors such as construction and capital goods will continue to report muted growth. Weak liquidity will also constrain the ability of highly leveraged companies to execute existing orders. Recent order inflow numbers indicate that the situation has improved marginally for select companies but a broad-based recovery, especially in private sector industrial capex, is unlikely before 2017.
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Although Nifty earnings growth in 2015-16 is likely to be disappointing around 4%, earnings are likely to recover to 15-17% in 2016-17. However, even factoring in this recovery, at current range of 7,800-7,900 the implied one-year forward P/E multiple for Nifty is around 17x, which does not appear to be low.
Information technology, private sector banks, media, pharmaceuticals and certain consumption-oriented sectors including auto have performed relatively better but public sector banks, capital goods, telecom, metals and real estate continue to witness headwinds in earnings growth. Going forward, recovery in rural demand on the back of a normal monsoon and higher budgetary allocation for the rural sector should drive earnings for sectors such as FMCG, two-wheelers, tractors, agri-inputs, cement and consumer durables. Large steel players are also likely to do better on account of a modest recovery in steel prices and reduction in imports. In addition, implementation of the Seventh Pay Commission and OROP (One Rank One Pension) scheme augurs well for passenger cars and consumer discretionary segments.
But, lack of meaningful pick-up in the investment cycle and continued asset quality problems in the public sector banking space will limit any large, across-the-board upside. Global markets and events can also cause downside risks.
Some Indian pharma exporters have received warnings from the US FDA on production practices at some of their facilities in the country. What is your call on the pharma sector and what could be the key drivers for growth of the sector, going forward?
CRISIL Research expects India’s pharmaceutical industry to grow at 12-14% CAGR between 2015-16 and 2020-21 owing to robust growth in domestic formulations and exports of both formulations and bulk drugs to regulated markets.
Growth in exports is expected to be led by continued demand for generic formulations in regulated markets, which are looking to control healthcare costs, thus boosting demand for cheaper generics. Indian companies have been consistently garnering a high share of regulatory filings of drugs, which is likely to support higher exports to these countries.
Indian companies are currently facing higher level of scrutiny from the US FDA, which is reflected in the regulators’ observations on some of their facilities. We expect Indian companies to be much more vigilant in future as the US is an important market for India’s pharmaceutical exporters and accounts for ~ 50% of pharma exports.
With the US economy showing signs of an uptick, what is your call on IT exporters for the current fiscal? At current valuations, which of them look attractive at current levels from a long-term perspective?
CRISIL Research expects IT service exports to grow around 11% in USD, over the medium term, driven by increasing focus on newer technologies such as cloud & related applications, mobility and social media, and greater adoption of analytics across verticals. These segments account for ~13% of industry revenues but are expected to grow above industry average growth rates.
However, the operating margin of Indian IT service vendors is expected to decline 50-100 bps (basis points) in 2016-17 due to pressure on billing rates in commoditised services following aggressive bidding by some players during renewals, expected wage hike of 8-10% and limited scope for improving employee utilisation.
Volume growth of FMCG companies has remained tepid over the last few quarters. In case we have a good monsoon this year what could possibly be the impact on the sector?
Volume growth has been tepid largely due to cut in spends in the rural market, which constitutes 35-40% of FMCG sales. The ban on sales of Maggi and increased tax on tobacco were other factors. However, with forecast of a normal monsoon this year, coupled with initiatives announced by the government in this year’s Union Budget to boost the rural and agricultural economy, we expect an improvement in demand growth in rural India.
Gross margins are expected to expand slightly as most of the crude-linked inputs remain low due to lower crude oil prices. Also, if the monsoon is normal, prices of other inputs will remain stable. However, gross margins of companies using sugar as their key input could see some pressure as prices of sugar have risen in recent quarters.
What about consumer discretionary sectors such as auto and consumer durables?
If we look at the auto sector, some segments such as light commercial vehicles (LCVs), motorcycles and tractors, which started on a slow note during the year, have picked up considerably in the last 2-3 months of 2015-16. We expect growth in these segments to remain healthy in 2016-17 on the back of a normal monsoon.
We expect commercial vehicle sales to increase by 10-12%. Sales of medium and heavy commercial vehicles (M&HCVs) is expected to grow at 16-18% on account of increased industrial activity, uptick in execution of infrastructure projects and replacement demand from large fleet operators. After shrinking for two years, the LCV segment is expected to grow at 7-9% due to improvement in consumption, rationalisation of capacities, and lower interest rates.
Passenger vehicles are expected to grow at 8-10%, driven mainly by lower cost of ownership on account of a decrease in interest rates as well as lower fuel prices. We expect two-wheelers to grow by 8-10%, driven by higher rural demand.
We expect consumer durables to grow by 8-9% in 2016-17 compared with 5.5% in 2015-16. The room air conditioners segment is expected to grow at a healthy 14-15% after weak growth in last year. On the other hand, the colour television segment is expected to grow at a moderate 4% driven by growth in panel televisions, which is expected to grow at 13-14%, offsetting de-growth in cathode ray tubes.
What impact do you see for the banking sector in wake of the huge quantum of non-performing assets? Will gains in their bond portfolios help cushion net profit growth to an extent?
CRISIL Research expects credit growth to pick up slightly to 11% in 2016-17 versus 8% in 2015-16. Private banks are expected to grow faster, at over 20%, and continue to gain market share. Growth will come from improvement in the economy and lower interest rates.
Gross non-performing asset (GNPA) levels are expected to remain high in 2016-17 as corporate cash flows continue to remain strained. Also, some slippage is likely from loans restructured during the past 2-3 years, primarily in infrastructure (especially power), construction and metals. Accordingly, GNPA is expected to increase from 6.8% in March 2016 to 7.7% by March 2017.
Gains in bond portfolio are expected to be insignificant. Private banks may still reap some gains, but as far as public sector banks are concerned, gains from the portfolio will have negligible impact on their net profit growth.
Capital goods companies are witnessing fresh order inflows. Is the worst over for the sector?
We expect the performance of capital goods companies to remain muted. Although order inflows have picked up in power transmission and distribution, as well as in earth moving equipment, fresh capacity additions in cement and steel remain low on account of lower utilisation levels.
In earth moving equipment, demand picked up in 2015-16 and is expected to rise further to 12-14% in 2016-17, primarily due to increased activity in mining, road construction, and urban infrastructure. In cement, utilisations are currently low, ~75%, whereas in steel the major part of the investments for upcoming capacities has already been done. As a result, fresh capacity additions are not expected in the near to medium term.
