Input prices, operating expensives rise across sectors; analysts downgrade earnings estimates for near term
India Inc posted robust sales growth of around 20 per cent in the first three quarters of financial year 2010-11, indicating demand momentum is sustaining. However, this was not supported by improvement in margins, which suggests rising cost pressure. Thus, the net profit growth rate came down from 35 per cent in the second quarter to 24 per cent in the quarter under review, the third.
Aggregate performance of the 2,383 companies studied here seems rosy, but the picture changes distinctly on a comprehensive look. For example, 211 firms companies accounted for 90 per cent of the sample’s net profit. These 211 reported a 32 per cent rise in net profit, while those for the remaining sample declined 19 per cent.
Even among the 211, the net profit growth is rosy due to the top six profitable firms in that sample. These six — Cairn India, Indian Oil Corporation, ONGC, Sterlite Industries, Tata Motors and Tata Steel — have aggregated net profit growth of 165 per cent. If one excludes these six from the sample of 211, the aggregate net profit growth rate of the remaining lot declines to 13 per cent.
Oil and gas companies pull up the average through their 47.7 per cent earnings growth, and 41.7 per cent share in net profit. Excluding oil and gas, the third-quarter profit growth rate moves down to 11.3 per cent. Automobiles, banks, fertilisers and pharmaceuticals are the other big sectors that hold their ground to contribute to overall growth in profit. Exclude these sectors and the corporate profit growth declines to three per cent.
Auto ancillaries and non-ferrous metals managed a brave show by posting a little more than 20 per cent growth in profit, but failed miserably to match the earlier quarter’s performance. The net profit of the steel sector declined 16 per cent, after magnificent growth in the previous four quarters. Information technology services did better than expected, while telecom and cement make up the rear, with performance was weaker than expected. Capital goods and fast moving consumer goods (FMCG) failed to show any encouraging trend.
The earnings’ growth of 29 per cent for Sensex and Nifty companies in the third quarter has been on the mark. The growth is largely in line, despite disappointment from the metal companies, Hindalco Industries and real estate firm DLF. The shortfall was made up by strong growth in automobiles and the oil & gas sector, even after adjusting for one-time gains for ONGC.
While the overall demand environment remains robust, rising headwinds from cost pressures dented margins across sectors. Margins in auto and capital goods declined on the back of rising commodity prices, while rising input costs, power and fuel affected margins in the cement sector. Borrowing costs increased 30 per cent overall, being high in rate-sensitive sectors such as real estate and construction.
The margin pressure was evident for the sectors that use raw materials (RM) to produce goods. The RM cost of 1,888 companies studied here jumped around 23.5 per cent, 429 basis points higher than the growth in net sales at 19.2 per cent. Thanks to Tata Steel and Tata Motors, net profit growth was healthy at 22 per cent. The net profit growth rate falls to 16.4 per cent after excluding these two Tata companies.
Margins remained under stress with both cyclical and defensive sectors facing the heat of increased cost pressure. Cement, telecom, metals, FMCG, automobiles and hospitality sectors felt the heat of rising input costs. The year-on-year margins contracted more than anticipated in engineering and capital goods due to higher raw material costs. FMCG witnessed fall in margins due to higher input prices, cement firms because of increase in operating costs and drop in realisations, and in telecom due to decline in voice revenue per minute (RPM).
Earnings downgrades
Going ahead, various broking firms have downgraded Sensex earnings for 2011-12. The analyst at Nomura has cut 2011-12 consensus earnings for the Sensex by 1.4 per cent since the beginning of the Q3 earnings season. Analysts expect earnings downgrades to continue and accelerate in the coming couple of quarters, to incorporate sharply rising commodity prices and interest costs into earnings estimates.
After the third quarter result, Bank of America Merrill Lynch has moved down the Sensex EPS estimates for 2010-11 from Rs 1,050 to 1,035 and for 2011-12 to Rs 1,265 from Rs 1,300. Analyst expects 2011-12 EPS growth to see further downgrades to 15-16 per cent, compared to current estimates of 22 per cent.
According to a Citigroup analyst, the top-down view, and market sentiment, suggests earnings expectations will start cracking. The third quarter shows some signs – but not enough – of this being the case. With 2011-12 earnings growth still at 18-20 per cent due to a favourable sector skew, (50-plus per cent earnings concentrated in the relatively cushioned energy, financials and IT services), the earnings growth rate was moderating above 15 per cent.
On an overall basis, the consensus earnings estimates for 2011-12 have been downgraded by 1.5-2 per cent by Sharekhan analysts, based on third quarter results. The revised 2011-12 consensus earnings growth is 18.8 per cent, as compared to around 21 per cent a few months before.
Edelweiss analysts have softened their earnings outlook for 2011-12 and now the focus has been shifted to 2012-13 estimates. Earnings estimates for the Sensex for 2010-11 at 1,040 and 1,264 for 2011-12 are a downgrade from the 1,271 estimated earlier. For 2012-13, Sensex earnings are estimated at 1,486.
Edelweiss analysts, however, believe there could be further downside risks to earnings estimates, as rising input costs continue to contribute to a tricky macro environment. The 18 per cent annual growth rate for 2012-13 earnings will be severely tested as margins become more susceptible to cost pressures.
Motilal Oswal Research has downgraded Sensex earnings for all the three years on account of rising cost pressure. Among 30 Sensex stocks, the earnings estimates for 2011-12 have been upgraded for eight companies including Tata Motors, Tata Steel and Bajaj Auto. The major downgrades for 2011-12 have been for Jaiprakash Associates, DLF, Reliance Communication, Reliance Infra and Cipla.
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