Smooth sailing

Q1 numbers have been better than what the Street bargained for. And the earnings momentum should sustain.

Kudos to corporate India! Shrugging off the effects of a high base and taking in its stride rising raw material prices, India Inc has turned in a splendid set of numbers for the first quarter of the current fiscal.

Armed with stronger balance sheets and leaner workforces, companies have leveraged their capacities to the hilt. To be sure, the economy continues to grow at a fast clip "� manufacturing in May was up a striking 11 per cent.

And consumer demand refuses to flag. Not surprising then that banks are lending like there's no tomorrow and hotels are full up.

Whether its mobile phone connections or motorcycles, there are buyers aplenty. True, competition is keen and the consumer is careful "� so there's not always room to pass on higher costs.

But with a little help from the investment kitty or the taxman, CFOs have been able to present shareholders with decent profits.

Says a delighted Anup Maheshwari, head of equities at DSP Merrill Lynch, "The Q1 numbers are certainly ahead of expectations and it looks like we're on for a 15-18 per cent earnings growth this year."

Topline: Coming up tops
What has surprised the Street more than anything else is that companies are able to sell high volumes on what were considered to be already high levels achieved last year.

Take Bajaj Auto which has turned in a 33 per cent rise in its sales "� its volumes were 53 per cent for motorcycles. Or telco Bharti which notched up a stunning 48 per cent increase.

That's despite a fall in ARPUs (average revenue per user). The 27 per cent rise in engineering major ABB's revenues may have been a tad lower than what was expected, but is nonetheless strong. 

REPORT CARD Total of 644 companies, excluding financials
Rs crore	Jun-05	Mar-05	Jun-04	Growth q-o-q	Growth y-o-y
Net sales	165719.30	183255.74	140282.41	-9.57	18.13
Other income	3355.64	5147.66	2635.95	-34.81	27.30
Operating profit	32536.89	37158.13	26448.75	-12.44	23.02
Interest	2460.53	2610.66	2879.37	-5.75	-14.55
Depreciation	7044.13	7829.91	7089.60	-10.04	-0.64
Tax	6853.60	6636.88	5239.62	3.27	30.80
Net profit	19143.18	23950.55	13416.27	-20.07	42.69

Battery maker Exide has managed to top up its revenues by a decent 20 per cent. And combating uncertainties relating to VAT, pharma major GlaxoSmithKline has pulled off a 29 per cent sales growth.

While the competition is intense, players do have some pricing power "� Maruti's average realisation per vehicle was up 7 per cent.

Retailer Trent has seen a 57 per cent rise in its revenues. And watch and jewellery maker Titan has, in what is believed to be the lean season, come up with a sparkling 43 per cent increase in sales.

Talking of lean seasons, banks at least, don't believe in them any longer. Its more like loan season, going by HDFC Bank's 43 per cent rise in interest income.

Driven by higher average room rents (up nearly 25 per cent y-o-y) and a shortage of rooms, Indian Hotels has grown its topline 27 per cent.

Even FMCG minnow Marico has done well to register a double digit sales increase in a difficult environment though biscuit maker Britannia struggled with just a 3 per cent increase.

Steel manufacturers Tata Steel disappointed with lower volumes and sales.

But on the whole, there's no doubt that the numbers have been impressive. Says Sandip Sabharwal, head (equities), SBI Mutual, "The volumes are good and one can see signs of pricing power coming back. With the monsoons turning out to be good, consumer demand should remain strong and that would help sustain the growth."

The profit picture: Conquering costs
Its not been an easy time for manufacturers of finished goods with prices of key inputs such as steel, aluminum, plastic or even fuel going through the roof.

But with scale, operating efficiencies are kicking in and to their credit companies have managed to keep a check on costs despite a huge inflation in salaries and other spends.

While technology companies with their growing armies of people, deal with it year after year, other sectors are now beginning to feel the pinch.

In Q1, for instance, NDTV paid out 30 per cent more as salaries compared to the March quarter, in a bid to retain employees.

Despite an increase of 570 basis points on fuel expenses as a percentage of revenues for its domestic business, Jet Airways is flying high with an EBITDA growth of 42 per cent.

Bajaj Auo managed to eke out a 76 basis points margin increase despite raw materials as a percentage of sales going up by 270 basis points.

Rival Hero Honda, however, saw its margin dented by 170 basis points. Engineering firm ABB managed an 80 basis points rise despite raw materials to sales going up.

Notes Sabharwal, "Most of the pressure on margins seems to be over. A good many companies have been able to sustain margins even with higher costs." He adds that the impact of falling steel prices should be felt a couple of quarters down the line, and that would help margins.

If the net profits of most firms are far higher than their operating profits "� for our sample the net profit has grown at almost twice the rate of the operating profit "� it's because they've managed to earn from their investment portfolios.

Other income has rescued many a profit and loss statement in the past and it's no different now. Or companies have been able to save either on interest, tax or in some cases even on depreciation.

Mahindra & Mahindra, for instance has interest and tax write-backs, while Reliance Industries has spent less on depreciation.

Overall, however, most companies will have to shell out more on taxes simply because they're going to make more profits. Interest costs for companies as a whole are lower than what they were in the first quarter last year. That's because almost all companies have raised resources through a mix of debt and equity issuances. This has been done at very low interest rates and companies are yet to use the money.

Besides, they're doing brisk business anyway; so cash flows are strong which means they don't need to borrow too much.

Sector scan: A mixed bag
The Street was disappointed with the tech set "� the volume growth quarter on quarter has been subdued and many firms have seen a drop in the operating margins with costs going up in one form or other.

The outlook "� as gleaned from the guidance given by the firms - isn't too great and they're not exactly trading at dirt cheap valuations, which range between 15 and 26 times for FY06, though for FY07 the range is lower at 12-22 times.

Banks, on the other hand, have done well given the strong retail demand for credit. Vinay Kulkarni, senior fund manager, Deusche AMC, observes that net interest margins have expanded and non-performing loans are under control, while DSP's Maheshwari believes that valuations for bank stocks are reasonable.

Engineering companies with bulging orderbooks remain popular picks. Notes Shriram Iyer, head of research at Edelweiss Capital," We've been meeting companies that supply to the infrastructure sector, whether its power or road, and there's definitely a huge amount of capital expenditure being planned.

Steel has disappointed while FMCG firms are showing a mixed trend with volumes showing some improvement though pricing power appears to be some time away.

Valuations: Reason to buy
The Sensex earnings for FY06 is estimated at around Rs 550. At 7700, that makes for a trading multiple of nearly 14.

Looking ahead, the estimate for FY07 is around Rs 630, which translates into a price-earnings (P/E) multiple of 12. Not compelling, by any stretch of the imagination, but not horribly expensive either.

"From here on, stock prices are likely to be driven more by earnings growth rather than any re-rating," says Shriram Iyer, adding that the P/E expansion seems to be over."

However, the concern on valuations of mid-cap stocks which continue to be far higher than those of large caps, remains.

Cautions Maheshwari, "While the mid-caps will post stronger earnings growth, valuations are no longer cheap and there isn't too much of a cushion for disappointment."

Talking of disappointment, Nandan Chakraborty, head of research at Enam Securities wonders whether there are any signs of deceleration.

Says he, "while the year-on-year numbers are excellent, the sequential numbers show a mixed trend. The first quarter numbers are usually always worse than the numbers of the fourth quarter of the previous year. This time, the fall in Q1 over Q4 has been slightly more than the average q-o-q fall of the last three years. Therefore, one could keep a close watch though from a long -term perspective things seem to be on track."

The bottomline: Growing on...
Net net, the outlook is bright. The Street is now clear that the days of 25-30 per cent earnings growth year after year are over. And they're willing to live with a 15-17 per cent growth.

And that should not be difficult. Observes Maheshwari, Going ahead, we should see the topline and bottomline growth synchronising .

Notes Chakraborty, " Given that the Q1 numbers have been strong and with the monsoons also good, there's a high probability of the GDP growth estimate being revised upwards and as a result the same could happen for earnings too" Says Kulkarni, "Even if there's some slowdown this year for any reason, the growth should pick up again next year." Spoken like a true bull.