Banks: Sitting pretty

Market is confident that banks can tide over the higher interest costs and inflation.

The banking sector has been the third best performing sector after capital goods and metals since the beginning of the first quarter of this year.

The cash reserve ratio and interest rates have gone up further since the beginning of 2007 and net interest margins had declined for the sector. This resulted in a correction in the stock prices of banks in March and April 2007, but since then bank stocks have rallied.

This is because the market is confident that banks will be able to pass on the higher interest costs and maintain margins. Inflation too is coming down from around 6.5 per cent three-four months ago to 4.13 per cent last week.

Advances, which have grown at around 30 per cent for the previous four years, have been tame in the June 2007 quarter at about 25 per cent. Growth in deposits, on the other hand, has increased from around 20 per cent last year to over 23 per cent in Q1 FY08.

The recent increase in lending rates in the fourth quarter of FY07 will show its effect this quarter, so margins should improve sequentially. The increase in deposit rates would not be felt as much in Q1, though it will have an impact from Q2.

Banks such as HDFC Bank, SBI and PNB, which have a larger share of current and savings accounts in their total deposits, will benefit more. Bond yields are up marginally over previous quarter, so the investment losses will be small.

Analysts are concerned about NPAs rising in Q1 as interest rates have gone up, and there can be new loan losses. Public sector banks will also have to account for some pension liabilities which have not been provided for in the June quarter, which will dent profitability.

Besides, analysts will also be watching for banks making announcements on the fund raising front from most banks in order to meet capital adequacy and finance loan growth.

The operating profit of PSU banks is expected to rise by 15-20 per cent y-o-y. Private sector banks will continue to post better results. HDFC Bank should see a 30 per cent growth rate in profits, while analysts expect ICICI Bank's operating profit growth at about 25 per cent.

Pharmaceuticals: A mixed bag

The large generic players are expected to report a mixed quarterly performance in the June 2008 quarter, as a rising rupee could hurt price realisations, coupled with pressure on operating profit margins, point out analysts. In addition, a high base effect in the previous year could also hurt growth for some companies.

For instance, in the case of Dr Reddy's, a decline in sales to the tune of 5-10 per cent y-o-y is expected in the last quarter, despite the 180-day exclusivity for ondansetron (medication for preventing nausea and vomiting due to chemotherapy).

Analysts point out to the absence of authorised generic revenues in the last quarter, which could affect sales growth in the June 2007 quarter. Its operating profit is also expected to decline by 15 per cent y-o-y in Q1 FY08.

In the case of Ranbaxy, a sales growth of 10-12 per cent y-o-y is forecast in the last quarter, helped by the earlier acquisition of Romania-based Terapia and 180-day exclusivity for the generic pravastatin (medication for lowering cholesterol).

However, its operating profit margins are expected to come under pressure in the June 2007 quarter on a y-o-y basis, given the surging rupee, coupled with high margin sales of simvastatin 80 mg sales under exclusivity in the corresponding period of the previous year.

Also, Cipla's operating profit margins are expected to decline by over 1000 basis points y-o-y in the June quarter, due to lower sales to regulated markets and rupee appreciation.

The street appears to have factored in a mixed performance from this sector, as the BSE Healthcare index has risen merely 4 per cent over the past three months as compared to a 14 per cent growth in the Sensex.

Meanwhile, MNC players like Glaxo are expected to see their core pharma division grow by 8-10 per cent y-o-y in the last quarter, broadly in tune with the growth in the domestic pharma market.

Its operating margins are expected to improve on a y-o-y basis in the last quarter, given its earlier disinvestment of the lower margin animal health business. Dr Reddy's trades at 19 times estimated FY 08 earnings, while Ranbaxy gets a discounting of 22 times estimated CY07 earnings.