December quarter corporate results indicate slower economic growth and persistent inflation have taken their toll on revenue and profitability
December quarter earnings growth was driven largely by exporters and companies with large overseas subsidiaries as the rupee’s depreciation last year shored up revenue and profitability.
Things are not always what they seem. Net income of the companies in the BSE Sensex grew 22.6%, the highest in 14 quarters, according to data collated by Kotak Institutional Equities.
Excluding oil and gas companies and banks, which can skew the picture, earnings grew 36.9%, which again was the highest rate of growth in the past 14 quarters.
But earnings growth was driven largely by exporters and companies with large overseas subsidiaries as the rupee’s depreciation last year shored up revenue and profitability.
Companies dependent on the domestic sector suffered, with volume growth declining for a number of companies and non-performing assets increasing in the banking sector.
Analysts at Nomura Research said in a note to clients that net profit growth declined significantly after excluding information technology (IT) services companies, pharmaceuticals, Tata Motors Ltd and Reliance Industries Ltd. For the universe of the companies the brokerage tracks, excluding oil and gas and financial companies, earnings grew 18.6% year-on-year (y-o-y). Excluding the above-mentioned companies and sectors, earnings fell by 2.1% y-o-y.
Analysts at Kotak wrote in a note to clients, “The ongoing slowdown in the Indian economy and high consumer price inflation resulted in a sharp decline in revenues and volumes of consumer discretionary products such as automobiles, beverages, cement, jewellery and quick service restaurants. Volumes of consumer staples companies grew modestly, in line with the modest growth in the past six-seven quarters. Given our expectations of a slow economic recovery, a recovery in volume growth will likely take time.” The decline or modest growth in sales of large cement companies also points to a slowdown in construction activity both in the real estate and infrastructure sectors.
An interesting trend was that some companies with predominantly domestic operations increased their focus on exports to offset the impact of the slowdown in their primary market.
For banks, the proportion of non-performing assets and restructured loans remained high, which reflects the problems in the economy. In addition, there were some of the usual concerns about quality of earnings. For instance, the contribution of non-interest income for financials and other income for non-financials remained high.
Among the positives, order inflows at capital goods companies grew at a decent pace last quarter, besides which there are signs that the government has increased the pace at which it is granting approvals to projects.
In sum, even though the headline numbers look impressive, the underlying message remains worrisome. It’s not surprising that the broader market index, BSE-500, has been flat since the beginning of the results season. The index has been range-bound for over two years now, and investors are clearly waiting for the general election, due later in the year, to take a definite view on the markets.
AUTO
The December quarter performance of auto companies was a mixed bag. Against a backdrop of gloom where product discounts are rising and auto sales volumes are contracting, a significant 300 basis points (bps) jump in aggregate operating margin of seven leading listed auto firms was commendable. However, unlike the September quarter when the margin rose across the board, this time round the increase was selective. One basis point is one-hundredth of a percentage point.
The winners clearly were those with a rural focus and export revenue. Mahindra and Mahindra Ltd continued to sell more tractors on the back of good monsoon rains and a better agricultural economy. The profit from the tractor segment, which increased for the fifth straight quarter, countered a fall in auto segment profit. Again, Hero MotoCorp Ltd among two-wheeler makers and car maker Maruti Suzuki India Ltd fared better than Bajaj Auto Ltd as both firms have a greater exposure to rural markets. Bajaj’s performance was lifted only because of exports as domestic volumes fell when compared with the year-ago period, both in two-wheelers and three-wheelers.
Commercial vehicle (CV) makers, as expected, posted a pathetic performance as domestic sales continued to be in the doldrums, despite high discounts in the market. They are operating at a little over half their capacity. Ashok Leyland Ltd, the second largest truck maker in the country, reported a net loss in the December quarter, compared with a small profit in the year-ago period.
Tata Motors Ltd’s pathetic domestic performance was seen in its sales contraction both in passenger vehicles and CVs, but was overshadowed by the vibrant results of its UK subsidiary Jaguar Land Rover Plc. Strong launches and a likely uptrend in developed markets augur well for the consolidated entity, whose operating margin has steadily increased over several quarters to touch 15.6% in December.
If rural markets and exports were the buzzwords in the last two quarters for auto companies, the excise duty cuts announced in the recent interim Budget a week ago would hopefully kindle demand.
What’s interesting is the continuous spending on advertising and marketing as well as product launches lined up by most companies, barring those in the CV segment. This signals a conviction on strong long-term prospects in the domestic market. A note by Crisil Research highlights that strong parentage for global firms entering Indian markets and healthy cash flows of most domestic companies will cushion capital expenditure plans, too.
That said, a quick run-up in valuation is typical of the sector, making it difficult for retail investors to participate for meaningful gains from auto stocks. The BSE auto index, in anticipation of better volume growth in the coming quarters, has already gained steam to outperform the BSE Sensex, following the December quarter results. The one-year return on the BSE auto index is twice that on the Sensex.
AVIATION
The season of losses continues for Indian airlines. Both Jet Airways (India) Ltd and SpiceJet Ltd posted a net loss in the last quarter. It’s discouraging that this came in the December quarter, which is generally stronger for aviation companies on account of festivals and holidays that fall during the period. Although both airlines reported year-on-year (y-o-y) revenue growth last quarter, they could not post a profit.
The culprits: higher fuel expenses, a weak rupee and the soft demand environment. Fuel costs as a percentage of revenue rose for both companies but the impact for SpiceJet was sharper. For instance, Jet’s fuel costs as a percentage of revenue increased to 42% in the December quarter from 40% in the same period last year. The same measure for Spicejet increased to 52% from 45% during the same time frame. Also, for SpiceJet, US-dollar denominated costs such as lease rentals, maintenance, spares and so on went up sharply.
Jet’s aircraft lease rentals, employee costs, other expenses, and selling and distribution expenses increased on a y-o-y basis. Its international passenger load factor—a measure of seat occupancy—increased while domestic load factor declined. SpiceJet’s load factor, too, declined.
The upshot: SpiceJet’s net loss for the quarter stood at Rs.173 crore and Jet’s net loss at Rs.268 crore. Both airlines had posted a net profit in the year-ago quarter.
Given the tough environment, the shares of both Jet and SpiceJet declined in the last quarter. What’s more disappointing for investors is that no significant improvement is expected in the operating fundamentals soon. On the domestic front, rising competition, a weak rupee and economic growth slowdown will affect the aviation sector for some more time to come.
In a post results note, analysts from ICICI Securities Ltd wrote, “given SpiceJet’s negative net worth of over Rs.800 crore and loan liability of over Rs.1,700 crore, funding the operations, going forward, would remain a very challenging task”.
For Jet, ICICI Securities maintains, “despite the ongoing challenges on domestic operations and recent US Federal Aviation Administration downgrade (lowering India’s aviation safety ranking), the company is in a better position to withstand the slowdown with sufficient funds from Etihad”, which has bought a 24% stake in the Indian airline. The brokerage has a “sell” rating on SpiceJet and “hold” rating on Jet.
Among other things, higher interest costs have been a concern for Jet. In a post-results press release, Jet said, post Etihad’s equity infusion, its debt had fallen to Rs.10,895.2 crore as on December from Rs.12,494.7 crore in September. That is expected to help lower Jet’s interest costs in the coming
months.
BANKS
The chief concern in the banking sector has been deteriorating asset quality. Most of the bad debts continue to be concentrated in the public sector banks, but in the December quarter, for the first time, there were some cracks seen in the asset quality of private sector banks, too.
Still, the performance gap between private and public sector banks continued to widen as the aggregate net profit of public sector banks dropped 43.5% year-on-year (y-o-y) in the December quarter, compared with 44.4% growth for the private sector banks.
The problem of bad assets worsened for some banks, with United Bank of India to curb lending for a while after its gross non-performing assets (NPAs) rose to 10.82% of advances. Central Bank of India’s and State Bank of Mysore’s gross bad debt was in excess of 6% of their loan books, while State Bank of India (SBI), Andhra Bank, Allahabad Bank, IDBI Bank Ltd and Indian Overseas Bank all recorded gross NPAs of more than 5%.
Nevertheless, there was some small comfort from the fact that slippages into bad debts for public sector banks declined, compared with the September quarter. While the fresh slippages remained steady, net non-performing loans and restructured loans increased sharply for state-owned banks such as SBI and Canara Bank Ltd. Overall, the operating profit declined by 2.2% y-o-y for state-run banks as they continued to see pain from higher employee costs and had to set aside more money to provide for bad loans.
What was worrying was that the problem of bad loans seems to have percolated into the private banks with gross NPAs rising 16% y-o-y, at the fastest pace in many years. “Finally, a little bit of stress is seen on books of private banks because the economy was bad for so many years, but in absolute terms their slippage levels are still half of that of public sector banks,” said Vaibhav Agrawal, vice-president, banking research, at Angel Broking Ltd. Operating profit grew 17.3% for these banks, with an improvement in the net interest margins helped by FCNR (foreign currency non-resident) deposits.
Public sector banks have underperformed the private sector banks in the past six months and the trend may continue for the next few quarters as long as the economy remains sluggish, while a large restructuring pipeline and Reserve Bank of India (RBI) guidelines will keep their credit costs high.
IDFC Institutional Securities Ltd, in a research note dated 17 February, said asset quality would remain vulnerable for another two-three quarters.
State-run banks’ capital adequacy is also significantly lower than that of private peers and they would need to raise equity capital frequently from public markets, which is likely to constrain balance sheets and earnings growth.
CEMENT
Cement companies are on a shaky foundation. In spite of the low base of the previous quarters, the growth rate clocked in revenue and profit failed to impress in the December quarter. Subdued construction activity, both in housing and infrastructure, kept the demand for cement low and thwarted price hikes.
The marginal 1-2% rise in realization on sales could not offset the rise in cost, primarily freight costs. Our data analysis of 18 large and mid-sized cement firms shows that freight costs as a percentage of sales rose four times to 12.9% in the December quarter from about 3.1% eight quarters ago.
Undoubtedly, the key reason is the unprecedented rise in diesel costs. The busy season surcharge added to freight costs in the December quarter.
Despite containing costs on most energy, staff, other expenses, and even raw material, cement companies’ operating margins suffered. On an average, operating profit fell by Rs.190-200 per bag across 20 cement firms for the quarter as profit margins fell by about 400-500 basis points when compared with the year-ago period. One basis point is one-hundredth of a percentage point. Moderate revenue growth also hindered operating leverage, dragging down operating performance. As a result, net profit contracted across the board, but the extent of contraction varied between 15% and 45%. Even large firms like UltraTech Cement Ltd, ACC Ltd and Ambuja Cements Ltd, which make up nearly two-thirds the total revenue of the cement sector, were no exceptions.
As a result, cement stocks have underperformed the benchmark indices over the last three months, reflecting a downgrade in earnings and a lack of confidence in near-term revival in the sector.
However, revenue and profit are expected to improve in the March quarter, given that it is often the best period in the year. Dealers say that cement manufacturers have increased prices since January, but are sceptical about an increase in demand in the next few quarters. In fact, analysts have scaled down demand growth guidance from 8-10% to a moderate 5-7% until fiscal 2015.
CONSUMER GOODS
Not long ago, the Indian packaged consumer goods sector seemed like a good foil against the macroeconomic worries facing India. But that period appears to have ended, along with the fading of the consumption story.
In the December quarter, the Indian packaged consumer goods sector logged a sales growth of 10.5% over the year-ago quarter. Take the market leader, Hindustan Unilever Ltd (HUL), whose sales rose by 9.4% while volume rose by a measly 4%. Another heavyweight, ITC Ltd, saw its sales rise by 13.1% but volume in its cigarettes business declined because of a series of price hikes.
There were some exceptions to this low volume growth phenomenon. One was oral care firm Colgate-Palmolive (India) Ltd, whose volumes rose by 10%, and another was Dabur Ltd, whose volumes rose by 9.2%. Companies such as HUL and Nestle India Ltd are keeping an eye on profitability and the resulting price hikes—chiefly to take care of inflation—could be affecting volume growth.
That’s the reason why the sector’s operating profit margins held up in the December quarter, compared with a year ago, though there was a slight decline compared with the September quarter. Though its operating profit rose by only 11%, an increase in other income helped net profit increase by a more respectable 16.6%.
The outlook for the sector depends on some of the crucial factors that have influenced its performance so far. The macroeconomic situation, of course, is the most important one as a combination of high inflation and low economic growth has hurt consumption. Non-food inflation is showing some signs of easing, which is a positive, though food inflation remains high. The economy is not showing any signs of a revival, barring the agricultural sector.
That’s why the rural market has proved to be a saviour. Most companies had expanded their distribution networks in rural areas, an investment that has proved worthwhile. This growth is expected to continue as higher output due to good rains and better realizations due to higher support prices will see the rural market outpace their urban counterparts. Rural volume growth, too, has fallen—due to inflation and perhaps also the effect of low economic growth on remittances from migrant labour—but is still healthier than in the urban areas.
FERTILIZERS
Better crop sowing and the subsequent improvement in demand helped the fertilizer industry arrest the fall in volumes. Compared with a 9% drop in the year-ago period, volumes fell by only 1% in the December 2013 quarter. High inventories, which have been weighing on sales, continued to recede. From 7 million tonnes (mt) in March 2013, industry inventories halved to 3.2-3.5 mt in December, analysts say.
According to Edelweiss Securities Ltd, Coromandel International Ltd expects the excess inventories to get back to normal by March 2014. Trends at the industry-level are encouraging. The financial performance of individual companies, however, is nothing to write home about.
Low international rates weighed on domestic fertilizer prices. To push sales and liquidate inventories, companies such as Coromandel and Gujarat State Fertilizers and Chemicals Ltd (GSFC) offered discounts. Coromandel even wrote down inventories. The steps helped them report decent sales. But low realizations meant that the companies’ financial performance was adversely affected. Margins and operating profits of both the companies were lower than analysts’ expectations.
Chambal Fertilisers and Chemicals Ltd and Deepak Fertilisers and Petrochemicals Corp. Ltd (DFPCL), on the other hand, reported better-than-expected earnings. Performance at these companies, though, is not driven by manufactured fertilizer businesses. Due to low import parity prices and uncertainty over government pricing policy (beyond the cut-off level) Chambal ran its fertilizer plants at sub-optimal levels. This weighed on urea volumes. But, thanks to low prices in international markets, the company was able to source agriculture inputs cheaper and increase its trading segment’s operating profit by a strong 15%. The healthy showing helped Chambal overcome subdued performance by the urea segment. Similarly, Deepak Fertilisers got a boost from chemicals and trading divisions.
Overall, the manufactured fertilizer business, which is the core business activity for most companies, did not perform well at most companies. Some benefited from a resurgent trading business. But the challenges staring at the fertilizer divisions are making analysts wary about the companies and stocks. Fearing a rise in raw material costs and the threat of cheap imports, two broking firms lowered their earnings estimates for Coromandel. Emkay Global Financial Services Ltd lowered its revenue and earnings before interest, taxes, depreciation and amortization (Ebitda) estimates for GSFC, citing margin pressures. Chambal and Deepak Fertilisers, which performed well, did not get earnings upgrades.
Apart from the weak margin outlook for the core fertilizer business, what is bothering analysts are the continued delays in subsidy payments. The delays are creating liquidity problems and driving up interest costs. While the government is yet to announce steps to mitigate the impact of higher gas prices, the plethora of negatives are clouding the fertilizer stocks outlook.
INFRASTRUCTURE
Save for a marginal improvement in order inflows, the December quarter had nothing to cheer for infrastructure firms—neither for construction companies nor for firms making capital goods. Stable execution prevented revenue from falling. But profitability across firms took a beating on account of poor operating leverage and rising costs.
The bane of the sector has been the spiralling interest cost that eats into profit. Data analysis of around 52 large- and medium-sized construction firms shows that the interest charge has spiralled from 5.5% of sales to about 14.3% even as the interest cover ratio declined to less than 1 over the last 12 quarters, showing the operating profit is not even sufficient to cover interest charges. These firms have seen a steady contraction in net profit. Nevertheless, well-managed roads and airport projects of GMR Infrastructure Ltd, IRB Infrastructures Ltd and IL&FS Transportation Networks Ltd clocked growth in revenue and profit margins.
The picture was equally gloomy for capital goods manufacturers. Barring gains from exports in the case of multinational companies, which outsource products from Indian operations, most domestic firms among the boiler-turbine-generator makers had hardly any positives to report for the December quarter. Siemens Ltd, Cummins India Ltd and Thermax India Ltd posted a significant drop in operating profit. Bharat Heavy Electricals Ltd’s (Bhel’s) fall in operating profit was the steepest at 40% from the year-ago period. A divergent trend in terms of a 21% rise in operating profit was seen in Larsen and Toubro Ltd, although the management revised the order inflow guidance for fiscal 2014, given that the pre-election phase will put the investment cycle into limbo.
A weak operating performance was compounded by high interest costs that dragged net profit down. Yet, given the few positive policy decisions taken in the last one year on restarting projects stuck due to policy issues, such as fuel scarcity for power projects, the BSE capital goods index outperformed the BSE Sensex in the last three months. The rally is on the fond hope that things could get better. But a recent report by India Ratings and Research Pvt. Ltd points out that in spite of a pick-up in investment activity, expected after the elections, the system would have to “work itself through numerous excesses of the past, including aggressive bidding, weak and inexperienced sponsors, poor project planning, high leverage, weak financial structures and revenue over-estimation.”
Besides, from an investors’ standpoint, the companies’ financials leave much to be desired. Return on equity and return on capital employed are down to low single-digits for both the construction and capital goods sectors. Sticky interest rates add to their woes. While the sector might have hit the bottom of the cycle, the recovery is still not in sight.
INFORMATION TECHNOLOGY
The National Stock Exchange’s CNX IT index has outperformed the broader market since the beginning of the results season in mid-January. With sectors dependent on the domestic economy showing increasing signs of weakness, it isn’t surprising that investors are taking refuge in stocks of exporters.
Having said that, the December quarter results of top-tier information technology (IT) companies didn’t provide much reason for cheer. So it makes sense for investors to proceed with some caution.
Among the large companies, only HCL Technologies Ltd beat street estimates of revenue growth convincingly. Tata Consultancy Services Ltd (TCS) reported sequential revenue growth of 3.03%, lower than estimates of about 3.6-3.8%. While Infosys Ltd and Wipro Ltd beat consensus estimates marginally, their growth continues to be rather low. On a year-on-year basis, Infosys’s revenue grew by only 9.9%. Adjusted for the Lodestone AG acquisition, which was effective only from 1 November 2013, growth was even lower. While it’s true that the December quarter has traditionally been weak owing to furloughs in certain industries and holidays, these factors had been built into the estimates.
Another worrying sign was that employee hiring was particularly subdued. While TCS added 5,500 employees, HCL Technologies added only around 1,100; Infosys and Wipro reported a surprise drop in employee count. This is in contrast with the commentary of these companies—all of them said that demand is picking up and that IT budgets of clients are expected to moderately rise in 2014, compared with a flattish trend in the past few years.
Interestingly, shares of TCS have underperformed since the beginning of the results season; relative to Infosys shares, they have underperformed by about 10%. This is largely because of the huge difference in the respective valuations of the two companies, coupled with the fact that TCS missed revenue growth estimates by a tad.
Among the positives, most companies reported a decent increase in operating margin, although in some cases, this was led by cuts in selling and marketing expenses. Besides, the increase in revenue was broad-based, with nearly all industries and geographies contributing. Early in February, Cognizant Technology Services Corp. also reported muted growth in the December quarter, and its guidance indicated a growth of 15.9% in organic revenue in 2014—almost the same as its growth guidance for 2013. This poses some question marks about the assertion of some other companies that growth is expected to pick up in the next financial year.
METALS
The December quarter was a tough one for the metals industry. Fears of a global economic slowdown, particularly in China, kept prices in check. The domestic market’s problems continued as a slowing investment environment and poor sentiment in the real estate and automobile market affected demand. Thus, it was no surprise that the industry’s sales rose by only 4% sequentially, compared with the 8.6% growth seen in the September quarter.
But the bright spot in their results was that margins improved, despite low sales growth and very little support from realizations. The main reason was that the cost of goods sold as a percentage of sales declined and fell by 0.4%. Companies have benefited from lower costs of imported inputs such as coal. Companies cut their power and employee costs, too. The result was that the sector’s operating profit margin improved by 1.7 percentage points to 18.3% on a sequential basis.
Among steel companies, JSW Steel Ltd did well, aided by higher exports with both sales and operating profit? growing ahead of its peers such as Tata Steel Ltd and Steel Authority of India Ltd. Tata Steel’s Europe operations did well during the quarter but its domestic business was under pressure. In the non-ferrous sector, realizations were flat but volumes improved due to capacity additions; here as well, margins have improved.
The December quarter’s performance does not give an impression of a sector in distress. A relatively stable trend in prices and a benign raw material situation get some credit for that. Most firms are implementing projects that have seen capacity increase and this will continue.
Growing capacity at a time of dull demand conditions in the domestic market will force firms to sell in the international market. That is a less profitable proposition compared with selling in the domestic market.
The real turning point for the metals sector will come when user demand from the automobile and real estate sectors picks up. When this will happen is not certain, but it is likely to precede a pick-up in capital investments. Large projects in the industrial and infrastructure segments consume large quantities of metal.
The capacities that are in the pipeline have all been set up with an eye on the domestic market’s demand potential. Firms will be waiting for the market to recover so that they can earn adequate returns on these projects. But that is in the longer run. In the near term, however, some headwinds are developing.
Non-ferrous metal prices on the London Metral Exchange (LME) have fallen since January and Chinese imported iron ore prices have declined by 9.3%. Those are all signals of a weakening market environment.
OIL
Indian oil companies’ December quarter financial results were no reason for celebration. Sure, Oil and Natural Gas Corp. Ltd (ONGC) reported a 28% year-on-year (y-o-y) increase in its net profit. But the state-run explorer’s profit got a big boost from one-time items, adjusting for which profit growth would have been far from impressive. Oil India Ltd’s (OIL) results weren’t very inspiring either, with the company reporting a 4% y-o-y decline in its net profit on account of a decline in other income and higher finance cost.
On the other hand, refining companies—Reliance Industries Ltd (RIL) and Essar Oil Ltd—delivered a good gross refining margin (GRM), the weighted average price of refined products less the price of crude oil, generally expressed in terms of per barrel of crude, in the December quarter.
That offers comfort, especially since the refining operating environment was weak in the last quarter. But profits of both these companies were affected on account of other reasons as well.
RIL’s net profit was better than Street expectations thanks to strong other income and better performance of its exploration and production (E&P) business, which reported its best performance in the last four quarters. RIL’s petrochemicals business performance was discouraging as spreads remained weak in some categories. Poor domestic demand for polymers and polyester affected the petrochemical segment’s earnings.
On the other hand, Essar Oil’s net profit was adversely affected due to its huge interest burden. Sure, its finance costs declined by 8% on a y-o-y basis, yet they remain very high as a percentage of operating profit, which, for the December quarter, was at 97.6%. Essar Oil’s operating profit declined due to costs growing at a relatively faster pace.
Meanwhile, oil marketing companies (OMCs)—Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd—posted net losses in the December quarter. The profitability of OMCs depends on the compensation they receive from the government and state-run upstream oil companies. Commenting on the results, Emkay Global Financial Services Ltd wrote in a note, “Q3FY14 results were in loss, mainly due to lower compensation from the government. Moreover, GRM also came in lower on a q-o-q (quarter-on-quarter) basis on the back of weak product spreads ($1.7 a barrel-$4.6 a barrel).”
Most of the above stocks trade at attractive valuations. Unfortunately, signs of a sharp appreciation from current levels are few and far between.
“In event of a likely diesel deregulation in 12-18 months, and notification of a domestic gas price hike in coming weeks, we prefer ONGC/OIL in upstream (significant earnings growth opportunity) and BPCL in OMC’s (strong balance sheet and E&P potential),” said Motilal Oswal Securities Ltd in its earnings review.
PHARMACEUTICALS
The US pharmaceutical market continues to be the main source of growth for Indian generic pharmaceutical companies. And that is likely to continue in the March quarter and in fiscal 2014-15 as well. But the domestic market was a source of pain as sales growth slowed. The situation is expected to improve from the current quarter onwards.
Most companies reported splendid sales growth from their US generics business in the December quarter and the size of this business ensured that it made up for slower growth in the home market. But companies dependent on the Indian market, such as the Indian subsidiaries of multinationals, did not have a very good quarter. The sector’s net sales rose by 19.2% over the year-ago quarter, while its operating profit rose 41.4% due to the higher proportion of US generic sales.
Large Indian companies such as Dr Reddy’s Laboratories Ltd, Sun Pharmaceutical Industries Ltd and Lupin Ltd are launching new products in the US market, and that is adding to the already growing base revenue in that market. Ranbaxy Laboratories Ltd and Wockhardt Ltd had a poor quarter due to their ongoing issues with the US Food and Drug Administration on compliance issues.
The domestic market’s sales growth was hit by the new drug pricing policy’s impact on realizations of newly covered products. But the bigger issue was that trade channels—those who distribute medicines to shops—refused to pick up stocks due to a lowering of commissions. Their move affected companies that are focused on the domestic market. GlaxoSmithKline Pharmaceuticals Ltd, for example, saw its sales decline by 4%. But the current quarter should see an improvement. The commission issue appears to have been resolved and sales have resumed.
Companies continue to pour larger sums into research, to develop generic alternatives of niche or complex drugs. Their quest is to have a pipeline of launches that can make up for a tapering of sales in the generic portfolio as competition expands. Higher research and development expenses did not hurt margins, thanks to the US market’s contribution to sales and profits. The pharmaceutical industry is expected to continue to benefit from high sales growth in the US market. That also makes it dependent on that market and vulnerable to risk if it stumbles in the US market for any reason.
POWER
Except NTPC Ltd, no major electricity generator did well in the December quarter. Due to low demand, state-owned NTPC produced less electricity. But the plant availability factor (PAF), based on which incentives are calculated, rose from 88% a year ago to 95% in the last quarter. PAF is a measure of the ability of a power plant to perform its operational function. Higher availability boosted the return on equity ratio (RoE) and helped NTPC generate a better-than-expected profit. What’s more, brokerages were enthused by encouraging management commentary about fuel supplies as they can help keep PAFs at elevated levels. The sanguine views, however, did not help to the stock. Analysts have cut their earnings estimates after the Central Electricity Regulatory Commission reduced financial incentives for the firm.
Private electricity generators, meanwhile, continued to struggle. Tata Power Co. Ltd generated 17% less power. Generation was hit by the lack of affordable fuel. Realizations at the coal companies were low and the so-called ultra mega power project (UMPP) in Mundra, Gujarat, continued to reel under losses. With all units of the Mundra UMPP commissioned, it is critical that the firm receives a favourable tariff order. Low realizations at the UMPP are weighing on the company. UMPPs are ambitious power projects capable of generating 4,000 megawatts (MW) or more of power.
Reliance Power Ltd maintained its profit at the previous year’s level, despite a 6% fall in revenue. A strong showing by the Rosa power plant in Uttar Pradesh helped the firm. Adani Power Ltd and JSW Energy Ltd, on the other hand, continued their bad run. New capacities helped increase Adani Power’s sales. But dependence on high-cost fuel meant the firm was forced to report losses for the ninth consecutive quarter. JSW Energy was also hurt by high fuel costs. With input cost pressures showing no signs of easing, analysts warned about earnings downgrades for Adani and JSW Energy.
Hydro-electricity generator NHPC Ltd also reported muted performance. Its performance was affected by generation losses. According to Prabhudas Lilladher Pvt. Ltd, availability (the PAF) of Uri-II and Chutak plants remained low due to a lack of transmission facilities.
Overall, except NTPC, no company did exceptionally well in the December quarter. For performance to improve, broadly two things have to fall in line. One is to let firms recover costs. The electricity regulator has allowed Tata Power and Adani Power to charge extra for fuel cost rise at their Mundra plants. While the decision will help them reduce losses, many companies are seeking similar orders—be it passing of costs or changes in power purchase agreements.
The second is an improvement in demand, production. Despite a 4% increase in electricity generation, the plant load factor—a measure of capacity utilization—at Indian power plants, on an average, fell by five percentage points to 65% in December quarter. True, new capacities have come on stream. But a 3% fall in demand means that consumption is weak.
Restructuring of the state electricity boards and the coming general election are expected to increase demand. But the election season and populist tendencies of political parties mean analysts are sounding cautious. “Within the power sector, the issues related to the power generation firms will need a lot more policy support to ease the pain,” Sharekhan Ltd wrote in a note, adding that populist moves to cut power tariffs keeping the elections in mind would stall the recovery process in the sector. “Consequently, we continue to recommend a very selective approach,” it said.
RETAIL
Diwali wasn’t lit up for retail companies this time around. Consumers generally tend to loosen their purse strings during the December quarter (which includes festivals) and indulge in purchases. However, the financial results of retail companies: Shoppers Stop Ltd, Titan Co. Ltd and Future Retail Ltd show that the last quarter was unusually different and disappointing. Clearly, the impact of slowing economic growth and weak consumer demand is telling on the numbers. Same store sales (SSS) growth—a measure of sales at stores that have been open for at least a year—has been far from impressive and volumes have been tumbling.
Take Titan for instance—both the jewellery and watch segments saw a decline in sales volumes. It’s very discouraging that the company’s jewellery business, which accounts for around four-fifths of Titan’s total revenue, saw a revenue decline for the first time in at least the last 11 quarters.
According to the company’s presentation, its jewellery revenue in the December quarter declined by 15% on a year-on-year basis. Reasons include weak demand, lower gold coin sales and declining volumes.
Sure, the watch business revenue increased, but that was mainly on account of price increases and the launch of new collections.
However, since the watch segment contribution is small, Titan’s overall results remained weak.
Shoppers Stop saw a 1% decline in its like-to-like (LTL) sales volumes indicating that overall LTL growth was mainly driven by pricing last quarter. The company’s LTL growth stood at 5.5%, slower than the double-digit growth seen in the first two quarters of the financial year.
Investors must note though that the previous year’s December quarter had a higher base. Even so, Shoppers Stop’s consolidated profit performance continues to be plagued by the weakness in its subsidiary, HyperCity. Improvement in HyperCity’s financial health is an important measure to keep a tab on this stock.
Future Retail’s numbers, too, were subdued. The company’s SSS growth for the December quarter slowed, compared with the previous two quarters, in both value and home retailing segments.
Moreover, the high debt on the books and the resultant interest costs are a major concern for Future Retail.
For the December quarter, the company’s finance cost stood at Rs.149 crore, compared with earnings before interest and taxes of Rs.151 crore.
After a very lacklustre festival quarter, it’s important that consumer sentiment improves and drives sales growth. Unless shareholders see substantial progress on that front, investors are likely to be cautious on the three stocks. The simple conclusion, therefore, is that if these stocks have to be fashionable, shopping has to be in vogue again.
TELCOS
Since mid-January, shares of Idea Cellular Ltd and Bharti Airtel Ltd have fallen by 23% and 13%, respectively. But this has little to do with the December quarter results announced during this period; the shares fell owing to overbidding in a recent auction of spectrum. Even so, the financial results for the previous quarter weren’t great.
Growth in volumes and wireless revenue were lower than Street estimates. Bharti reported a 2.6% sequential growth, while Idea’s growth stood at 4.6%; in comparison, Street estimates hovered around 4% and 5.5%, respectively. Also, year-on-year growth in volumes has trended down in the past three quarters. (See chart).
Year-on-year growth in wireless revenue, however, was healthy, owing to the steady increase in tariffs in the past year. But the moot question is if the hike in tariffs is affecting volume growth. Analysts at Kotak Institutional Equities wrote in a 7 February note to clients, “The underlying reason for weak volume growth is critical to understand. At this point, it is too early to say whether the weak volumes reflect usage elasticity (effective tariffs have gone up 10-12% over the past one year) or are just a reflection of the general slowdown in the economy. We do expect the companies to go a tad slow on voice RPM (revenue per minute) uptick target for some time to assess the situation carefully. We are not unduly worried on this front, however.”
Of course, the situation is far better than a few years ago, when tariff hikes had backfired and volumes fell for operators who weren’t flexible with pricing.
Also, according to Bharti’s management, high inflation is taking a toll on usage by customers. Average minutes of use have fallen by almost 5% in the past three quarters for Bharti.
Among positive signs, data revenue continued to grow at a fast pace—it doubled for both Bharti and Idea. Thus far, the growth in 3G data hasn’t affected growth in the older 2G data segment.
Coming back to the stocks, investors are clearly worried about the high prices incumbent telecom operators paid in the recent auction. This has ramifications for future licence renewals as well. If data revenue continues to grow at the current rate, the investments may make sense; else, operators will have little choice but to raise tariffs. Considering that there are some question marks already on demand elasticity, raising tariffs will be easier said than done.
The silver lining, of course, is that telecom stocks already seem to reflect these bleak scenarios.
In other words, the stocks seem to have reached a bottom, unless of course Mukesh Ambani’s Reliance Jio Infocomm Ltd springs a nasty surprise when it launches operations.