Sharekhan Special October 10, 2016 1 Sharekhan Special Q2FY2017 earnings preview Visit us at www.sharekhan.com October 10, 2016 Q2FY2017 to be another weak quarter: The headline growth figures for the Sensex companies do not inspire much confidence in Q2FY2017 also. The aggregate net profit of the Sensex companies is likely to remain flat in the quarter despite a mid-single digit growth in the revenue and a margin expansion of close to 50 basis points as compared with the corresponding quarter of the last year. However, excluding the financials, the growth in the Sensex companies would stand at 3.5% in Q2FY2017. Banking, technology and metal lag; auto, FMCG and pharma to post a healthy performance: In terms of sector-wise performance, the earnings growth is likely to be pulled down by the usual suspects, ie the information technology (IT) services companies (weak demand resulted in a weak performance in a seasonally strong quarter), banks (ICICI Bank, Axis Bank and State Bank of India [SBI] to show a decline in the net profit) and metals (Tata Steel, largely due to foreign exchange [forex] impact and weak demand). On the other hand, auto companies continue to race ahead while the fortunes have turned for the pharmaceutical (pharma) sector. The consumer staples space is likely to sustain its high double-digit growth rate in Q2 also. Outlook Turn-around to be driven by cyclicals: Notwithstanding the weak results in the first two quarters of FY2017, the Street is still factoring in a healthy double-digit earnings growth in the aggregate profit of the Sensex companies which implies a strong recovery in the earnings growth in the second half of the fiscal. The biggest turn-around in the earnings growth trajectory is expected to be driven by banks (due to a low base owing to the balance Q2FY2017 earnings preview Weakness to continue in Q2 also but earnings growth set to turn around in the coming quarters sheet cleaning exercise triggered in Q3 last year and a possible bottoming of the asset quality issues in H1 this year) and global commodity-driven metal and energy companies (again due to a lower base and some upsurge in commodity prices lately). More importantly, the benefits of a good monsoon-driven record agricultural output and salary hikes for the government employees would get reflected in the second half of this year. Valuation The Sensex trades at a price/earnings (PE) multiple of close to 16.5-17.0x on a one-year forward basis which is at a premium to its historic multiple. However, this needs to be seen in the context of extremely low interest rates globally and falling interest rates and bond yields in India. Normally, lower interest rates tend to expand the PE multiple, though the growth in the earnings remains the key re-rating driver for the equity market. Thus, a revival in the earnings growth remains a critical factor for the sustainability of the rally in Indian equities. Sensex’ one-year forward P/E band Source: Bloomberg, Sharekhan Research 7.0 10.0 13.0 16.0 19.0 22.0 25.0 Oct-08 Oct-10 Oct-12 Oct-14 Oct-16 +1 sd PER Avg PER -1 sd
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Sharekhan Special October 10, 20161
Sharekhan Special Q2FY2017 earnings preview
Visit us at www.sharekhan.com October 10, 2016
Q2FY2017 to be another weak quarter: The headline growth figures for the Sensex companies do not inspire much confidence in Q2FY2017 also. The aggregate net profit of the Sensex companies is likely to remain flat in the quarter despite a mid-single digit growth in the revenue and a margin expansion of close to 50 basis points as compared with the corresponding quarter of the last year. However, excluding the financials, the growth in the Sensex companies would stand at 3.5% in Q2FY2017.
Banking, technology and metal lag; auto, FMCG and pharma to post a healthy performance: In terms of sector-wise performance, the earnings growth is likely to be pulled down by the usual suspects, ie the information technology (IT) services companies (weak demand resulted in a weak performance in a seasonally strong quarter), banks (ICICI Bank, Axis Bank and State Bank of India [SBI] to show a decline in the net profit) and metals (Tata Steel, largely due to foreign exchange [forex] impact and weak demand). On the other hand, auto companies continue to race ahead while the fortunes have turned for the pharmaceutical (pharma) sector. The consumer staples space is likely to sustain its high double-digit growth rate in Q2 also.
Outlook
Turn-around to be driven by cyclicals: Notwithstanding the weak results in the first two quarters of FY2017, the Street is still factoring in a healthy double-digit earnings growth in the aggregate profit of the Sensex companies which implies a strong recovery in the earnings growth in the second half of the fiscal. The biggest turn-around in the earnings growth trajectory is expected to be driven by banks (due to a low base owing to the balance
Q2FY2017 earnings previewWeakness to continue in Q2 also but earnings growth set to turn around in the coming quarters
sheet cleaning exercise triggered in Q3 last year and a possible bottoming of the asset quality issues in H1 this year) and global commodity-driven metal and energy companies (again due to a lower base and some upsurge in commodity prices lately). More importantly, the benefits of a good monsoon-driven record agricultural output and salary hikes for the government employees would get reflected in the second half of this year.
Valuation
The Sensex trades at a price/earnings (PE) multiple of close to 16.5-17.0x on a one-year forward basis which is at a premium to its historic multiple. However, this needs to be seen in the context of extremely low interest rates globally and falling interest rates and bond yields in India. Normally, lower interest rates tend to expand the PE multiple, though the growth in the earnings remains the key re-rating driver for the equity market. Thus, a revival in the earnings growth remains a critical factor for the sustainability of the rally in Indian equities.
Sensex’ one-year forward P/E band
Source: Bloomberg, Sharekhan Research
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Sharekhan Special October 10, 20162
Sharekhan Special Q2FY2017 earnings preview
Estimated PAT growth by sector (%) Estimated sector-wise contribution to Sensex’ earnings growth (%)
Source: Bloomberg, Sharekhan Research Source: Bloomberg, Sharekhan Research
HDFC Bank, Capital First, LIC Housing Finance,Bajaj Finance Bank of India, IDBI Bank, Allahabad Bank
V-Guard, Finolex Cables, RIL Thermax, Va tech Wabag
Infosys, HCL Tech, Zee Entertainment Wipro, Inox Leisure
Maruti Suzuki, TVS Motors Bajaj Auto , Ashok Leyland
13.5 11.79.2 8.6 8.4 7.3
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FY17 EPS Estimate FY18 EPS Estimate
Sharekhan Special October 10, 20163
Sharekhan Special Q2FY2017 earnings preview
AutoVolume growth to drive earnings
Q2FY2017 result expectations
Improved rural sentiment coupled with the onset of the festive season to lead to a double-digit top line growth: Sharekhan’s automobile universe (ex Tata Motors [TAMO]) is expected to register a healthy double-digit top line growth of 14% year on year (YoY) driven mainly by a volume growth. Improved rural sentiment on the back of a normal monsoon and improved demand ahead of the upcoming festive season has led to a healthy volume growth in the automotive segment (ex medium and heavy commercial vehicles [MHCVs]). Maruti Suzuki India and Eicher Motors are expected to lead the space with a growth of 31% and 35% YoY. Ashok Leyland (due to declining MHCV volumes) and Bajaj Auto (due to a dip in the export volumes) are expected to post a drop in the top line. In the auto ancilliary space, Exide Industries and Suprajit Engineering are expected to outperform, growing by 18% and 15% respectively, on the back of better demand traction from the end-users. Bharat Forge (due to weak export demand) and Jamna Auto Industries (due to declining sales of MHCV original equipment) are likely to underperform reporting a 7% top line dip.
Increasing raw material prices and input pressures to lead to a marginal dip in the OPM: The operating profit margin (OPM) of Sharekhan’s automobile universe (ex TAMO) is expected to decline by 60 basis points (BPS) YoY to 15.4% for the quarter. The firming up of the prices of raw materials (especially steel) is likely to affect the profitability of the auto companies. Further, increased marketing expenses (due to increased competition and the onset of festive season) would also drag the profitability. Amongst the auto companies Eicher Motors, Exide Industries and Suprajit Engineering are expected to report a remarkable improvement in the operating profit margin (OPM; up 300BPS, 100BPS and 100BPS YoY respectively) while Maruti Suzuki India and Bajaj Auto could report a decline in their OPM by 180BPS and 80BPS YoY respectively. The hardening natural rubber prices are expected to adversely affect the margins of the tyre players including Apollo Tyres, Ceat and Balkrishna Industries whose margins would contract by 200BPS, 230BPS and 280BPS YoY respectively. Tracking the top line growth and margin performance the adjusted profit after tax (PAT) of the auto universe (ex TAMO) is expected to grow by 14% YoY.
Outlook
The south-west monsoon for 2016 was well spread out and normal (a 3% deficiency observed) after two consecutive years of drought. This has led to a positive rub-off effect on the automobile demand, especially from the rural areas (an uptick was witnessed in two-wheeler and passenger vehicle sales). In addition to the improved rural sentiment, the hike in the salaries of the government employees based on the recommendation of the Seventh Pay Commission and the upcoming festive season are expected to maintain the growth momentum in the passenger vehicle and two-wheeler sales. We expect the two-wheeler sales to grow by 15% in FY2017 while the passenger vehicle segment is expected to grow by 8% to 10% in FY2017. The MHCV segment, though has reported weak sales for the quarter, is expected to pick up in H2FY2017 on the back of an improved demand for transportation of agri-products and a pre-buying ahead of the new emission norms kicking in from April 1, 2017.
Valuation
In the automotive universe, we prefer Mahindra and Mahindra (M&M) as it is a pure rural play and would be the key beneficiary of the impending uptick in rural demand due to a good monsoon. We also prefer Maruti Suzuki India, as it would outpace the passenger vehicle industry in growth on the back of a robust demand for its newly launched products. We also like Ashok Leyland, as it is a pure commercial vehicle (CV) play and would benefit from a strong demand for CVs. In the auto ancillary space we prefer Rico Auto Industries (due to an increasing customer penetration and margin improvement) and Gabriel India due to a strong traction in the two-wheeler volumes.
Preferred picks for the earning season: Maruti Suzuki, TVS Motors and Rico Auto Industries
Sharekhan Special October 10, 20164
Sharekhan Special Q2FY2017 earnings preview
Q2FY2017 estimates of Sharekhan’s auto universe
ParticularsSales (Rs Cr) EBITDA margins (%) PAT (Rs Cr)
Incremental slippages expected to be lower: Coming after couple of challenging quarters, when asset quality pressures increased sharply, Q2FY2017 will be a significant quarter, as overall performance of the banks is likely to improve a tad (relatively speaking). Lower intensity in incremental stressed assets [due to the RBI’s Asset Quality Review (AQR) and conservative internal assessment] is expected to have frontloaded NPL formation. As a result, we expect a decline in slippage run-rate compared to the previous quarters, although the same is expected to remain above normal.
Subdued credit growth; Retail only bright spot: As per the latest RBI data, non-food credit growth remained at sub-10% levels, owing to weak corporate demand and feeble capex revival. However, the retail loan book has shown good traction with a growth of ~18%. Retail loan segment growth has been driven by Housing, Vehicle Loans, Consumer Durable Financing and Personal Loans. We expect State Bank of India (SBI) and Bank of Baroda (BOB) to perform relatively better in the PSB space while private banks like HDFC Bank, Yes Bank and IndusInd Bank are expected to show better results. Few private sector banks like Axis Bank and ICICI Bank (having considerable exposure to Corporates & Project Loans) could end up reporting weak a performance during the quarter.
Comfortable liquidity, softening interest rate cycle indicate stable margins: Q2FY2017 witnessed adequate liquidity position, with the RBI taking a liquidity-neutral stance. During the quarter, most banks have not made any significant cut in their base rates while the deposit rates have declined, which is a margin accretive situation. Also, the quantum of interest rate reversals (as a result of high slippages) in Q1 & Q4 should see relatively lesser impact. However, a weak growth in high-yielding Corporate Loan book and a tilt towards Retail Lending (especially Home Loans) could impact overall yields. Therefore, we expect Net Interest Margins (NIM) to remain stable during Q2FY2017, as these factors will largely cancel each other out.
Non-interest income could be boosted by treasury gains: Indian bond yields have declined by ~60BPS during the quarter, which potentially allows banks to book profit. Since the RBI has conducted several OMOs (Open Market Operations) during the quarter, banks had the option to book profit on HTM category investment portfolio as well. We believe that banks may choose to utilise treasury profits to offset higher NPL and general provisions to augment their balance sheets. At the same time, we expect the fee income growth to remain tepid, as the Corporate Loan segment continues to struggle. The retail fee sub-segment should report a healthy uptick. Notably, ICICI Bank could see a sharp rise in Other Income due to stake sale in its insurance subsidiaries, which it could use to cover up its stressed book.
NBFC sector expected to benefit from softening rates, credit demand: We expect NBFCs (especially consumption / retail focused ones) to post strong Q2FY2017 results, aided by strong loan demand and improving scale / efficiency benefits. Decline in wholesale lending rates, which leads to cheaper Cost of Funds (CoF), is another positive for NBFCs. We expect strong traction in Consumer Durables, Home Loans, LAP, SME and MFI segments. As a result, NBFCs like Bajaj Finance, Capital First and LIC Housing Finance are expected to report strong Q2FY2017 results.
Outlook
We expect the quarter to be an important indicator on the extent of bad loan problem left in the system. Also, Q2FY2017 is expected to be a mixed bag, as the Corporate Loan segment continues to struggle although the Retail segment is expected to show better traction. We expect loan book growth to pick up from H2FY2017, with improving economic scenario, improvement in rural demand (due to good monsoon) and consumption driven growth from urban areas ( helped by implementation of 7th Central Pay Commission payouts and OROP).
Valuation
We find that valuations for PSBs have improved, as investors have started building in the end of the correction phase. We also believe that differentiated/well run PSBs like SBI and BOB will eventually gain market share at the expense of other PSBs and may justify a premium pricing. At the current levels, select NBFCs like LIC Housing Finance and Capital First are available at a discount to their peers and have attractive business model.
Preferred picks: HDFC Bank, Yes Bank, IndusInd Bank, Capital First and LIC Housing Finance
Earnings outperformers in Q2FY2017: HDFC Bank, Capital First, LIC Housing Finance and Bajaj Finance
Earnings laggards in Q2FY2017: Bank of India, IDBI Bank and Allahabad Bank
Banking and NBFCPace of slippage addition expected to moderate, treasury income to aid earnings
PublicState Bank of India Buy 315 258 0.5 0.5 0.5 7.3 8.0 9.0 1.5 1.4 1.3Punjab National Bank Hold UR 143 -0.6 0.2 0.3 -10.3 4.2 5.7 0.8 0.8 0.7Bank of Baroda Buy 180 164 -0.8 0.3 0.3 -13.5 5.4 5.6 1.0 1.0 0.9Bank of India Hold 130 117 -1.0 0.1 0.2 -19.1 1.8 3.4 0.3 0.3 0.3Union Bank Hold 150 149 0.3 0.3 0.5 6.3 5.8 9.5 0.5 0.5 0.4Corporation Bank Reduce 30 43 -0.2 0.1 0.0 -4.6 1.6 0.0 0.4 0.4 0.4Allahabad Bank Hold 83 78 -0.3 0.3 0.3 -5.4 4.9 5.4 0.3 0.3 0.3IDBI Bank Hold UR 72 -1.0 0.2 0.3 -14.1 2.9 4.3 0.7 0.7 0.6PSBs total / avg. -0.3 0.3 0.3 -5.4 4.5 5.5 0.7 0.6 0.6PrivateICICI Bank Hold 290 251 1.4 1.6 1.7 11.4 12.6 14.2 1.7 1.5 1.4HDFC Bank Buy 1,415 1,281 1.9 1.9 1.9 18.3 19.1 20.1 4.5 3.9 3.3Axis Bank Hold 575 533 1.7 1.6 1.6 16.8 15.6 16.3 2.4 2.1 1.8Federal Bank Buy UR 73 0.5 0.7 0.9 6.0 9.4 11.5 3.2 1.5 1.3Yes Bank Buy 1,386 1,275 1.7 1.8 1.9 19.9 20.9 22.6 3.9 3.3 2.8Private banks total / avg. 1.4 1.5 1.6 14.5 15.5 16.9 3.1 2.4 2.1Grand total / avg. 0.6 0.9 0.9 4.6 10.0 11.2 1.9 1.5 1.4Soft CoverageIndusind Bank Positive NA 1.6 1.8 1.9 16.1 16.7 17.6 4.2 3.7 3.1L&T Finance Holding Positive NA 1.5 1.5 1.6 10.6 11.8 13.0 2.3 2.1 1.8NBFCsHDFC Ltd Buy 1,550 1,406 2.6 2.5 2.4 21.7 21.2 21.1 6.5 5.8 5.1LIC Housing Finance Buy 660 602 1.5 1.6 1.6 19.6 20.6 21.3 3.3 2.8 2.4Capital First Buy 840 742 1.3 1.5 1.6 10.1 13.2 16.7 4.0 3.5 3.1Bajaj Finance Buy 1,120 1,083 3.2 3.3 3.3 20.9 21.3 24.1 7.8 6.5 5.2PTC India Fin. Ser. Buy 55 39 5.0 3.2 3.2 24.6 18.0 20.3 1.3 1.1 1.0NBFCs Average 2.7 2.4 2.4 19.4 18.9 20.7 4.6 3.9 3.4UR - Under review
BanksNet interest income Pre-provisioning profit Profit after tax
Q2 FY17E
Q2 FY16
YoY %
QoQ %
Q2 FY17E
Q2 FY16
YoY %
QoQ %
Q2 FY17E
Q2 FY16
YoY %
QoQ %
PublicState Bank of India 14,618.4 14,252.6 2.6 2.1 10,591.1 10,265.9 3.2 -4.2 2,419.7 3,879.1 -37.6 -4.0Punjab National Bank 4,107.6 4,322.0 -5.0 11.0 2,837.1 2,938.5 -3.5 -13.4 422.7 621.0 -31.9 38.0Bank of Baroda* 3,475.6 3,244.5 7.1 3.1 2,779.7 2,337.0 18.9 4.1 559.8 124.5 349.7 32.1Bank of India 2,980.3 3,019.7 -1.3 7.4 1,337.6 1,458.3 -8.3 -19.1 -799.9 -1,126.2 NA 7.9Union Bank 2,053.6 2,101.7 -2.3 -2.3 1,541.5 1,490.1 3.5 -5.1 181.5 817.0 -77.8 9.1Corporation Bank 992.7 1,161.3 -14.5 -3.7 707.3 862.6 -18.0 -11.3 -65.5 188.6 NA NAAllahabad Bank 1,464.0 1,621.5 -9.7 5.1 1,024.6 1,158.8 -11.6 5.9 31.1 177.1 -82.4 -105.5IDBI Bank 1,492.7 1,611.8 -7.4 -12.5 1,432.6 1,518.8 -5.7 -2.3 96.4 119.5 -19.3 -60.0PSBs total 31,185.1 31,335.0 -0.5 2.6 22,251.5 22,029.9 1.0 -5.3 2,845.8 4,800.5 -40.7 19.2PrivateICICI Bank** 5,282.6 5,251.5 0.6 2.4 11,082.6 5,158.4 114.8 112.5 2,274.0 3,030.1 -25.0 1.9HDFC Bank 7,887.2 6,680.9 18.1 1.4 5,963.5 5,042.9 18.3 2.5 3,425.2 2,869.5 19.4 5.8Axis Bank 4,604.9 4,062.1 13.4 1.9 4,321.5 3,628.0 19.1 -3.3 1,692.1 1,915.6 -11.7 8.8Federal Bank 710.9 608.3 16.9 2.6 418.5 336.6 24.3 -1.7 184.5 161.3 14.4 10.3Yes Bank 1,361.0 1,108.5 22.8 3.3 1,286.0 1,019.1 26.2 -1.6 732.0 610.4 19.9 -0.1Private banks total 20,021.7 17,711.3 13.0 2.9 17,170.6 15,185.0 13.1 -0.4 7,868.4 8,586.9 -8.4 -0.7Grand total 36,407.6 34,793.8 4.6 2.4 28,458.2 26,949.0 5.6 -4.2 8,179.1 9,508.3 -14.0 4.9Soft CoverageIndusInd Bank 1,465.5 1,094.3 33.9 8.0 1,336.7 1,006.5 32.8 8.3 734.8 560.0 31.2 11.1L&t Finance 934.5 795.7 17.4 11.1 620.7 500.7 24.0 -9.4 231.2 215.4 7.3 11.5NBFCsHDFC 2,225.6 2,005.5 11.0 -0.2 2,649.1 2,277.7 16.3 -12.9 1,711.9 1,506.7 13.6 -8.5LIC Housing Finance 874.3 716.9 22.0 6.0 796.7 674.3 18.2 7.7 490.3 411.7 19.1 20.2Capital First 247.1 184.6 33.9 -11.1 159.1 109.4 45.4 -9.0 63.7 41.0 55.5 29.5Bajaj Finance 1,314.4 897.4 46.5 2.5 865.7 564.8 53.3 4.1 403.4 279.4 44.4 -4.9PTC India Fin. Ser.*** 103.9 94.1 10.4 4.5 109.3 308.4 -64.6 3.7 68.6 211.3 -67.5 1.7NBFCs Total 4,765.4 3,898.6 22.2 1.1 4,580.0 3,934.7 16.4 -6.4 2,737.9 2,450.1 11.7 -2.9* Q2FY2016 profits had declined significantly due to surge in NPAs resulting in higher provisions and interest reversal** Profit from stake sale through ICICI Preduntial Life IPO assumed to be utilised for NPA provisioning*** During Q2FY2016 profit had surged due to one-off income from sale of investment
Q2FY2017 estimates of Sharekhan’s banking and NBFC universe
Sharekhan Special October 10, 20167
Sharekhan Special Q2FY2017 earnings preview
Capital Goods and EngineeringOrder activity in select pockets; consumer segment momentum continues
Q2FY2017 result expectations
Mixed revenue growth for coverage companies; overall topline growth to touch double digits: We expect a wide variation in revenue growth across our coverage companies and hence see mixed topline in Q2FY2017. Among the heavyweights, we expect BHEL’s revenue to grow by 19% YoY and that of L&T to grow by 10% YoY in this quarter. Some of the smaller companies like Kalpataru Power Transmission (KPTL), Skipper and Triveni Turbines are expected to show strong growth. We highlight that Q2FY2016 numbers are subject to revision as per IND AS (which will be declared by the companies along with their Q2FY2017 results). We have taken actual (pre IND AS) numbers due to unavailability of IND AS numbers for Q2FY2016. In the case of Crompton Greaves (CGL), the Q2FY2016 numbers include business from discontinued operations. Therefore, the same would also be restated excluding the discontinued part (mainly International Power Systems business).
Strong bottomline performance likely; with better margins and lower interest costs: We expect an overall strong performance on the bottomline by most of our coverage companies, driven by better Operating Profit Margin (OPM) and drop in interest costs. Among the large companies, BHEL is expected to turn profitable from a loss in Q2FY2016 and L&T should report a healthy growth in comparable numbers (on revised Q2FY2016 numbers). In some of the smaller companies, we expect strong earnings growth in Q2FY2017. We estimate earnings of KPTL and V-Guard Industries to jump by 50% YoY and 38% YoY, respectively. V-Guard’s strong earnings growth would come from better margins while KPTL will get benefits from debt repayment and lower interest costs YoY. Other smaller companies like Finolex Cables, Skipper and Triveni Turbines are also likely to deliver earnings growth in the high teens.
Outlook
Domestic capex cycle mostly government driven; sustained traction in consumer business: We broadly bifurcate our coverage universe companies into Industrials (project oriented) and Consumers (product oriented). Clearly, the consumer-facing product-oriented companies have shown strong earnings traction in the last two quarters compared to project-centric companies. We believe that the project-oriented companies would be dependent on the revival of the domestic capex cycle. Although the capex cycle is yet to kick off on a secular basis, the government led capex should provide the push initially. The ordering activities continue in select areas like Power Transmission, Water, Solar Power, Road and Railways. Recently, OPEC agreed to cut oil production after almost eight years, which could give some stability to international oil prices, indirectly improving order inflow prospects from oil producing countries.
Valuation
View - Earnings performance will be key trigger: Driven by the favorable macro-economic factors like the impending GST implementation and the 7th Central Pay Commission (CPC) payouts to government employees, the consumer-facing businesses have been re-rated recently, supported by strong traction in earnings. Therefore, a healthy earnings growth expectation is already baked into the current stock prices for most of the consumer-centric companies. We believe that incremental earnings growth could drive the stock prices for these companies going forward. On the contrary, the project-oriented companies are yet to witness traction in order inflows. So, indications of better order inflows could be a key trigger for these companies. Overall, given the latest rate cut from the RBI, we expect interest sensitive companies to do well due to effectively lower interest costs in the near to medium term.
Preferred picks this earnings season: We prefer L&T in the large cap space while among the smaller companies we like KPTL, V-Guard, Triveni Turbines and Finolex Cables.
Q2FY2017E estimates Rs cr
Company Net sales (Rs cr) OPM (%) PAT (Rs cr)Q2FY17E YoY growth (%) Q2FY17E BPS (YoY) Q2FY17E YoY growth (%)
Revenue to grow in single digits; no major improvement in sales volume: With demand environment yet to pick up, the revenue growth for most of the FMCG companies under our coverage is expected to remain in single digits (volume growth is expected to stay in mid-single digits). The discontinuation of promotional offerings and judicious price hikes will add to overall revenue of most of the FMCG companies. HUL’s volume growth is expected to sustain at ~4-5% while we expect ITC’s cigarette business sales volume to grow by 1-2%. Volume growth of Britannia Industries, Marico and Jyothy Laboratories is expected to sustain in the range of 6-8%. The expected improvement in Household Insecticide (HI) category would support the overall revenue growth of Godrej Consumer Products (GCPL). Better demand for Automotive Paints and festival-related demand cheer would help Kansai Nerolac to post strong operating performance.
Margins to remain mixed: Higher prices of key commodities such as Palm Oil, Caustic Soda, Milk and Sugar would result in flat / marginal decline in Operating Profit Margin (OPM) of companies such as GCPL, GSK Consumer and Britannia. Though HUL’s gross margins are expected to remain flat, lower ad-spends and operating efficiencies would help in posting 60BPS YoY improvement in OPM. On the other hand, lower Copra and LLP prices would continue to provide margin benefits to companies such as Marico, Bajaj Corp and Emami.
Outlook
H2FY2017 is expected to see traction in volumes: With the southwest monsoon spreading out well and sustaining for a longer period, agriculture production (both Kharif and Rabi) is expected to be better than some of the previous years. This is likely to give boost to rural demand, which has remained muted for the past few quarters. Further, lower food inflation (Pulses and Vegetable prices have started correcting) and benefits from the implementation of the Seventh Central Pay Commission (CPC) would start reflecting from H2FY2017 amid improvement in urban consumption. On the other hand, the FMCG companies have taken measures to mitigate the impact from rising Raw Material (RM) prices by reducing promotional offerings and taking judicious price hikes in key brands. These measures, along with operating efficiencies would lead to stable OPM for most of the FMCG companies under our coverage. The introduction of GST will play a major role in the consumer sector in the long run.
Valuation
Consumer Goods companies continue to gain good acceptance among investors on the back of stable cash flows, sturdier balance sheets and improved earnings visibility in the long run. In the large-cap space, we continue to like HUL and ITC. In the mid-cap space, we continue to like Britannia, Emami, Manpasand Beverages and Kansai Nerolac. In the Consumer Services space, we continue to like Wonderla Holidays and Thomas Cook India.
Higher volume, a marginal rise in realisations amidst increasing power cost: We expect the revenues of the cement companies under our coverage (active and soft) to increase by 9.6% in Q2FY2017 largely supported by an increase in the volume (due to an increase in capacity). On the realisation front, the northern and central regions have maintained pricing discipline where the prices are up by 14.7% and 9.8% YoY respectively (up 2.0% and 3.8% QoQ respectively). The western region shows a downtrend (down 4.5% YoY and 2.5% QoQ) while the southern and eastern regions display an uptrend in the prices sequentially although the prices are down 2.4% YoY. We expect cement players like UltraTech Cement, Shree Cement, JK Lakshmi Cement and Mangalam Cement to benefit from a higher volume growth along with a marginal rise in the realisations. However, the key monitorable would be the impact of a rise in the pet coke and imported coal prices on the OPM of the companies.
Southern players’ lower blended realisation YoY to be offset by higher volumes: This time around, the southern players have seen a sequential increase in the prices though the prices are still are down by 2.4% YoY. This is expected to result in a lower operating performance YoY for Q2FY2017. We expect India Cements and The Ramco Cements to be affected by the lower realisations. However, a better volume growth is expected to lead to an earnings growth.
Outlook
The northern and central belts have continued to sustain higher prices along with better capacity utilisation while we are yet to see pricing discipline in the south and an improvement in the utilisation levels. Going ahead, the demand is expected to pick up in H2FY2017 after a better monsoon, a pick-up in government infrastructure spending and a revival in rural demand. However, the input cost, which is on the rise, would be the key monitorable.
Valuation
Most of the players in the cement space continue to trade at higher valuation assuming a pick-up in demand. But we believe an increase in the input cost would remain a headwind in the near term. We remain selective in the cement space and advise you to enter it on correction.
Preferred picks this earnings season: Shree Cement, JK Lakshmi Cement and UltraTech Cement
Sharekhan Special October 10, 201611
Sharekhan Special Q2FY2017 earnings preview
Valuations
Company Reco CMP (Rs)EPS (Rs) PE (x)
FY16 FY17E FY18E FY16 FY17E FY18E
Shree Cement* Hold 17,865 136.2 455.7 581.2 131 39 31
UltraTech Cement Hold 3,963 80.9 108.5 131.3 49 37 30
UR – Under Review # soft coverage * Shree Cement M9FY2016, change in accounting year to March
ITSoft performance in a seasonally strong quarter
Q2FY2017 result expectations
Modest growth exacerbated by cross-currency headwinds: Despite the July-September quarter being a seasonally strong quarter historically for the IT sector, the USD revenue growth in Q2FY2017 will remain modest, owing to cross-currency headwinds (8% GBP depreciation vs USD), delay in ramp-up of large deals and lower discretionary spending in key verticals like Banking, Financial Services & Insurance (BFSI). We expect cross-currency headwinds (50-90BPS) to restrict USD revenue growth in the range of negative 0.3% to positive 2.8% (multi-year low Q2 growth), whereas the constant-currency (CC) revenue growth is expected to be in the range of 0.5% to 3.3%. On an organic basis, Infosys will be back on top of the IT pack with a CC revenue growth of 3.3%, followed by 2.8% for HCL Technologies (HCL Tech), 2.4% for Tata Consultancy Services (TCS), 3.1% (including inorganic) for Tech Mahindra (organic growth at 0.5%) and 0.5% for Wipro. On the operating margins front, we expect the OPM of top IT companies to be under pressure, owing to lower revenues, absence of rupee benefits, partial wage hikes (Wipro & HCL Tech) and integration/restructuring expenses (Wipro, HCL Tech & Tech Mahindra). However, we believe that Infosys and TCS would manage to expand OPM (40-50BPS) during Q2FY2017, driven by absence of wage hikes and higher visa costs.
Key issues to watch out for would be: (1) Trend in discretionary client spends in key verticals like BFSI, Telecom, Retail and Energy. In a recent press release (September 2016) TCS highlighted that the management foresees a sequential loss of momentum in its US BFS vertical (2) Demand environment outlook in FY2017E and commentary on macro headwinds. Infosys is likely to cut its FY2017 revenue growth guidance, owing to RBS deal cancellation and softness in spending by few clients due to Brexit. HCL Tech is expected to maintain its industry-leading FY2017 revenue growth guidance (3) Commentary on positioning in the digital/platforms/automation technologies and growth prospects in this space and (4) Commentary on margins and pricing (pressure on pricing is evident in deal renewals given the commoditisation of legacy services). We expect TCS to revise its targeted margin band of 26-28%, considering the cross-currency headwinds in Q2FY2017.
Outlook
Macro issues continue to remain overhang: Cross-currency headwinds, along with macro uncertainties are expected to drag the IT companies’ performance in Q2FY2017 - diluting the benefits of strong seasonality. However, we expect the overall industry growth to pick up momentum in the coming years, driven by higher capital allocation towards new-age digital technologies and traction in key verticals like ERD, Manufacturing etc. We maintain our stance that the IT industry is in a transition phase (investing and adding capabilities for newer technologies in the digital space) and modernising the best practices for its legacy business (which is gradually getting commoditised). This transition phase will take some time (~2-3 years) and would result in volatility in the earnings performance in the near to medium term.
Valuation
Inexpensive, but slower growth restricts upside: We believe that the overall CC revenue growth in FY2017E will be in high single digits on account of the anticipated 50-90BPS cross-currency headwinds in Q2FY2017, softness in key verticals like BFSI, weak discretionary spends, pricing pressure in legacy services and ongoing macro uncertainties. However, the demand environment is expected to improve gradually in FY2018E. We believe that lack of clarity on business impact from Brexit and the US presidential election rhetoric will restrict the stock outperformance in near to medium term, although stocks like Infosys, HCL Tech and Tech Mahindra are trading at inexpensive valuations.
Preferred picks: Infosys and HCL Tech (in large-cap space) and Persistent Systems (in mid-cap space). We maintain our cautious stance on IT sector.
Sharekhan Special October 10, 201612
Sharekhan Special Q2FY2017 earnings preview
Oil & gasGRM remains healthy; crude to get some respite
Q2FY2017 result expectations
Crude oil prices stable; cut in natural gas price: Crude oil prices improved slightly QoQ and remained around $46/bbl in Q2FY2017. The dollar remained fairly stable during the quarter. Therefore, we expect some improvement in the revenue of the upstream companies. We estimate crude oil revenue of Oil India Ltd (OIL) to be higher by 10% QoQ, mainly on account of a better realisation. However, we are building in flattish natural gas revenue for OIL, resulting in an 8% sequential improvement in the overall revenue of OIL in Q2FY2017. However, the domestic natural gas price has been revised down to $2.5/mmbtu from September this year which will push down the domestic gas realisation further from Q3FY2017 onwards.
Refining margin remains healthy; positive for refiners: During Q2FY2017, the benchmark Singapore gross refining margin (GRM) remained highly volatile swinging in a wide range between $3/bbl and $7/bbl. On an average, the Singapore GRM remained near $5.2/bbl, which is broadly in line with the last quarter’s level. Therefore, on a sequential basis, we expect the GRM to remain healthy in Q2FY2017. We expect Reliance Industries Ltd (RIL) to notch a hefty premium over that to touch a GRM of $10/bbl against $11.5/bbl in Q1FY2017. On the positive side, the petrochemical business would continue to perform well. Against this backdrop, we expect RIL to report earnings of Rs7,192 crore, 5% lower QoQ but 10% higher YoY in Q2FY2017.
Q2FY2017 results estimates
ParticularsSales (Rs cr) OPM (%) Net profit (Rs cr)
*Changed its financial year ending from June-end to March-end during March 2016-ending quarterly results; hence, FY2016 consists only 9-month period Source: Company, Sharekhan Research
Oil India 414 42 33 40 (3.4) 9.8 12.4 10.5 Hold 400
Non-coverage
GAIL 420 18 27 33 36.8 23.7 15.3 12.6 NA NA
ONGC 265 19 19 26 17.2 14.2 13.9 10.3 NA NA
Outlook
The sector witnessed significant swings in the last 24 months. The prices of energy commodities (both crude and natural gas) corrected sharply and challenged many pre-existing dynamics. The Organization of Petroleum Exporting Countries (OPEC) seems to be contemplating a production cut, which could provide some stability to the global crude oil prices. However, the domestic natural gas price has been revised down by 18% to $2.5/mmbtu (NVC based) with effect from September 2016 which will significantly reduce the profitability of the gas production business of ONGC and OIL in the next quarter. While the domestic gas price cut would adversely affect the gas-producing upstream companies like ONGC, OIL and RIL, this could be a positive development for city gas distribution (CGD) players like Indraprasta Gas, Mahanagar Gas and Gujarat Gas. We believe the CGD players could retain some benefit, given the current situation where petrol and diesel prices are inching up and likely to remain firm in line with the global crude oil prices but domestic gas price is soft.
Valuation
We believe RIL will continue to outperform its peers, backed by a strong premium to the Singapore GRM and an improvement in the petrochemical business. Further, the launch of Reliance Jio has attracted significant attention and looks promising with extremely attractive offerings compared to peers. We retain our Buy rating on RIL. However, we retain our Hold rating on OIL and believe stability in oil prices could be a positive for OIL’s future earnings.
Preferred pick this earnings season: RIL
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Sharekhan Special Q2FY2017 earnings preview
Q2FY2017 result expectations
Power generation in India is expected to grow by 2% YoY but decline by 3% QoQ to 289BU in Q2FY2017. During this quarter, we expect the energy deficit to be almost nil as more power was generated than required during Q2FY2017. Consequently, the merchant power prices are under pressure. In the meanwhile, the coal supply situation has improved.
We expect CESC to report a flattish earnings growth YoY due to both flat volume and average realisation during Q2FY2017. However, sequentially we expect the earnings to grow at 9%. The volumes are expected to be flat due to lower generation of power as the company has decided to strategically source more power from its new plant at Haldia. We expect CESC to report a PAT of Rs190 crore in Q2FY2017. On the other hand, PTC India is expected to witness a healthy volume growth (~16% YoY) and a flat average realisation. Hence, the top line is expected to grow at 15% to Rs4,062 crore. We expect the OPM per unit at 7 paise, which would translate into a PAT of Rs83 crore vs Rs101 crore in Q2FY2016. Among the non-rated companies, the consensus expects a 4% top line growth in NTPC and a 27% top line growth in Power Grid Corporation of India (owing to a sustained higher rate of capitalisation of assets). However, the earnings of NTPC are expected to decline while that of Power Grid Corporation of India are expected to remain healthy.
Outlook
The power sector has moved from one corner to another now, as the sector is likely to witness surplus thermal power generation capacity. That’s because the demand has not moved up meaningfully in the last couple of years while the capacity addition has remained steady in the same period. In the meanwhile, a major thrust is now on the renewable energy sector (with an aggressive capacity addition target from the central government). The unconventional power generation resources could pose a threat of disruption to the conventional plants in the long run. The state electricity board reform (the Ujwal DISCOM Assurance Yojana [UDAY]) is under way though some states need more time to comply. Among the coverage power companies, we retain a Hold on both CESC and PTC India with a price target of Rs 710 and Rs90 respectively.
Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.
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