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Challenging first quarter, managed well

Srividhya Sivakumar

Allaying market fears of a reversal in fortunes, India Inc has put out a robust earnings card for the June quarter. Despite last year’s bigger base, Corporate India scored a 17 per cent increase in revenues, while earnings grew about 36 per cent, year-on-year (inclusive of the ‘other income’ component, which was up a substantial 39 per cent).

While there has been a perceptible slowdown in sales growth, largely due to base effect, growth in earnings has remained stable, thanks to the improving operating efficiencies of India Inc. On a sector-wise break-up, while usual high-performers — construction, telecom and banks — continued their winning streak, sectors such as automobiles and engineering and technology recorded a slowdown in earnings’ growth (because of the rupee effect).

Among other sectors, while power companies posted firm numbers, sugar companies slipped into the red. The findings in this article are based on the numbers reported by about 1,400 companies for the June 2007 quarter. Here is a brief overview of sector-wise performance for April-June.

Double-digit growth for banks: Banks had a good quarter, with public sector banks (PSB)faring better than their private counterparts. While PSBs reported a near 48 per cent growth in earnings, private banks witnessed a 35 per cent incr ease. Given the robust loan growth over the year, it was no surprise to see the interest income component of most banks swell.

While interest income grew 50 per cent for private banks, public banks, on an average, recorded a growth of about 34 per cent. Among the private banks, Yes Bank and South Indian Bank more than doubled their profits. Interestingly, while all the banks recorded double-digit growth in earnings, IDBI reported flat earnings growth.

State Bank of India, the country’s largest bank, reported 78 per cent earnings growth, backed by a 28 per cent increase in total income. While the impressive performance could be due to last year’s low base, the overall earnings card was marked by stable net interest margins and an improvement in asset quality. The write-back of provisions in the AFS (Available for Sale) category also spurred earnings.

ICICI Bank, on the other hand, reported a modest 16 per cent increase in net interest income, a result of the contraction in net interest margins. While the bank’s earnings were up 25 per cent, the increase in non-performing loans rekindled concerns on asset quality.

Margin pressures in engineering: Engineering and capital goods companies continued to chip in with firm revenue numbers on the back of buoyant demand trends from user industries, but margin pressures remained. The sector reported a 25 per cent growth in revenues, but higher input costs and the subsequent contraction in operating margins led to a slowdown in earnings growth. Future performance, however, may rest on the timely commissioning of capacity expansion plans by companies in this sector.

L&T reported 140 per cent growth in earnings (helped by forex gains on overseas loans) on the back of a 30 per cent growth in revenues. Among other companies that put up a laudable performance were Praj Industries, Bharat Bijlee, HEG and Texmaco.

Construction and realty companies, despite slower growth in revenues, almost doubled their earnings. The lower revenue growth could be attributed to a sharp increase in interest rates (for real estate companies). Most real estate companies recognise revenues on a percentage completion basis of their projects. Earnings, therefore, got a boost from the booking of revenues from projects sold in earlier quarters at higher prices. Earnings volatility for companies in this industry is inevitable given the accounting system followed. Positive signals from telecom: Led by strong subscriber growth, telecom companies yet again notched up a good score, despite pressure on realisations.

The last quarter was marked by cuts in international call rates and roaming charges, reduction in cost of pre-paid lifetime schemes and introduction of low-cost handsets; as mobile operators stepped up efforts to deepen the market.

These efforts translated into healthy monthly additions in customers. For June 2007 monthly additions reached a high of 7.6 million, with key players gaining significant market share.

Bharti Airtel, driven by 54 per cent increase in revenues, saw earnings surge by about 71 per cent. Reliance Communication, backed by a 33 per cent growth in revenue, more than doubled its profits.

Subscriber churn and declining average revenue per user (ARPU) marred the growth picture for MTNL.

Mixed bag from cement: Cement companies reported a lower level of earnings growth, at 50 per cent, on the back of a 25 per cent rise in revenues. On a sequential basis, however, earnings grew by about 30 per cent, with improved realis ations leading to a rise in growth percentage.

Mysore Cements, helped by a high ‘other income’ component and zero debt status, reported a seven-fold increase in earnings. India Cements and Ambuja Cements reported healthy growth in profits, while ACC witnessed a slowdown in earnings growth.

Going forward, while the short-term scenario appears promising, given the firming prices and buoyant demand, the outlook for the sector over a two-year time-frame is uncertain.

Incremental capacities being installed in the next three years create concerns about pricing power. This apart, with the MRTPC (Monopolies and Restrictive Trade Practices Commission) probing the sector for price collusion and cartelisation, regulatory risk may remain a key concern for the sector.

Tough quarter for software: Software companies disappointed as a sharp appreciation in the rupee trimmed revenues as well as margins. Contraction in operating margins dented earnings growth, which was up just about 30 per cent. This is almost half the growth rates of the industry last year.

Top-tier companies such as Infosys, TCS and Wipro saw their operating margins come down by about 2-4 percentage points, quarter-on-quarter. However, given that most companies are now actively hedging their forex exposures, other margin levers such as billing and utilisation rates could offset the rupee effect.

This apart, strength in demand, improving offshore revenue contribution and subsidiaries’ profitability may cushion the firms, to some extent, against any further impact from rupee appreciation. While profitability for Tier 2 companies was under pressure, companies such as KPIT Cummins, 3i Infotech and Rolta India registered impressive numbers.

Headwinds put brakes on automobiles: A hardening interest rate scenario trimmed sales for auto companies — the commercial vehicles and passenger vehicles segment witnessed a modest growth in domestic sales while three-wheeler sal es reported lower growth.

Maruti Udyog scored high, with about 26 per cent rise in revenues and 35 per cent growth in earnings, backed by higher realisations and stable margins. Tata Motors reported just about 5 per cent rise in revenues.

The two-wheeler industry, however, seemed to be hit hard by interest rate headwinds. Lower motorcycle volumes led to a decline in revenues of TVS Motor and Bajaj Auto.

Hero Honda, however, managed a revenue growth of about 4 per cent backed by higher realisation and improvement in its product mix.

Powering ahead: Companies in power generation and supply had an impressive first quarter, driven partly by higher tariffs, partly by an increase in power generation and consumption and to some extent by “other income”.

This apart, growth in earnings may also have been driven by increased load factors in the quarter, resulting in a higher contribution to earnings. The sector recorded 44 per cent increase in earnings on the back of a 20 per cent rise in revenues and a 39 per cent increase in other income.

Reliance Energy recorded a 41 per cent rise in revenues on the back of higher electricity tariffs. Earnings, however, got a lift from the 103 per cent rise in ‘other income’ component. Other companies, such as Tata Power, NTPC and CESC, also reported firm numbers.

The big picture

Despite areas of concern surrounding the rupee’s effect on technology companies and the impact of interest rate hikes on asset purchases, India Inc largely managed to better consensus expectations on earnings this quarter.

Import-intensive businesses received help on their margins from a rising rupee; but the three-month period also brought to light the ability of large and the emerging large-cap companies to build on a high base and actively manage challenges to their margins from firm input prices and interest costs.

The quarter was however, not without its grey areas. One, with a significant proportion of companies registering a surge in “other income” (in many cases, from forex gains), the quality of earnings witnessed some deterioration. Further, mid-cap companies witnessed a stark divergence in performance, even within the same sector.

All this underscores the increasing role that stock selection will play in the performance of individual portfolios in the days ahead.

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