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Q3FY2011 Retail earnings preview

• The continued consumer confidence on the back of sustained economic buoyancy, the festive season (Diwali, Chirstmas) that fell this time in the third quarter and a strong winter across the country kept the retail stores busy with increased footfalls and higher conversion.
• Over the past 12 months, retail companies have undertaken stringent cost-control measures, rationalisation of overheads and inventory, and the streamlining of the working capital cycle. They have also taken care of the leverage position in this period. Thus, overall we expect the below-earnings before interest, tax, depreciation and amortisation (EBITDA) level costs like interest and depreciation to remain benign. We, therefore, expect a strong earnings growth from the sector. In our retail universe, we expect a 38.4% year-on-year earnings growth for the quarter.
• Kewal Kiran Clothing amongst our retail coverage is likely to see a strong year-on-year earnings growth of about 70% in the third quarter of FY2010.

Q3FY2011 earnings preview

Key points

• The third quarter of FY2011 started on an extremely positive note with the equity markets surging sharply in September 2010 on the back of the continued momentum in economic revival and strong foreign inflows. However, the sentiments turned edgy by the end of the quarter due to a series of negative news flow (scams, political instability etc) and the emergence of macro headwinds in forms of rising commodity prices globally and stubbornly high food inflation domestically.
• On the earnings front, the news flow remains positive. In spite of the higher base of the previous year and the emerging macro headwinds, the cumulative earnings of the Sensex companies in Q3 are estimated to grow at a healthy rate of 21.8% (over Q3FY2010) and the Sensex? earnings (ex-oil companies) are estimated to grow by 16.3% year on year (YoY).
• The growth in the earnings of the Sensex companies (ex-oil companies) would mainly be achieved on the back of a relatively better performance in the oil & gas companies (up 75.9% YoY); the automobile sector (a 54.3% year-on-year [Y-o-Y] earnings growth) and the metal sector (a 50.0% Y-o-Y earnings growth). Meanwhile, the telecommunications (telecom), utilities (power generation) and pharmaceuticals (pharma) sectors are likely to be a drag on the Sensex? earnings.
• Within sectors, the stocks that will comprehensively outperform their peers in terms of better Q3FY2011 results are Tata Motors, Tata Steel, Tata Power, HDFC Bank, Tata Consultancy Services (TCS), Bharat Heavy Electricals Ltd (BHEL) and ITC whereas the underperformers would be Maruti Suzuki, Reliance Communications, National Thermal Power Corporation and Cipla.
• Given the expectations of the Q3 report card, the implied growth for earnings in Q4 works out to a steep 25-26% to achieve the consensus estimate for FY2011. This leaves little scope for error. Consequently, it would not be surprising if the Street downgrades the FY2011 and FY2012 earnings estimates marginally after the announcement of the Q3 results especially given the pressure on the input cost and the stressed liquidity during the third quarter.
• At the current level, the Sensex is trading at 15.5x one-year forward earnings (on a rolling basis) which is close to its long-term average multiple. The valuations are not expensive anymore and would limit the downside risk from the current levels.

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