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MARKET OUTLOOK It's more global than local this time around
Benchmark indices are likely to consolidate in a broader range Volatility picks up as Ben pulls the plug and cues turn negative in China, Europe: The unexpected move by the US Federal Reserve to begin tapering of the monetary stimulus under the quantitative easing (QE) programme jolted the financial markets globally. As part of the knee-jerk reaction to the Fed's statement a scramble began for unwinding of the leveraged dollar carry trades which perked up the bond yields, strengthened the dollar and led to the withdrawal of money from risky assets. India also suffered its share of collateral damage with the sudden outflow of $7.5 billion from the Indian debt market and the freefall of the rupee beyond the important psychological barrier of Rs60 to the dollar. The deterioration in the Chinese economic data and the re-emergence of issues in some of the troubled European nations added to the uncertainty in the equation. Rupee dives but creates room for radical policy moves: The global uncertainty and the steep depreciation in the rupee have galvanised the government into taking policy decisions on some pending critical issues. The cabinet committee has approved the new gas price formula that makes investment in oil & gas exploration much more attractive, taken steps to address the availability of coal for the power sector and is looking at hiking foreign direct investment (FDI) limits in certain sectors. Therefore, by hiding behind the compelling circumstances and due to the growing differences within the opposition parties the government may be able to push some pending bills in the forthcoming parliamentary session. Though the government has passed the food bill ordinance, hopefully the pressure on the rupee would act as a grim reminder to the government to maintain fiscal prudence rather than focus on giveaways under social schemes during the election year. RBI to retain cautious monetary stance; corporate earnings to remain muted: Despite the moderation in the inflation rate, the Reserve Bank of India (RBI) is likely to retain its cautious view in the light of the inflationary pressures resulting from the rupee's depreciation. We do not expect it to cut the key policy rates or take any measure to ease liquidity during the policy review meet at the end of July. Thus, the cyclical uptick in the economy could be more sluggish than expected or get delayed due to the uncertainty caused by external factors. The earnings season would be rather lacklustre with the expectations of a marginal decline in the cumulative earnings of the Sensex in Q1 of FY2014 and the growing risk of further downgrades in the FY2014 earnings estimates. Nifty likely to fluctuate in a broader range: The global events pushed the market towards the lower end of its multi-month trading range of 5600-6100; however, the benchmark indices are stabilsing after the initial knee-jerk reaction. In the immediate term, the continued pressure on the rupee remains the key risk to inflation, might delay monetary easing by the RBI and put further stress on already stretched corporate balance sheets. However, the valuation is quite reasonable with a one-year forward price/earnings (PE) multiple of 13.8x, which is at 5% discount to the long-term average valuation of the Sensex. Consequently, the benchmark indices are likely to consolidate within a broad range though with increase in volatility.
SHAREKHAN SPECIAL Q1FY2014 Cement earnings preview
Earnings to contract in Q1 on early monsoon Key points -
Expect weak performance in Q1: During Q1FY2014, the earnings growth of the cement companies would be dented due to a sluggish demand environment, an early arrival of monsoon and the continued cost pressure on the margin. Hence, the cumulative earnings of Sharekhan's cement universe are expected to decline by 32.5% on an annual basis. Among the companies under Sharekhan's cement universe, the south-based companies like India Cements and Madras Cements are expected to witness a relatively higher pressure on earnings. -
Sluggish demand; weak volume offtake: On account of a slower than expected execution of infrastructure projects and an early arrival of monsoon, the volume offtake during Q1FY2014 was weak and is unlikely to support the revenue growth of the cement companies. The cumulative revenues of the Sharekhan's cement universe are expected to largely remain flat on a year-on-year (Y-o-Y) basis. On the volume front, UltraTech Cement (UltraTech) and Shree Cement are expected to post a degrowth in the volume of 1-8%. On the other hand, the south-based companies are expected to post a volume growth of 4-13% on account of a low base effect. Further, the non-cement businesses like construction in case of Jaiprakash Associates (JP Associates), viscose staple fibre (VSF) in Grasim Industries (Grasim) and power in Shree Cement will offset the negative impact of a muted volume growth and a lower realisation in the cement division. -
Average realisation largely remained flat on a Q-o-Q basis: Given the sluggish demand environment and an increase in the supply from the new capacity, the cement prices corrected in April-May in most parts of the country. However, in June, there was a recovery, which makes the average cement realisation for Q1FY2014 flat or a marginal decrease on a quarter-on-quarter (Q-o-Q) basis. Among the various regions, the eastern and southern regions witnessed an increase in the realisation on a sequential basis. On the other hand, the average cement prices in the western, central and northern regions corrected marginally during Q1FY2014. We estimate the average cement realisation in Q1FY2014 to be lower by around Rs150-180/tonne on a Y-o-Y basis for the companies under our coverage. -
Outlook and top pick: Given the poor demand environment, we believe the volume growth will be unable to support the revenue growth of the cement companies in FY2014. Further, the sustainability of the cement prices is a key risk going ahead in anticipation of an increase in the supply through stabilisation of the new capacities. In addition to this, the cost pressure in terms of higher freight charges continues to keep the margin under pressure. However, from H2FY2014 we expect a recovery in the demand environment through faster approvals of infrastructure projects and a likely increase in the government spending. Hence, we maintain our neutral view on the cement sector but we are positive on selective pick. In the large-sized space, we prefer UltraTech due to its strong balance sheet, pan-India presence and recent correction in the stock price. Among the mid-sized companies, we like Orient Cement (the demerged arm of Orient Paper & Industries), which is yet to be listed. Q1FY2014 Capital Goods & Engineering earnings preview
Bottom line trend diverging from top line; profitability concern remains Key points Double-digit top line growth YoY (excluding BHEL)
In Q1FY2014, we expect our coverage companies (excluding BHEL) to witness a double-digit top line growth in Q1FY2014 (year on year [YoY]). We believe the revenues of Bharat Heavy Electricals Ltd (BHEL) will continue to decline (as witnessed in the last few quarters) on account of a sluggish order inflow trend. We expect ~5% year-on-year (Y-o-Y) decline in the revenues of BHEL in Q1FY2014. Larsen & Toubro (L&T), Thermax, Kalpataru Power Transmission Ltd (KPTL) and Crompton Greaves Ltd (CGL) are likely to deliver a revenue growth of around 10-12% YoY in Q1FY2014. On a low base, V-Guard Industries (V-Guard) is expected to grow at 21% YoY in this period. We expect our coverage universe to witness a sales decline of 41% quarter on quarter (QoQ). Traditionally in the capital goods sector, the conversion of revenues remains highest in the last quarter of the year; hence, the sequential comparison is not fair. Margin pressure continues; operating profit a mixed bag
The operating profit margin (OPM) of our coverage universe is expected to remain under pressure both on Y-o-Y and quarter-on-quarter (Q-o-Q) bases, given the current environment. Among the universe, CGL and V-Guard are expected to see a significant margin contraction of around 241 basis points YoY and 347 basis points YoY respectively. Given the post-restructuring process of one of its European plant, GCL's OPM is expected to remain subdued on a Y-o-Y basis. V-Guard is also likely to witness margin pressure on account of higher advertisement expenses (in line with Q4FY2013). L&T, KPTL and Thermax are expected to maintain the OPM level at around 9%, 10% and 10% respectively. The operating profit of our coverage universe is expected to be flat, while excluding BHEL, the growth is estimated at 8% YoY. Below operating line, higher interest cost could tab net profit growth
The net profit growth of our universe is expected to decline by 5% YoY in Q1FY2014 on a flat operating profit growth, due to the higher interest cost. The cumulative interest cost of our coverage universe is likely to go up by 14% YoY during this period on a flat operating profit growth. On an absolute basis, the decline in BHEL's operating profit could drag the overall profit of the pack. Following that, CGL is likely to witness a significant fall (59% Y-o-Y decline) in the net profit. The profit after tax (PAT) of V-Guard is also expected to decline by 29% YoY on lower OPM. L&T and Thermax are expected to record a net profit growth of 7-9% YoY each while that of KPTL is expected to decline by 8% YoY. We expect the PAT of our universe to decline sharply due to seasonality of higher execution or revenue translation in Q4. However, V-Guard and CGL are expected to reverse the trend as they are estimated to recover from an abysmally low OPM in Q4FY2013. Healthy order flow observed but book-to-bill ratio still remains low
Amidst bleak environment, the order inflow showed a very healthy growth of 36% sequentially to Rs31,424 crore. Though the order inflow in this quarter declined by 13% YoY, on an absolute basis the order inflow size was respectably high in the last eight quarters. Also, in Q1FY2013, the order inflow was highest compared with any quarter in the last two years. While the healthy order inflow springs some hope of revival but it is not prudent to consider it as a trend. Further, the current book-to-bill ratio of our coverage companies remains at a historically low level.
The recent initiative of Cabinet Committee on Economic Affairs (CCEA), like allowing power producers to pass on higher cost of imported coal and pushing fast-track approval for selected large projects, could help the investment cycle to restart. Further, the progress in fuel supply agreement (FSA) issue of Coal India with various power generators could be another catalyst for the whole power sector. The series of development done recently in the stalled power sector may possibly churn the wheels of investments in the near future. Nevertheless, any meaningful cut in the interest rate could also be an important trigger for the sector.
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