| Summary of Contents SHAREKHAN SPECIAL Q2FY2009 earnings review Key points - The Sensex' earnings (adjusted for the one-time items) grew by nearly 10.1% in Q2FY2009 on the back of the strong performance of the financial service companies (earnings up 30% year on year [yoy]), telecommunications (telecom) companies (earnings up 28% yoy) and capital goods companies (earnings up 18% yoy). However, the Sensex (excluding the oil companies) saw an earnings growth of 13.4% yoy during the quarter and the same is ahead of our estimate of a 10.1% earnings growth for the quarter.
- Notably, the revenue growth for the Sensex companies (ex-oil and banking companies) was healthy at 28.3% yoy. However, the same could not translate into an equally good operating performance largely due to a 228-basis-point contraction in the operating profit margin (OPM) and a higher capital cost. The margins in most sectors were affected by the rising input cost, employee cost (especially provisions for wage hikes by the public sector undertakings [PSUs] as per the Sixth Pay Commission's recommendations) and a steep spike in the cost of power & fuel (both coal and oil). The margin contraction was more pronounced in case of automobile, cement, real estate (read DLF), pharmaceutical, cement and oil & gas sectors. On the other hand, metal and information technology (IT) companies registered an expansion in their EBITDA (earnings before interest, tax, depreciation and amortization) margin on an annual comparison basis.
- In terms of a strong performance, telecom and banking sectors positively surprised the markets. The telecom companies have proven their ability to grow in spite of a worsening economic environment whereas the banking sector has reported a higher than expected credit growth, healthy margins and a buoyant growth in the fee-based incomes (in case of the private sector banks).
- Though the second quarter's earnings growth is ahead of expectations, the signs of stress are quite evident. The utilisation rates have declined in key manufacturing sectors and the working capital cycle is deteriorating. In addition, the management commentary indicates possible delays in the investment/expansion plans of companies on account of the difficulty in mobilising fresh capital (both equity and debt) and the worsening demand environment. Despite the recent easing of the macro challenges (in terms of lower commodity prices and a reversal in the interest rate cycle), the earnings growth momentum could decelerate further in the coming quarters.
- The second quarter results season witnessed a sharp downward revision in the earnings estimates for the Sensex companies. Now the consensus earnings per share (EPS) estimate for FY2009 stands at Rs933, sharply down from Rs972 at the beginning of the results season. For FY2010 also, the consensus EPS estimate for the Sensex has been reduced by 4.6% to Rs1,076. As anticipated, the main culprits are the metal stocks and Reliance Industries. In view of the collapse in the commodity prices and the sharp deterioration in the demand outlook, analysts have cut the FY2009 and FY2010 estimates for the metal stocks like Hindalco Industries, Tata Steel and Sterlite Industries by 40-60%. Tata Motors is another company that has seen a massive downward revision in its earnings estimate because of its sliding domestic sales and the worsening outlook for its international operations (especially Jaguar and Land Rover [JLR]).
- After the sharp downward revision in October, the compounded earnings growth estimate for the Sensex stands at around 12-13% vs 20-22% in the beginning of the year. In fact, the Sensex' compounded earnings growth estimate for FY2008-2010 would drop to single digits if one were to exclude the incremental earnings from the commissioning of Reliance Petroleum Ltd (RPL)'s refinery and the production of gas at the Krishna-Godavari Basin of Reliance Industries in FY2010. After the steep revision in the earnings estimates for India Inc over the past nine months, most of the negatives already seem to be factored in the estimates. Hence, there is perhaps limited scope for another round of serious earnings downgrades in future. Currently, the Sensex trades at 10.5x FY2009 and 9.2x FY2010 estimated earnings, which is close to its historic low level.
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