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Corporate Earnings: Gain For Some, Pain For Others

Author: Kumar Shankar Roy/Wednesday, October 16, 2019/Categories: Exclusive

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Corporate Earnings:  Gain For Some, Pain For Others

After finance minister Nirmala Sitharaman announced a cut in corporate tax rates to 22 per cent for existing domestic companies and 15 per cent for new domestic manufacturing companies, there was euphoria all round. The stock markets rallied like never before, but that euphoria was short-lived. It is now time to take a look at the corporate earnings. However, the endless wait for earnings jump just got longer. Expect a soft quarter and earnings revival could still take some time. India Inc’s revenue likely fell to a 14-quarter low in Q2. Nine-quarter low for EBITDA growth as gains on input costs nullified by high fixed cost, says CRISIL Research. Stock markets, on a high after the corporate tax cut steroid boost, will not be amused. A sharp drop in demand across consumption segments pulled down corporate revenue - barring banking, financial services, insurance and oil companies – by nearly 3% in the second quarter of fiscal 2020. Let us take a look at what experts have to say about the second quarter i.e. July to September 2019 earnings.

The Q2 earnings season has already started on a soft note with TCS reporting a below par performance both in terms of revenue and margin. Weakness was on account of a slowdown in retail, capital market segment and European banks.

This is the first time in 14 quarters that revenues have declined. In the previous four quarters (between Q2FY19 and Q1FY20), aggregate revenue had grown 11-12% on average. "Automobiles, one of the key sectors driven by consumption spending, continues to reel under a demand slowdown. Aggregate revenue of listed automobile players is estimated to have dropped 25% in the second quarter. In a rub-off, revenue of automotive component makers is estimated to have fallen 14-16% amid production cuts. As for FMCG, weakened rural consumption and a high base are expected to have caused a moderation in growth to 6-7% compared with 8.7% on average in the previous four quarters,” says Prasad Koparkar, senior director, CRISIL Research.

Construction-linked sectors are expected to log an overall decline of 5% on-year in revenue in the second quarter. This is on account of 15% on-year decline in steel products, mainly due to declining realisations, as flat steel prices dropped 14%. Cement players will likely log a 5-6% rise in revenue despite a drop in volumes, given higher realisations.

On the industrial side, revenue of petrochemical companies is expected to fall 23-25% due to lower petrochemical realisations amid a fall in feedstock naphtha prices (25% on-year decline) following lower crude oil prices. For companies in power sector, aggregate revenue growth is estimated to have logged a slower pace of 3-4% against an average of 10% in the previous four quarters due to a slowdown in power demand across regions.

As for earnings before interest, tax, depreciation and amortisation (EBITDA), growth is expected to have fallen to 0-1% as higher fixed cost amid weak demand for sectors such as automobiles nullified the gains from lower commodity prices and weak global demand and absence of rupee tailwind hurt export-linked sectors. Among others, domestic prices of flat steel and aluminum were lower on-year by 14% each in the second quarter, though long steel prices remained range bound. Additionally, oil prices softened 18% on-year.

Interestingly, Q1FY20 had witnessed a healthy EBITDA growth of 7.1% despite a 4.1% revenue growth. This was on account of a sharp improvement in the EBITDA of consumer discretionary services such as airlines, telecom and retailing, and lower commodity prices. While overall EBITDA continues to show growth, excluding sectors such as airlines and telecom, which are benefiting from consolidation and a revival in pricing, the EBITDA profits may show a decline of 5-6% for the second quarter. Indeed, 10 of 19 key sectors evaluated are expected to show an on-year drop in margins.

For key sectors such as automobiles, auto components and steel products, EBITDA margins are likely to decline by 250-300 bps. On the other hand, cement companies are likely to witness margin expansion by 500 bps on account of improved realisations and lower power and fuel costs. Airline and telecom services are also expected to see some expansion in margins. In the second half of this fiscal, a low base of last year could provide some respite to corporate revenue growth.

"Across Emkay coverage universe, our team expects growth trends to weaken further from Q1 levels, with the decline led by auto, telecom power, IT services and pharma sectors. On a positive note, cement (positive pricing trends Y-o-Y), engineering/capital goods and media/entertainment (subscription and multiplex footfalls growth) could see an acceleration in top-line growth trends," says Sunil Tirumalai, Head of Research and Strategist, Emkay Global. Emkay feels that margin performance should be aided by commodity pricing trends. Softer commodity prices should help margins of input-cost dependent sectors like cement, FMCG, durables. Strong GRMs/marketing mix should lift margins for refiners/OMCs.  However, margins should decline for auto (low volumes) and pharma (step up in R&D investments).

Tirumalai estimates that PAT growth should be helped by corporate tax cuts. Some companies may report some write-backs of excess taxes paid in Q1, leading to a lower than 25% ETR (Effective Tax Rate). Overall PAT growth for Emkay universe should be flat -1% (up from -4% for Q1FY20). PAT growth should be led by cement, BFSI and FMCG, while sharp PAT declines are likely for auto and mining sectors. However, another poor quarter of earnings means that Nifty EPS growth asking rate remains high. First half of Nifty PAT growth should come in at about 5% yoy versus 15% Y-O-Y growth expected for the Nifty for FY20 – implying room for cuts in the Nifty earnings estimates.

As per Motilal Oswal Research, the second-quarter earnings-report season will be tepid and uneventful. Underlying demand slowdown in the domestic economy and weak global commodities prices are expected to take a toll on earnings with few bright spots, if any. However, it is important to look at this quarter’s numbers from a PBT (Profit Before Tax) perspective as the reduction in the corporate tax rate cuts will result in several adjustments in this quarter’s tax numbers (e.g. large corporate banks will make deferred tax adjustments).

If Emkay expects the stocks it covers to show PAT growth of just about 1% in Q2, Motilal Oswal projects its stock universe PAT to decline 6% Y-o-Y, dragged by automobiles and metals. This 6% number is not in line with what others like Edelweiss have also projected for their universe in Q2. Motilal Oswal's FY20 Nifty EPS estimate has been cut by 3.8% to Rs 539 (prior: Rs 560). The brokerage is telling investors that it is now building in EPS growth of 12% for FY20. Ex-corporate banks, it expects 3% profit growth for the Nifty in FY20.

"Markets have remained weak in Q2FY20, despite the sharp bounce back post tax cut. Nifty’s divergence with the broader markets has expanded significantly. Earnings risks continue to be tilted to the downside on account of the underlying weak demand scenario in the domestic economy, the uneven asset quality trends in financials and the deflationary trends in commodity prices. At this point, tax rate cuts will limit the downgrades rather than driving big upgrades on the earnings front," says Motilal Oswal.

Edelweiss expects retail banks, OMCs and consumer discretionary to post 25% plus growth. It forecasts Nifty’s revenue/profit to decline 4%/4%; (grow 3%/5% excluding corporate banks and commodities).

Amid this gloom and doom, do not forget pockets of resilience. For instance, IT revenue/EBITDA/PAT is estimated to grow 8%/4%/(1.8)% in 2QFY20. Private Banks are expected to report a healthy quarter (26% PPoP and 9% PAT growth), despite factoring in DTA adjustments for corporate banks in 2QFY20 itself.  NBFCs too are likely to post healthy 20% Y-o-Y growth. Cement is expected to post 26% Y-o-Y EBITDA and 24% Y-o-Y profit growth on a flat base, after delivering 34% profit growth in 1QFY20. Lastly, Healthcare is expected to deliver growth of 11% in EBITDA and 1% in PAT off a low base (+3% Y-o-Y in 2QFY19).

Now let us take a look at some select sectors to gauge the depth of the Q2 show.

Autos

BNP Paribas expects Q2FY20 to be a painful quarter for the automotive sector with a sharp 16% Y-o-Y drop expected in revenues. Volumes dropped in double-digits across automotive segments viz (2W, PV and CV) due to slowing economic growth, increased cost of ownership and inventory correction by OEM’s. Auto OEM’s are the worst hit with topline expected to drop 21%. Ancillary companies (due to replacement demand and increasing exports) could report a much lower 5% fall in topline. Negative operating leverage due to the steep volume drop coupled with increased marketing expenses would drag the margins. Most of the auto OEM stocks are trading at P/E of 17-22 times which is at the higher end of the long term historical average. With the possibility of earnings cut looming, the current valuations are unlikely to sustain.

Consumer

According to Reliance Securities, investors can expect the consumer sector coverage universe (of RSec) to record higher single-digit revenue growth in 2QFY20 led by mid-single digit growth in volume. As per the recent management commentaries and channel checks, the consumption trends continued to remain soft in 2QFY20 with little sequential improvement in liquidity. Rural sales growth is likely to decelerate further after growing at par with urban channel in 1QFY20. Reliance Securitries says the sectoral volume growth may come in at 4-5% range, while the pricing growth remains the critical, which is pegged at 2-3% for the quarter. Benign raw material cost and operating leverage are likely to lead EBITDA growth of 11.8% YoY with 106bps expansion in EBITDA margin. Lower effective tax rate is likely to help net earnings grow by 18.9%YoY.


Oil & Gas Sector

Uptrend in GRMs (Gross Refining Margins), stable retail margins to support robust earnings. "We expect a massive surge in Q2FY20E EBITDA and PAT for the three PSU refining and marketing stocks (OMCs), IOC, BPCL and HPCL based on improved outlook for GRMs and stable petrol, diesel retail margins above Rs3/litre. Our positive ve view on 2Q GRMs is based on the revival in 2QFY20 Singapore complex netbacks to US$6.13/bbl vs. US$2.9/bbl QoQ and US$5.94/bbl YoY. The growth in EBITDA on lower revenues resulting from the near 20% fall in Brent price YoY would help boost EBITDA margins for OMCs," says Amit Agarwal, senior research analyst, Nirmal Bang Institutional Equities.

Prospects for city gas stocks Indraprastha Gas (IGL) and Mahanagar Gas (MGL) look encouraging due to healthy margins, although IGL will by far show higher volume growth (low teens) vs. just 3% expected for MGL. Petronet LNG will be a steady performer with marginal volume growth from Dahej expansion and gross margins in line with 1QFY20, which should support healthy growth in EBITDA.

Real estate

The NIFTY Realty index has corrected 12.1% over the last three months. Weak property buying sentiments, high unsold inventory and paucity of new launches has impacted 2QFY20 pre-sales. As we enter into the festive season, new launches have picked up. Parikshit D Kandpal, analyst, HDFC Securities, believes that discounts/sales promotion will speed up ready inventory monetization. Negatives are (1) Traditional sources of real estate funding drying up. (2) PE funds/NBFCs remain a pain point (3) Unavailability of easy money for land bank accumulation (4) Unorganized developers finding it difficult to get construction/land financing (5) Demand shifting to select developers (6) End-user driven market limiting pricing power (7) Rise in cost of capital , with multiple PE funds failing to deliver returns. The Positives include (1) Commercial real estate holding steady (2) More volume driven residential launches aiding capital churn (3) Price cuts aiding monetization of ready/near-complete inventory (4) Interest rate cut by RBI welcome step, transmission awaited. "Amongst our coverage universe we expect Sobha/Prestige/Kolte Patil to deliver strong financial results whereas DLF/Oberoi/Brigade will deliver average financial performance. "During 2QFY20E, our coverage universe aggregate Revenue/EBIDTA/APAT will grow 7.2/(2.2)/(6.8)% YoY," says Kandpal. (The writer is a journalist with 14 years of experience)

 

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