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Q3 earnings preview: Forecasts keep powder dry, Financials May Lead, While Commodities to Weigh on

Author: Kumar Shankar Roy/Wednesday, January 15, 2020/Categories: Exclusive

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Q3 earnings preview: Forecasts keep powder dry, Financials May Lead, While Commodities to Weigh on

The Sensex is at 41,500 level and the Nifty at 12,200 mark, reflecting the optimism surrounding corporate earnings. Will third quarter (Q3), October-December period of 2019-20 fiscal, earnings meet estimates and thus prove the ongoing rally on the bourses is backed by strong reasons? Experts think Q3 results will be muted in line with the overall economic slowdown and structural issues. As such, it is clear that domestic corporate performance will be more of the same. For six long years, the domestic markets have been sailing on growing hope and an elusive earnings recovery. Thus, the expectations of tremendous growth in corporate earnings appear misplaced, even as domestic benchmark stock indices keep on going up every week. The only saving grace is in the form of giant caps or the biggest companies present in the Sensex and Nifty clubs, who keep on fighting the earnings battle. The Finapolis looks at the Q3 earnings preview in detail and presents key sectors to watch out for.

How are overall earnings placed

ICICI Direct research coverage universe (ex-BFSI) is likely to register revenue and PAT (profit after tax) de-growth of 4.8 per cent and 1.5 per cent, respectively. A de-growth means drop. Sectors like oil and gas, auto, metals, and construction are likely to register negative revenue growth. On the other hand, sectors like capital goods, IT, FMCG, Consumer discretionary, Retail and healthcare are likely to report decent numbers.

Motilal Oswal research universe’s 3QFY20 PBT/PAT to increase by 1%/9% YoY, led by BFSI (estimated to contribute 81 per cent of incremental profit YoY), automobile (low base effect) and consumer (beneficiary of tax cuts). However, metals/ O&G (oil&gas) are likely to drag the performance, given the underlying weak commodity prices. Telecom is expected to sharply reduce losses YoY, which will support earnings. Ex-BFSI, MOFSL Universe’s PBT is estimated to decline by five per cent and PAT to increase by two per cent YoY. Alongside, the soft data indicators for Q3 FY20 suggest further weakness in India’s growth slowdown, as per Shubhada Rao, Chief Economist, Yes Bank.

Sensex story

For Q3FY20, ICICI Direct expects Sensex companies (ex-HDFC) to register 3.9 per cent YoY revenue growth. Again, as was the case in Q2, the growth driver will be BFSI segment, with some leg-up from IT and FMCG sectors. On the flip side, companies from oil & gas and auto (except Maruti) are likely to be laggards. Banking is expected to continue to arrest topline fall for Sensex companies, driven by resolution of large stressed asset. Companies from IT, FMCG space are likely to register decent growth as also capitals goods players.

Among individual players HDFC Bank, Kotak Mahindra Bank, SBI, L&T, Infosys, Bajaj Finance are likely to be the main drivers. Conversely Hero Honda, Tata Steel, NTPC, ONGC among others are likely draggers.

"The scenario at the bottomline level is likely to be better where YoY growth (ex-HDFC) is likely to be at 23 per cent. This positive delta is likely to be on the back of strong profitability expected in the BFSI companies and leg-up in manufacturing on account of benign commodity prices, lower scalability and shift towards the new favourable tax regime," writes Pankaj Pandey, Head Research, ICICI Direct. Axis Bank, HDFC Bank, SBI, Kotak Mahindra Bank, Bajaj Finance, Maruti, Nestle, Ultratech are likely to be the drivers. On the other hand ONGC, Tata Steel, Sun Pharma are likely laggards among others.

Information Technology

Revenue growth in HDFC Securities (Institutional Research) coverage universe in 3Q FY20 will remain steady (+1.7/7.6% QoQ/YoY vs. 8.3% YoY in 1HFY20) in a seasonally weak quarter. Margins are also likely to be steady supported by Rupee, cross currency (GBP), offset by furloughs and wage increase for select companies.

"Within the sector, tier-1 IT will deliver +1.6/7.5 per cent QoQ/YoY (vs. 8.3 per cent YoY in 1HFY20) and tier-2 IT is expected to post +2.1/7.9 per cent

QoQ/YoY (vs. 8.7 per cent YoY in 1HFY20). Indian IT’s increased investments in (1) Re-skilling, (2) Localisation/near-shore (HCLT - Canada, Lithuania; Wipro - Virginia, Melbourne), (3) Platforms and partnerships (HCLT-GCP; WiproMulesoft) continue to augment its digital prowess with increasing penetration across the portfolio," says Apurva Prasad, Analyst, HDFC Securities & Amit Chandra, Analyst, HDFC Securities.

Headwinds such as (1) Tighter cost controls by enterprises /clients (particularly in large BFS), and (2) Elevated onsite metrics (localisation, sub-contracting) persist.

However, HDFC Securities expects a steady 2020 as reflected in strong deal pipelines and continuity in large deal wins (TCS-Phoenix, INFY-Telenet, Siemens, Arlanxeo, Wipro-Olympus) and stable outlook/guidance increase by Accenture.

The brokerage has rolled forward valuations to Dec-21E (Sep-21E earlier) and revised EPS estimates by +0.9/-0.4 per cent for FY20/21E. It maintains tier-1 IT  pecking order of INFY, HCLT, TechM and prefer LTI, LTTS, Sonata within tier-2 IT.

BFSI

Centrum Broking expect banks under its coverage to report moderate loan growth (+11.6 per cent YoY) in Q3FY20, leading to an uptick in YoY NIM. (net interest margin). Banks’ non-interest income should surge, led by the recoveries in a few large NCLT accounts in large-cap banks. Pre-provision operating profits could grow +74.1 per cent YoY. Provision costs are likely to drop 5.7 per cent QoQ (led by SBI). PAT is thus likely to improve sharply YoY and QoQ.

It expects large-cap banks (SBI, Axis, ICICI) to report 11.6 per cent YoY loan growth, led by ICICI and Axis. NIM is likely to stay stable QoQ. In terms of PAT it is expected to improve by 20 per cent to Rs 8.85 billion mainly led by Federal Bank.

For asset financers (AFCs), Centrum Broking sees a lower AUM growth at 14.1 per cent YoY (driven mainly by Sundaram) owing to the auto slowdown. Asset quality for MMFS in terms of provisions may come in lower, thus positively impacting overall PAT for AFCs. Micro lenders (MFIs) might see a better sequential AUM growth of 40.6 per cent YoY led by Satin Creditcare. Asset quality remains a key monitorable due to the impact of the CAA-NRC protest on the north eastern portfolio (WB, Assam). Hence it has factored higher provisions for MFIs.

As the CV and PV space, which have been slowing down, make up for 80 per cent of Sundaram Finance (SUF) AuM, it foresees lower AuM growth to continue (+7.8% YoY vs 11.1% QoQ). Q3 being the strongest quarter for Mahindra Finance (MMFS), Centrum Broking expects a sequential pick-up in disbursements leading to an AuM growth of 17 per cent YoY. NIM for AFCs is expected to increase to 6.94 per cent (vs 6.50 per cent QoQ) mainly driven by MMFS as last quarter saw surplus liquidity and lower CP share. Its covered micro lenders are expected to see an uptick in YoY AuM growth to 40.6 per cent YoY led by Satin; Ujjivan (+51.8% YoY) is expected to maintain its healthy trajectory. Other income is expected to remain high due to a larger proportion of the assignment in case of Satin.

"NBFCs have been switching toward a longer-tenure bank borrowing from capital market funding, which is a relatively stable source of funding with lower volatility; however, at a higher cost. The share of bank borrowing has increased to ~33.1 per cent as of September 2019 from ~30.2 per cent in March 2019. With the softening of monetary policy by the Reserve Bank of India (RBi) and the newly initiated ‘operation twist’, we believe cost of funds for NBFCs have peaked, though the transmission might appear away a quarter or two. We expect NBFCs to report sequentially flat margins in Q3," says Jignesh Shial, research analyst, Emkay Global Financial Services.

For rating agencies, revenue may likely be impacted by continued drop in bank credit growth (impacting their bank loan ratings business). For AMCs, Centrum Broking expects PBT to rise ~6% QoQ given marginal QoQ growth of 1.3% in AUM and four per cent growth in core EBITDA.

The drop in bank credit growth could impact rating agencies’ bank loan rating business and thus revenue. Centrum Broking estimates 0.5 per cent YoY revenue growth combined for CRISIL and CARE Ratings. For AMCs, it has built in flat QoQ revenue yields for HDFC AMC and RNAM with QoQ QAAUM growth seen at 1.6%/0.8% resp. Core EBITDA is expected to grow 0.7%/13.0% resp, with PBT growth at 1.7%/16.5% resp.

"We continue to prefer SBI and ICICI Bank among large-cap banks. Commentaries on growth, margins and NPA resolutions remain a key monitorable. We like Federal Bank and DCB Bank in the mid-cap banking space. We would watch for commentaries on asset growth for AFCs, and customer acquisition and state exposure in case of MFIs," writes Cyrus Dadabhoy, Gaurav Jani and Rahul Nandwani of Centrum.

Specialty chemicals

Emkay believes that Q3 numbers will be a mixed bag for its speciality chemicals stock universe due to lower realization and muted demand. Although things have started showing improvement in some chemistry lately from December, the current geopolitical situations between the US and Iran would be the key monitorable for crude oil prices. New facilities by most companies during H2FY20 will be viewed as a positive move amid improving sentiment.

"We continue to remain positive on SRF, NFIL and CFIN due to their strong outlook on the specialty chemicals segment, while GHCL and ADVENZY look attractive with cheap valuations. In our sector EAP, we remain OW on SRF and CFIN," says Rohit Sinha, Research Analyst,  Emkay Global Financial Services Ltd.

Building materials, Capital goods, cement

YES Securities expects its coverage universe to report ~5.4% yoy revenue growth led by Kajaria Ceramics (5.8% yoy growth), Cera Sanitaryware (5% yoy growth) and Century Plyboards (CPBI) (5.1% yoy growth). EBITDA margin is expected to improve by 41bps yoy to 15.1% in Q3FY20 primarily led by Century Plyboards (+168bps) due to softness in raw material prices. Net profit is likely to grow by 12% yoy largely due to benefits from corporate tax rate cut. Century Plyboards India is its top pick.

The brokerage expects the companies in coverage universe to report ~10.9% YoY revenue growth led by project-based companies such as L&T (10 per cent yoy growth), Kalpataru Power Transmission (KPTL) (20% yoy growth) and KEC International (24% yoy growth). EBITDA margin of coverage universe is expected to decline by 94bps yoy to 11.7% in Q3FY20 due to unfavorable revenue mix, lumpy project execution & soft seasonality. Net profit is likely to grow by 13.6 per cent yoy largely due to cut in corporate tax rates. We think order inflow guidance cut is certainly on the cards for L&T. KEC International, Cochin Shipyard and GRSE remain our Yes Securities top picks in the sector.

Q3FY20 will be yet another quarter of strong earnings growth for cement industry, characterized by a.) flattish trend of industry-wide organic volume growth, b.) healthy prices vis-à-vis last year and c.) softening of input costs. Further, we expect distinct disparity in earnings among companies as regional dynamics will come into play with North and Central based players showcasing significant outperformance while South based companies to suffer a double whammy led by sharp decline in volume and prices. In Yes Securities coverage universe, they are expecting a.) net realization/tonne to improve by 1.6% YoY, b.) volume growth to stand at 5.2% YoY (primarily due to UltraTech acquiring Century Cement) and c.)  weighted average EBITDA/tonne to improve by 23.6% YoY, hovering around Rs 921. UltraTech Cement and Birla Corp will be likely outperformers in Q3FY20E and they remain top picks in the sector.

Real estate

The NIFTY Realty index has delivered ~21% returns over the last 3M, largely driven by DLF delivering 58 per cent returns. Whilst residential markets remain muted, cap rate compression has started reflecting in stock prices. Though there is a marginal recovery in the premium segment viz. Gurgaon for DLF and in pockets of Mumbai, the overall sentiment still remains muted.

Negatives for organized players (1) Government resolve to revive stuck projects may slacken market share consolidation towards organized players, (2) Property prices still remain elevated, restricting volume led demand, (3) NBFC  funding/liquidity is still constrained & (4) Balance sheet deleveraging is not yet visible.

Positives: (1) On the back of Government measures to revive real estate, buying sentiment is improving which may drive overall demand over the next few quarters, (2)  Commercial leasing is robust and vacancy is reducing, (3) Developers -planned fund raising over the next one year will result in deleveraging.

"During 3QFY20E, our coverage universe aggregate revenue/EBIDTA/APAT is estimated to grow 9.3/0.1/11.6% YoY. Amongst our coverage universe we expect Prestige/Sobha/Kolte Patil to deliver strong financial results whereas DLF/Oberoi/Brigade are expected to deliver average financial performance. We have rolled over our NAV valuation estimate to  Dec-20E," says Parikshit D Kandpal, Analyst, HDFC Securities.

Oil & Gas, Healthcare

Oil & Gas is expected to report a flattish PBT/PAT performance, dragged by 40 per cent YoY decline in ONGC PAT. OMCs are expected to post strong YoY profit growth off a benign base (inventory losses in base). RIL is expected to deliver a three per cent EBITDA decline and flattish 4% profit growth. Ex-OMCs, we expect a 14 per cent decline in profits for O&G, says Motilal Oswal Research.

Healthcare is likely to deliver another muted quarter with four per cent profit growth. Large-cap names like Lupin/Dr Reddy/Aurobindo are expected to post 1%/-7%/-2% profit growth, while Cipla/Sun’s profits are likely to grow by 22%/12% YoY, says Motilal Oswal Research.

Consumer

Consumer universe profits are expected to increase 17 per cent YoY, led by tax cuts. PBT growth is expected to be modest at four per cent YoY. Nestle (34%), Pidilite (20% YoY) and ITC (23%) are expected to exhibit a strong performance, while Godrej Consumer, Marico and UBBL are expected to post weak results.

Under ICICI Direct coverage universe, Astral Poly and Kansai Nerolac likely to report PAT growth of 28% each supported by EBITDA margin expansion and low base of last year.

Nirmal Bang Institutional Equities' FMCG coverage universe is expected to grow its top line by 5.8 per cent, led by low to mid single digit volume growth in the domestic business. While overall commodity environment remains benign for the quarter, there is a visible inflation in food and oil commodities during the quarter. Rest of the FMCG commodity basket has been fairly benign. In a soft demand environment, new launches have taken a back seat.

"Our coverage Alco-bev companies (UNSP and UBBL) are expected to continue to see the effects of slowdown this quarter. We estimate sales of UNSP and UBBL to grow by 5.5 per cent and five per cent YoY, respectively in 3QFY20. On a YoY basis, gross margin pressure will be witnessed by both the companies as barley, ENA (Grain and Molasses) and glass prices are up YoY," says Vishal Punmiya, research analyst, Nirmal Bang Institutional Equities.

While the overall consumer demand environment remains subdued, QSR companies in Nirmal Bang coverage (JUBI and WDL) are expected to deliver decent double digit sales growth for the quarter. This will be driven by high single digit SSSG, mainly supported by companies’ own initiatives. There could be gross margin pressure going forward for both the companies as some key raw materials are seeing inflationary pressures, mainly in onion, dairy and wheat. Store expansion is expected to remain on track for both the companies, added Punmiya.

(The writer is a journalist with 14 years of experience)

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