CLSA expects autos, pharma, pvt oil & gas to do well in Q3; but momentum to fall sharply

The brokerage suggests that telecom, cement and PSU oil & gas firms should see a decline in profits compared to the second quarter. Going ahead, seasonality, strong commodity prices and interest costs will hurt

CLSA, an independent investment and brokerage institution, expects Sensex earnings growth to slow from 28% in the second quarter of the current fiscal to 22% year-on-year in Q3. It believes that the best growth in the third quarter will come from autos, pharma, and private oil & gas, but telecom and cement and public sector oil & gas companies should see a decline in profits. The base effect will start to wear off for domestic cyclicals such as auto and banks, as well as global cyclicals such as metals and oil and gas, and that both these categories should see a sequential dip in topline growth. Seasonality and strong commodity prices will hit at least eight domestic sectors and interest costs will rise more rapidly than they did in the September quarter, the brokerage says.

The operating margins of almost all sectors, except oil & gas and property, are expected to ease in the December quarter. The sharpest fall in margins will come for cement, power, and telecom sectors.

Overall, FY12 will see healthy EPS growth of around 19%, but most of this will come from cyclical metals and energy sectors along with some steady growth from the IT sector. Other sectors will face macro headwinds, the base effect and rising competition. This will limit market returns, with the highest returns coming from metals, IT, energy and industrials. CLSA's top picks are Bharat Heavy Electricals, Dr Reddy's Laboratories, Hindalco Industries, IDFC and Mahindra & Mahindra.

While the auto and metals sectors and private oil & gas firms will see the strongest growth, they will also see a significant easing in year-on-year growth momentum compared to the September quarter. In fact, pharma, cement and telecom sectors will see their losses narrowing and stronger growth. Autos, private oil & gas and banks would contribute more than 65% incremental profits in Q3FY11.

Sales growth is expected to be the highest for auto, media, private oil & gas, power, property, software, and telecom sectors and the decline is expected to be the worst for the cement sector. Pharma, telecom, and auto sectors will see forex losses. Net profit growth is expected to be the best for auto, private oil and gas, pharma, software, and capital goods sectors and the worst decline will be seen by telecom, state-run oil & gas and cement sectors.

"The biggest positive swings in stocks will be in Cairn, Oil & Natural Gas Corp and Ambuja Cement. Tata Motors, Ranbaxy Laboratories and Sesa Goa will see significant deceleration in growth," CLSA says.

Strong volume growth will prop up earnings of auto companies (except Maruti Suzuki and Ashok Leyland). Maruti's results will be lower due to poor margins, while Ashok Leyland will be impacted by weaker volumes.

The banks that CLSA tracks are likely to report a 29% year-on-year growth in core pre-provision profit, but net profit growth will be only 13% because of lower treasury gains and higher loan loss provisions. While loan growth and NIMs (net interest margins) will be higher year-on-year, there could be some pressure on a quarter-on-quarter (q-o-q) basis. Fee growth will be good with an uptick in lending activity. Some banks may take a mark-to-market hit on the available-for-sale part of their bond portfolio due to the 20-50 basis points rise in medium-term bond yields. PSU slippages, which were high in Q2 will be keenly watched.

Cement demand has remained weak, but prices improved in the southern and western regions. Operating profit contraction should continue for most companies, except Ambuja Cement. Media companies may report strong revenues due to the festival season. Metals will do well mainly due to higher product prices, and in some cases even higher volumes. Best performers in steel would be Jindal Steel and Power and Tata Steel, while JSW Steel and SAIL will see a drop in net profits. Base metal companies will report strong q-o-q numbers on higher prices, CLSA says.

In oil & gas, "higher crude price will be offset by a higher subsidy burden, which should keep reported profit of OIL and ONGC largely flat on a q-o-q basis." In the case of Reliance Industries, lower KGD6 production would be more than offset by higher refining margins (CLSA assumes $8.9 per barrel, which is about a dollar higher q-o-q) and petrochem margins. Cairn India will benefit from higher volumes from Rajasthan and higher crude prices, while Petronet LNG will benefit from higher spot LNG volumes.

In pharmaceuticals, it is generally a strong quarter seasonally for domestic formulations. For IT, CLSA believes that Infosys should beat the upper end of its dollar revenue guidance, while absence of visa costs should drive positive surprise on margins. TCS should continue the momentum shown through 2010 reporting an 8% q-o-q growth in dollar revenues.

In telecom, October and November mobile net additions were strong. An improvement in network traffic will be keenly watched. Competitive intensity could ease a bit.

(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife.)


Oil, metals, banks and auto expected to lead December quarter growth

Oil & gas, metals, banks and auto sectors will drive earnings; cement and telecom are expected to lag behind; low base effect may be over for the Sensex from this quarter, according to a brokerage house

An important factor to keep in mind when looking at the October-December 2010 quarter results, says Motilal Oswal (MOSL), is that the low base effect is almost over. At an aggregate level, the Sensex PAT growth was 23% in 3QFY10 and the brokerage expects it to be 23% for 3QFY11. Oil & gas, metals, banks (especially private banks) and auto sectors are expected to perform well, while cement and telecom will probably be laggards. The pharmaceutical sector is also expected to do well.

MOSL states in its December quarter earnings preview report, "Nine of the top 10 earnings growth companies in the Sensex are expected to be from autos (Tata Motors, M&M), commodities (Tata Steel, ONGC, Hindalco, Reliance Industries, Sterlite), and private banks (HDFC Bank, ICICI Bank). Telecom is the biggest drag on Sensex PAT growth with Reliance Communications' PAT expected to be down 67% year-on-year and Bharti's PAT (may be) down 23%."

With reference to the auto sector, MOSL expects volumes to be strong. An increase in end prices may cushion margins somewhat, but overall EBITDA levels are expected to come off a bit due to higher raw material prices.

Going forward, the auto sector is expected to face headwinds in the form of higher interest rates, steeper fuel prices, and higher product prices. This could be a trend across consumer-driven sectors in India, which is why MOSL says that export-driven sectors could perform better than domestic ones.

The report says, "We believe near-term challenges will impact performance of several sectors, particularly those dependent on domestic markets. We expect rising input costs, fuel prices and interest rates to impact discretionary consumption spends including (the) auto (sector). In this backdrop, global commodities and export-oriented sectors like technology and pharma would continue to outperform."

For the December quarter, in banking, MOSL expects credit growth to remain strong, but deposit growth to lag, putting pressure on net interest margins. Further clarity is expected on pension and gratuity related liabilities. Margins seem to have peaked for this sector, the brokerage believes.

Cement demand momentum is muted with volume growth of 7.3% year-on-year, but down almost 10% quarter-on-quarter. Domestic prices are about 7% higher quarter-on-quarter and 4.5% year-on-year.

Overall EBITDA margins may improve quite a bit quarter-on-quarter, but they are still down almost 800 basis points year-on-year. MOSL believes prices have bottomed out and that utilisation will improve from here.

The construction sector is expected to benefit from order flows from the National Highways Authority of India (NHAI) and the building segment after a sluggish first half. Construction costs and interest rates will rise, but MOSL expects "EBITDA and net profit margins to stabilise with growing composition of higher margin contracts in the order book."

Growth in the FMCG sector is expected to be volume-led, as very few have taken price increases. Although input costs have risen, players haven't passed all of them on. But this may not impact margins yet because of cost cuts.

The information technology (IT) sector is expected to see 5%-7% topline growth; commentary on near-term prospects is expected to be bullish; and rupee appreciation will hurt margins.

In metals, domestic steel demand and pricing was sluggish and only picked up towards December. "The shutdown of Ispat Industries in November helped in a supply-side correction. Improved price sentiment globally helped in recovery of prices in the domestic market." Margins may be under pressure due to higher iron ore prices. Zinc and aluminium prices have been strong and may reflect in earnings.

Inventory gain is seen for oil & gas companies, as crude gained $10 per barrel this quarter. It also expects strong GRMs (gross refining margins), led by naphtha cracks. Polyester margins were strong but polymer margins were weak. Despite a number of new launches, real-estate sales momentum could have been impacted due to sharp rise in prices and higher interest rates, says the brokerage.

In telecom, MOSL expects a revival of revenue and operating profit growth after a sluggish September quarter, "driven by a seasonal volume uptick and relatively stable pricing environment." For utilities, imported coal prices were higher and merchant prices continued to be lower.

(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife.)


Market may scale new highs, but broking stocks may make you broke

Broking stocks are staring at a bleak future, with a decline in revenues on account of a shift in volumes from cash to derivatives and poor penetration in retail stock investing

Experts have forecast a good year for the stock market. But even as the Sensex climbs to new highs, the picture doesn't look so bright for shareholders of brokerages firms which operate at the heart of the stock market, according to analysts tracking these companies.

Consider this: Since 1 January 2008 up to 5 January 2011, the stocks of major brokerages have fallen by more than 50%. Motilal Oswal Financial Services is down by 55%, Edelweiss Capital is trading down by 72% and India Infoline has plummeted a whopping 79%. Similarly, Indiabulls Financial Services has tanked by 77% and Geojit BNP has fallen by 62% in the period. It is interesting to note that during the three-year period, the BSE benchmark index-the Sensex-has remained flat.

All leading brokerage firms have been performing poorly over the last three years, even as the market is headed higher. The recent quarterly results of these firms show no signs of revival. The total revenue of Motilal Oswal Financial Services in the September 2010 quarter stood at Rs8.95 crores, a sharp decline of 61% over the previous corresponding quarter. India Infoline, which is not as dependent on broking income, still saw September quarter revenues decline by 6% compared to the year-ago quarter.

The main reason for decline in revenues of brokerage firms has been the change in revenue mix and poor penetration of retail stock investing. Despite powerful economic growth and a rising stock market, the retail investor community has not been enthusiastic about stock investing. This is partly due to the inadequate developmental role of the regulator and stock exchanges and too many cases of malfeasance by the broking community.

Moneylife has written a series of stories on the diminishing investor population, with analysis and commentary on various issues such as price manipulation, the role of market regulators, and so on. The reports pointed to the comments by union minister of state for finance, Namo Narain Meena, in response to a question in Parliament, that the Indian capital market is narrow, shallow, illiquid and concentrated in the hands of a few individuals located at a few centres. (Read, 'Different Strokes: Where are the investors?' )

Sardar Sukh Dev Singh Dhindsa, member of parliament, had raised a question in parliament about the number of client identities and PAN identities that traded actively in the market on the National Stock Exchange (NSE), in April-June 2010, and accounted for 50%, 60%, 70%, 80% and 90% of the total trading turnover on average, on a daily basis, in the cash equity market and in the F&O (futures & options) segments. The minister said in his reply that 30.90 lakh investors traded on the NSE's cash market in the three months, but 90% of the investment came from only 1.92 lakh investors-in other words, trading volumes of the bulk of investors are trivial and irrelevant. The number drops to a fourth (41,654) when you consider 80% of the turnover. And, finally, 50% of the turnover came from a shockingly low 451 investors, of which 156 were proprietary traders. He further stated that 106 participants account for half the derivatives market turnover. The minister's comment suggests that the market being very narrow, tracking price manipulation should be easy.

Poor market penetration has combined with the change in market structure itself. Even those who are trading regularly have taken to options, which results in low revenues for brokerage firms.

According to Aditi Thapliyal, analyst - banking and financial services, Execution Noble, "The main reason for the fall in broking stocks is muted growth in the cash segment of the market, with a majority of the volumes coming from the futures and options segment, which is a very low margin business."

This was echoed by Apurva Shah, head of research at Prabhudhas Lilladher, "There are multiple factors for the poor performance of these stocks. The major one is volumes, which are growing, but the commission pool remains very low. Also, there is not much margin from options trading."

Another analyst feels that the low retail participation is also a reason for the low performance of these stocks. "There is very low retail participation, which has taken toll of the stocks of brokerage firms. Currently, there is more participation by foreign investors. Equity investment, which is the main driver for these stocks, is largely under-penetrated in India. May be after a quarter, we would see some improvement," said the vice-president of research at a leading brokerage firm, who requested not to be named.

According to Mr Shah, "It is tough to say if these stocks will perform anytime soon as the cash segment remains mired in low volumes. In the near future there won't be any change. Long term we can see some change as valuations may come down."

Within this segment, there would be some stocks which would do better than the others. "Our top pick among broking stocks is Edelweiss. We expect the stock to outperform its broking peers given that its financing segment in particular is showing a great deal of traction. For India Infoline, the stock is yet to recover from the reputational damage to its franchise from its involvement in the Money Matters QIP," Ms Thapliyal said.




7 years ago

Insurance is sold every corner of India, because agents are taken care of by the insurance companies. No one worried about return from insurance and it is also accepted by retail investor. When agents are getting 2% upfront commission for MF, MFs are not penetrated in INdia. Now who will take the message to Retail Investor. "Now rich will become richer" because of no upfront commission. Everyone knows there is no free lunch. Instead of correcting the ill brokers, mf industry is in doll drum.

Devjeet Chakraborty

7 years ago

Broking companies are too focused in brokerage generation through fancy products or taking risky positions for their clients. None of the Brokerage Company is focusing in increasing the market. All of them have a funny Compensation and Incentive structure. Employees will justify his employability by generating min 3 times of his/her CTC and will earn incentives only when he or she is able to generate more than 4 times of his/her CTC. So, the structure makes their employees focus in for high account margin, taking position in cash & derivatives and all the funny stuffs you can think of.
None of the Company is making any serious effort to expand & improve the market. Sales and Marketing has taken a back seat. These are the primary reason for lacklustre performance of broking companies. And in near future things are not going to improve also.

R Balakrishnan

7 years ago

Retail business is humbug. For the volume of retail business, the market cannot support more than twenty odd brokers. with close to a thousand, it is a joke! The zero entry barrier to this business is the cause.
The listed ones rely on 'other' business- captive nbfc, investment banking, FII broking, selling research etc to make money. That space is fully occupied.


7 years ago

Food inflation is quite high and interest rates are going up , in these scenario invest in stocks with high margin of safety.

nn bala

7 years ago

The broking houses themselves encourage future & option tradng. I get atleast 10 to 15 SMSs per day from two broking houses all related to futures and options buy or sell calls. If it is a low margin segment why do they push this so hard.

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