According to Credit Suisse, earnings estimates are coming down again. Its January consensus estimate for FY14 EPS ticked upwards but this seems like a head fake and there would be another 8%-10% downside in coming quarters.
During the third quarter (Q3) that ended in December 2012, sales growth of Nifty companies slowed to 10%, a new post-crisis low, which also affected the stock markets. Most stocks are now trading close to where they were in September 2012 and there is no turnaround from here, says Credit Suisse in a research report.
According to the financial services provider, the Indian stock market was very discerning during the third quarter as companies that beat estimates did exceptionally well after results while companies reporting in-line or weak results were beaten down. However, many of the bad results seemed to have been well flagged.
Of the 113 stocks that Credit Suisse India covers, formal quarterly previews were published for 78. For these 78 companies, combined reported net profit was 3% below estimates. Only oil & gas companies like Reliance Industries, GAIL and ONGC and IT services and financials, mainly private banks, and some public sector banks (PSBs) that had dropped non-performing loans (NPL) coverage had results better than estimates. There were large disappointments in most other sectors, it said.
The minor recovery in the year-on-year (YoY) growth trend of operating profit was short-lived. It turned downward again, as the number of companies seeing outright operating profit decline increased sharply. “With Nifty operating margins still below March 2009 levels, we note that although consumer discretionary, healthcare and consumer staples are much above March 2009 levels, industrials, energy and telecom are much below,” the research note said.
Credit Suisse said that the stock markets have reacted accordingly to the December quarter earnings. Gains from the sharp rally in investment-driven stocks that started on 6 September 2012—around the time that the government action on economic reforms grabbed headlines—have already disappeared. Metal stocks had also rallied, in line with a global rally in risk, but have now given up most of those gains, it added.
While the slowdown in investment activity has been prolonged and well-flagged, Credit Suisse said, commentary from companies did not suggest any bottoming out or inflection. It said, “In fact, results showed that construction activity, steel and cement demand, and even order books slowed during the quarter. BHEL, the bellwether power equipment manufacturing company saw its first YoY revenues declined in a decade. Even Larsen & Toubro (L&T), which surprised positively on the growth in its order book, had to rely on gaining market share in the middle-east and in real-estate construction orders and its own assessment of the investment environment was not positive,” the note said.
Credit Suisse said, below the operating profit line, the pressure from interest costs continued to rise (up 40% YoY in the December quarter), because projects are now starting to get commissioned, and capitalised interest is now appearing on the profit and loss (P&L). Worryingly, interest coverage continues to get worse.
Overall, FY14 earnings fell 2.3% during the earnings season. Credit Suisse said its analysts cut estimates across the board for FY14, though continuing with past trends the cuts in FY15 were more muted except for a few sectors. Earnings for Technology, Utilities and Private sector banks were upgraded. Interestingly, earnings estimates for consumer staples as well as consumer discretionary stocks were downgraded quite meaningfully: in case of the former, it was primarily the royalty impact on HUL, it added.
More than 90% of sales for Balkrishna come from exports, making it vulnerable to the imposition of anti-dumping duty by any target market, says broking firm Espirito Santo Securities. We in our Antelope Stockletter had recommended Balkrishna Industries in the weekly issue date 11 July 2011 from which we exited with a gain of 42% on 20 February 2012
Balakrishna Industries reported a 15% y-o-y (year-on-year) decline in sales volumes in the third quarter of FY13, resulting in a 10% y-o-y revenue drop. While the fall in volumes was worse than expectation, Espirito Santo Securities’ view is that it is primarily due to an inventory cut-off and quarter-specific demand issues. The brokerage’s market update report expects volumes to pick up from Q1FY14.
According to the brokerage, primary channel checks in America and Europe, and commentary of Titan International (well known for its Titan and Goodyear brands of farm tyres) reinforce the confidence in revival of demand in CY2013. Espirito Santo Securities leaves its estimates unchanged and reiterates a BUY recommendation with 38% upside for the shares of Balkrishna.
Balakrishna Industries is a Siyaram-Poddar group company in which the promoters hold a 54% stake. It specialises in the development and manufacturing of a wide range of off-highway specialty tyres (OHT). The specialty tyres are meant for agricultural, industrial, material handling, construction, earthmoving, forestry, lawn and garden equipment and all-terrain vehicles. Balkrishna derives about 90% of revenue from exports, with Europe the larger share (46% of sales). Balkrishna’s portfolio is skewed towards the replacement market (80% of sales) and the agriculture sector (62% of sales). It has a strong distribution network of over 200 distributors spread across 120 countries.
The slowdown in demand coupled with destocking by distributors was responsible for the volume decline. However, the company benefited from declining rubber prices, which helped EBITDA margins expand by 393 basis points (bps) to 22.1% in Q3FY13. The company’s management cited an increase in the monthly production run-rate of tyres to 11,000-12,000 from 9,000-10,000 seen in Q3FY13 and it expects demand to revive from hereon. Furthermore, upbeat guidance on the demand outlook for CY13 by Titan and Michelin enhances Espirito Santo Securities’ confidence in its FY14E estimates.
According to the market update report of the brokerage, key risks for the company include:
(a) Euro depreciation: Balkrishna derives over 40% of its sales from Europe; hence,
any significant depreciation of the euro against the rupee will have an adverse financial impact on the company.
(b) Imposition of anti-dumping duty: More than 90% of sales for Balkrishna come from exports making it vulnerable to the imposition of anti-dumping duty by any target market.
(c) Strong rubber prices: Rubber forms 50% of the raw material consumed for Balkrishna. Significant rises in the prices of rubber can dent profitability.
(d) Goodyear’s manufacturing facility in France, which manufactures Agri-OHT
tyres catering to Europe, Africa and several other countries, is about to shut down, which means 10%-15% of the European Agri OHT market is up for grabs.
(e) Lower market share in India: Titan’s management has acknowledged losing market share to low-cost Indian manufacturers, especially in the smaller tyre segment.
Increase in capacity and ability to price product at 20%-25% below competitors will help increase market share in the global OHT market. Opportunities to increase market share by entering newer geographies, increasing penetration in existing geographies by widening product offering. Lower presence in the US gives an opportunity to grow further in a big OHT market.
Balkrishna is a value stock which we had recommended in our stockletter in July 2011 and suggested an exit with a 42% gain about seven months later, earlier this month. If you are interested in our stockletters, click here to subscribe.
The Tulip Telecom stock has crashed even as Nomura held out ‘Buy’ and ‘Hold’ recommendations. This shows how analysts can go completely wrong if they allow themselves to be misled by the company they track
Brokerages and research institutions, especially those dealing with the securities market, are expected to do a thorough research before providing any recommendation on any company. However, here is one case where it seems that instead of doing independent research, the analysts remained dependent on the company for inputs which they were tracking.
Nomura Equity Research, in its latest recommendation has suspended rating of Tulip Telecom from neutral on delays in foreign currency convertible bonds (FCCB) redemption, weak operational trends and data centre utilisations. On 17 May 2012, Nomura rated Tulip Telecom as neutral with a target price of Rs90, when the company shares were trading at Rs76.70. Thereafter, Tulip shares rebounded for a few months. On 6 July 2012, Tulip recorded its 52-week high of Rs129. Since then Tulip shares are on a freefall and today touched a 52-week low of Rs11.50, thus hitting the circuit limits.
The stock has crashed 93% from 3 December 2010 when Nomura rated Tulip as ‘Buy’ with a target price of Rs230, against a closing price of Rs178.15. Even on 10 February 2012, Nomura had a target price of Rs150 for Tulip when the closing price was Rs110.30. On both instances, the company share price, however nosedived, thus raising a big question on the research and recommendation process of an elite, foreign broking house like Nomura.
Tulip shares have been falling since 3 December 2010, when Nomura rated it as ‘Buy’. The freefall continued even as Nomura changed its target price for Tulip on 10 February 2012. So, what went wrong in the recommendations?
While suspending Tulip from ‘neutral’, Nomura said, "The (Tulip) stock is down by around 70% in the past three months and our long-term thesis on it being able to capitalise on its network investments has been impacted by delays in meeting its debt repayments and high cash flow needs. In addition, weak customer demand, and its execution missteps have also clouded the outlook and investor confidence.”
In the December 2012 quarter, the company reported a net loss of Rs85 crore compared with a net profit of Rs77.25 crore, same period last year. During the quarter, its total revenues fell 23% to Rs528.67 crore from Rs686.59 crore in the year-ago period.
As of December 2012, Tulip Telecom had a debt of about Rs2,700 crore which includes Rs780 crore in FCCBs, Rs600 crore worth of term loans, non-convertible debentures (NCDs) of Rs545 crore and external commercial borrowings (ECBs) of around Rs340 crore.
Last year in February, Forbes India published a highly upbeat story on Tulip Telecom saying that though the company's bets appear audacious, in reality, they are often conservative and textbook examples of expansion. "...unlike most of his (Col HS Bedi (retd), the CMD of Tulip) peers who invest billions of dollars in pursuit of often ephemeral markets, Bedi prefers to line up customers for Tulip's services before incurring the capital expenditure for the underlying infrastructure," the article said.
"...instead of spending serious money laying inter-city (between cities) fibre-optic, it cannily chose to lease that capacity from other operators thanks to the glut in supply there. In contrast, intra-city fibre is usually in short-supply. As a result of these moves, Tulip has been able to increase its addressable market tenfold from Rs1,400 crore to Rs14,000 crore within just 3-4 years," Forbes India had said.