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| Summary of Contents | SECTOR UPDATE Q2FY2015 IT earnings review
Outlook remains positive, reasonable valuation offer further upside Key points - Top line performance fails to meet expectations, Infosys and Tech Mahindra surprise positively: The September quarter being seasonally strong for the information technology (IT) sector, the Street's expectations were high before the earnings season. In this context, except for Infosys and Tech Mahindra, the top IT companies disappointed with their Q2FY2015 earnings performance as they failed to meet the heightened expectations. On an organic basis, Tech Mahindra led the pack with a 5.2% QoQ growth, followed by Tata Consultancy Services (TCS; up 3.6%) and Infosys (up 3.2%). On an aggregate basis, the top five IT companies' revenues grew by 4.1% (QoQ) against 3.4% in the June quarter.
- Margin performance below expectation despite absence of visa cost and rupee tailwinds: For the quarter gone by, the margin performance of the top IT companies was below the expected line, except for Infosys and Tech Mahindra, which delivered a strong margin performance. Of the mid-cap stocks under our coverage, the margin performance of Persistent Systems and Firstsource Solution Ltd (FSL) was below par. Infosys and Tech Mahindra positively surprised on the margin front.
- Demand environment remains positive, deal pipeline improves significantly: Management commentaries on the overall demand environment remain positive, though the top IT companies have been facing some client-specific and vertical issues. Also, cross-currency headwinds (an impact of 70-130 basis points (BPS) in the September quarter) affected the overall growth for FY2015. Nevertheless, the deal pipeline and increasing spending on digital technologies, as indicated by both the management commentaries and Information Service Group, indicate a strong demand trajectory for FY2016.
- Reasonable valuation, offers further upside: We remain positive on the IT sector in view of expectations of an improvement in the demand environment in FY2016 and FY2017, and the reasonable valuation of the top IT companies. Our preferred picks in the large-cap space are TCS, Infosys and Tech Mahindra (unrated) whereas in the mid-cap space we like Persistent Systems and FSL.
Q2FY2015 Pharma earnings review
Stronger traction in India and USA boosts Q2 Key points - Healthy performance continued in Q2: The performance of the pharma companies in our universe remained strong throughout Q2FY2015, despite an absence of exclusivity products in the US market which affected their sequential performance. The growth was led by a recovery in the domestic formulation business and better traction in the base business in the US market. On an aggregate basis, these companies reported a 20% rise in net sales, a marginal expansion in the OPM and an 18% growth in the earnings for the quarter. While players like Aurobindo Pharma, Divi's Laboratories, JB Chemicals, Sun Pharma and Torrent Pharma reported a better than expected performance, players like Cipla, Ipca Laboratories and Cadila Healthcare disappointed us with a muted export performance.
- Performance may moderate in subsequent quarters: We expect the performance of the pharma players to moderate in the subsequent quarters because of: (a) a lack of exclusivity products in the US market, (b) a slower rate of product approvals from the USFDA, (c) the strong growth in the Indian market (on a low base) may not sustain, and (d) political instability in some of the Asian and Middle-Eastern countries.
- Recommend going selective in pharma space Most of the players in our universe have been re-rated successively in view of their improved fundamentals and positive market sentiment. Though some of these players are trading at historically high multiples, we do not rule out further re-rating of select stocks as market sentiment continues to be positive and liquid. We keep a neutral stance on the sector and recommend going selective on quality pharma stocks even though the upside is visibly lower. However, we have downgraded our rating on most of the stocks in our universe to a Hold.
- Our preferred picks are Aurobindo Pharma (focus on niche segments; integration of API units of Actavis; capacity built up to carry on peptide business); Lupin (focus on niche segments; a recovery in Japan); Sun Pharma (a stronger performance in the USA and India; integration of Ranbaxy Laboratories); and Torrent Pharma (better traction in the newly acquired branded business of Elder Pharma, a stronger recovery in the Brazilian business).
Q2FY2015 Capital goods & engineering earnings review
Uptick in margin and improving trend in new order booking in Q2 are positive signs of better times ahead Key points - During Q2FY2015, the aggregate earnings (ex Bharat Heavy Electricals [BHEL]) of our capital goods and engineering coverage universe grew at a healthy rate of 20% as most of the companies reported an improvement in margin over the last year. The other positives were an overall improvement in the order inflows and a relatively better management commentary on the demand outlook.
- Among the coverage companies, Thermax and V-guard Industries surprised us positively by delivering earnings ahead of our estimates and registering a very strong earnings growth of above 30% YoY. On the other hand, the earnings of BHEL continued to decline but that was expected. Larsen & Tourbo, Crompton Greaves and Finolex Cables delivered a healthy double-digit earnings growth in this quarter.
- Though the improving business environment would take time to revive the investment cycle and subsequently reflect in the financial performance of the capital goods companies, the initial signs are encouraging enough to support a re-rating of the capital goods and engineering companies. We remain positive on these companies and would view corrections as opportunities to increase exposure to them.
MUTUAL GAINS | Debt Mutual Fund Picks Bond / Debt market round up - Bond yields fell initially during the month on the back of drop in international crude oil prices. Bond yields fell further on hopes that the Government may soon hike the debt investment limits for Foreign Portfolio Investors (FPIs). The trend continued after both wholesale and retail inflation fell in September, which raised hopes of a rate cut by the RBI. Bond markets got further support after the Government deregulated diesel prices. Bond prices continued with their upward momentum on hopes that the Government will announce more economic reforms measures going forward. However, gains were capped after the Open Market Operations (OMOs) conducted by the Central Bank did not come along expected lines.
- The yield on the 10-year benchmark bond dropped 23 bps to close at 8.28% against the previous month's close of 8.51%, after moving in the broad range of 8.28% to 8.48% over the month.
Bond / Debt Outlook - Bond yields are likely to remain range bound in the near term. The movement of inflation and stance adopted by the Foreign Portfolio Investors will be tracked closely by market participants. The movement of the domestic currency and monetary policies adopted by the Central Banks across the globe will also remain in focus especially in the U.S. and Euro region. The Central Bank will conduct auction of 91-days, 182-days and 364-days Government of India Treasury Bills for an aggregate amount of Rs. 57,000 crore in November. It will also conduct the auction of dated securities for an aggregate amount of Rs. 58,000 crore in the same month.
| | | Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article. | |
| Regards,
The Sharekhan Research Team |
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