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| Summary of Contents SHAREKHAN SPECIAL Q4FY2014 earnings review
Earnings growth remains skewed; hopes of a broad-based recovery building up Key points - Q4 profits up 10%; but growth remains skewed: The aggregate earnings growth of the Sensex companies stood at a respectable figure of over 10% in Q4FY2014 (as compared with Q4FY2013). However, the earnings growth was quite skewed with just three sectors (IT, energy and banks & financials) contributing 90% of the growth in the earnings. That's not all, eight companies reported a decline in earnings out of the 30 stocks in the index. The incremental profit from only six companies (Infosys, Tata Consultancy Services [TCS], Wipro, GAIL, Larsen and Toubro, and Sun Pharmaceutical Industries) was higher than the aggregate incremental profit of the 30 index companies. This essentially means that the profit of the rest of the 24 companies actually declined marginally in Q4FY2014 as compared with the corresponding period of the last year.
- Hopes of economic revival and broad-based recovery in earnings: The emergence of a stable government at the centre having a strong mandate for reforms may result in bold decisions to fast track a recovery in the economy. Till now the export sectors had been driving a growth in the earnings; this is likely to be replaced by the domestic-demand based sectors now. Therefore, in the past two to three months the cyclical sectors (private banks, auto) and the energy sector have seen upgrades while the defensive sectors (pharmaceuticals [pharma], IT, FMCG) have witnessed downgrades. The consensus FY2016 earnings estimate for the Sensex has witnessed a marginal upgrade and more action is expected after the announcement of the Union Budget.
- Churn towards beta has narrowed valuation gap: Despite a continued robust earnings performance by the IT services and pharma companies, the defensive sectors have seen a correction in valuations due to a churn towards cyclical and domestic recovery-driven sectors. The churn away from the export-driven defensive sectors is also led by a change in view on the rupee (after a significant improvement in the current account deficit situation) and a huge valuation gap between the exporters and the domestic-demand driven sectors. We expect re-rating of the sectors driven by the revival of the domestic economy depending on an improvement in the operating metrics (namely order book, balance sheet de-leveraging) and financial performance.
- Retain bullish stance; set for multi-year rally: Notwithstanding the recent run-up (and some hiccups like the inflationary fears on account of the forecast of a weak monsoon this year), we believe it is just the beginning of a multi-year rally. The Sensex' valuation at 15.0-15.5x one-year forward earnings is still just about the 10-year average valuation of 15x and leaves scope for significant re-rating as the efforts of the new reformist government take shape. The high expectations are self-fulfilling and boosting the business and consumer confidence. Going ahead, the Reserve Bank of India (RBI) is also expected to unwind the monetary policy towards H2FY2015 which could build a case for a meaningful upgrade in the earnings estimates and additional re-rating of the valuation multiples especially in the domestic-demand driven sectors like industrials, power, construction, auto and banks.
VIEWPOINT Ador Welding
Current market price: Rs217
View: Positive Well poised to capitalise on cyclical upturn Key points - Ador Welding Ltd (AWL) is the pioneer of welding technologies in India and among the leading players in the industry. Welding technologies are essentially being used in the fabrication process in key industries like auto, power, infrastructure & construction, oil & gas, ship building and mining. The company earned revenues of around Rs409 crore in FY2014, with the total industry size pegged at around Rs4,000 crore (consumables and equipment).
- In the last two to three years, the domestic welding industry has gone through a severe downturn and shrunk by around 15-20% in FY2014. The policy paralysis of the previous government affected most of its user industries too. Nevertheless, with a strong government at the helm now and the likelihood of an improvement in the investment climate, AWL is well poised to capitalise on the pent-up demand from the next investment cycle for at least the next four to five years.
- Our interaction with the management suggests that the welding industry can grow by over 50% in the next few years once the gross domestic product growth touches around 7-8% (the welding industry can reach from Rs4,000 crore currently to Rs6,000 crore in that event). AWL's management is quite confident of facing bravely the competition from the multinationals and expects to deliver a strong earnings performance in FY2016. Also, apart from the domestic market AWL is also aiming at increasing its export especially to the Middle-East. Currently exports constitute around 12% of its total revenues, which is expected to increase to 20% in the next two to three years.
- AWL could be an early beneficiary of an economic revival and its earnings could more than double in the next two years. Even in tough times, AWL generates positive free cash and consistently pays dividend. With a healthy balance sheet and a strong earnings growth expected over FY2014-16, we see a potential upside of 15-20% in the stock price of AWL in the next few months.
| | | 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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