| Summary of Contents SECTOR UPDATE Q1FY2015 earnings review
Earnings growth moves up to a higher growth trajectory High double-digit earnings growth with important encouraging signs
The aggregate earnings growth of 17.5% in the Sensex companies seen in Q1FY2015 was largely contributed by the usual export-driven sectors like information technology (IT) services and pharmaceuticals (pharma) in addition to private sector banks and a few select companies like Tata Motors and Sesa Sterlite. However, we see two encouraging signs. - First, the average earnings growth has been close to 14% in the last four quarters (Q2FY2014 to Q1FY2015) as against less than 5% in the four quarters preceding these (Q2FY2013 to Q1FY2014). That shows sustained improvement in the growth trajectory (refer to the graph on page 2).
- Second, the earnings growth in the domestic-demand driven sectors (non-export companies) also improved significantly to around 12% in Q1FY2015 which is way higher than the growth trend of low single digits in the past ten quarters.
The trends are comforting and support the expectations of an improvement in the earnings growth (though the improvement would be more gradual than the unrealistic expectations of a sudden revival in the earnings from certain sections of the market). Steady growth in revenues
The revenues of the Sensex companies on an aggregate basis expanded at 14.3% year on year (YoY; ex energy), largely contributed by automobiles (auto; mainlyTata Motors), fast moving consumer goods (FMCG), information technology (IT) and pharma sectors. The capital goods sector has disappointed the most while the other sectors are showing close to a double-digit growth in the top line. As the government is focusing on consumption and the economy is gradually reviving (as suggested by the better IIP numbers and increase in the non-oil, non-gold imports), the revenue growth can get better in the ensuing quarters Margins on uptrend, earnings growth to turn more broad-based going ahead
The operating profit margin (OPM; earnings before interest, tax, depreciation and amortisation [EBITDA]) for the Sensex companies (ex banks) expanded on both sequential and year-on-year (Y-o-Y) bases by over 100 basis points (BPS) to 19.2%. The sectors like energy, auto and pharma posted an increase in the EBITDA margin while the capital goods and IT companies saw margin pressure on a sequential basis. The earnings breadth was stable as compared with Q4FY2014 (nine companies in the Sensex posted a decline in earnings), though it is likely to improve going ahead. Consensus earnings estimates--upgraded again
With the second consecutive quarter of an upgrade in the consensus earnings estimate for the Sensex, the consensus is already building that the earnings would grow at a 16.7% compounded annual growth rate (CAGR) during the two-year period of FY2014-16. That is a significantly higher growth rate as compared with close to 8.2% average earnings growth in the past six years. Thus, we do not expect any significant upgrade in the Sensex' consensus earnings estimate from the current level but we do expect the mix of earnings to turn more broad-based with the growth in the domestic cyclicals picking up going ahead. Q1FY2015 Pharma earnings review Key points - The strong performance of pharma companies in our universe continued during Q1FY2015, on the back of a strong recovery in the domestic formulation business, benefits of exclusivity on generic Cymbalta and better traction in the base business. On an aggregate basis, these players reported a 25% rise in net sales, a 168-BPS expansion in the OPM and a 22% growth in the earnings during the quarter.
- While most of the players reported a performance either broadly in line with expectations or better than expected during the quarter, players like Aurobindo Pharma, Lupin and Torrent Pharma surprised us positively. The disappointment came from Cipla, Divi's Labs and Dishman Pharma.
- 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) the integration of the newly acquired entities by the key players as it would affect the operations in the short term; and (c) the strong growth achieved in the Indian market (from a low base) as it may not sustain.
- Most of the players in our universe have been re-rated successively on the back of improved fundamentals and positive market sentiment. Though some of these players are trading at historically high multiples, but 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 most stocks in our universe to a Hold rating.
- Our preferred picks are: Aurobindo Pharma (focus on niche segments; integration of API units of Actavis); Lupin (focus on niche segments); and Torrent Pharma (integration of branded business of Elder Pharma).
STOCK UPDATE Gayatri Projects
Recommendation: Buy
Price target: Rs180
Current market price: Rs124 Q1 weak; better outlook for H2FY2015 Key points - In Q1FY2015, the stand-alone revenues of Gayatri Projects Ltd (GPL) declined by 23.0% year on year (YoY) to Rs342 crore on account of execution delays caused by the Telangana related issues facing Andhra Pradesh. The weakness in the stand-alone performance could continue in Q2 also but the management is quite confident of better order inflow and execution rate from the third quarter of this fiscal.
- In terms of subsidiaries, Gayatri Infra Ventures (has seven road projects of which six are operational; GPL has a 70% stake and 30% is with private equity) does not require any more equity infusion and all the operational road projects are generating enough free cash after accounting for the interest charges and debt repayments. In power, Gayatri Energy Ventures Pvt Ltd (GEV; a holding company for two power projects of 1,320MW each) also reported a steady progress in construction and the first phase (660MW) of one of its projects (in joint venture with Singapore-based Semcorp Industries) is likely to get commissioned in Q3FY2015. NCC Power projects (GEV: 25%, Sembcorp: 45%, NCC: 30%) is on schedule with the equity requirement of GEV at Rs250 crore, assuming GEV increases its stake to 35%.
- The management is hopeful of an improvement in the overall business operations during H2FY2015. Firstly, the order inflow of its stand-alone operations should pick up while issues related to irrigation orders will get sorted out improving the overall stand-alone profitability. Secondly, the two phases of power projects will be commissioned during the period, leading to a re-rating of the valuation of its power assets. Thirdly, debt should gradually reduce with options like raising of equity capital, deferment of debt and monetisation of road asset. We have revised our estimates for FY2015 and FY2016 downwards after factoring in lower execution of orders on account of the issues mentioned above. We maintain Buy on the stock with a price target of Rs180.
MUTUAL GAINS | Debt Mutual Fund Picks Bond / Debt market round up - Bond yields declined over the month due to fall in both consumer and wholesale inflation rate coupled with an increase in the investment sub-limit of Foreign Institutional Investors (FII) in bonds. The Central Bank introduced a new 10-year benchmark paper 8.40% GS 2024, which witnessed strong demand. As a result, the cut-off yield on the new 10-year benchmark paper came in at a much lower level compared to 8.83% GS 2023. However, the Central Bank's unexpected decision to sell the new 10-year bond in the weekly auction for the second consecutive week and also at a higher amount, capped the gains. In the weekly auction, out of Rs14,000 crore, the allocation towards the new 10-year paper stood at Rs9,000 crore against the usual allocation of Rs7,000 crore.
- The yield on the 10-year benchmark bond fell 2 bps to close at 8.72% against the previous month's close of 8.74%. The yield on new 10-year paper bond yield closed at 8.50%.
Bond / Debt Outlook - The bond yields are likely to remain range bound due to higher supply of papers from the Central Government. Next month, the Central Bank will conduct the auction of 91-days, 182-days and 364-days Government of India Treasury Bills for an aggregate amount of Rs60,000 crore. It will also conduct the auction of dated securities for an aggregate amount of Rs70,000 crore.
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