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Moderation in earnings
Expect moderation and high dispersion in earnings growth.
The 3QFY11 earnings season should flag off the moderation in earnings
momentum, with 25% YoY growth in Sensex consolidated earnings, versus
45% in 2Q. With the favourable base effect wearing off and margin
pressures creeping in, variance in performance across companies is rising.
Our growth forecast for Sensex EPS in FY12 is a healthy 19%, but upgrade
potential is concentrated in cyclicals and we see margin risks for domestic
cyclicals. Overweight global plays in metals, energy and IT.
Earnings growth moderation should be visible in 3Q. As with the
Sensex, CLSA Universe (ex-oil & gas) should see earnings growth slow, to
22% YoY, from 27% YoY in 2QFY11. Reported profit growth will be 50% for
autos, pharma and oil & gas (private), but telcos, cement and oil & gas
(state-owned) should see YoY profits decline. Top-line growth will ease
6ppt versus 2Q, as the base effect starts to wear off for domestic cyclicals
(autos, banks) as well as global cyclicals (metals and private oil & gas).
Ebitda margins will be 126bps higher than 2Q, but primarily due to
seasonality and strong commodity margins; eight domestic sectors will see
margins fall YoY. Interest cost too will rise 7.6% on a sequential basis,
against 0.6% in 2Q.
Expect high dispersion in earnings growth. The trend in earnings
across companies clearly reflects the move into a more mature phase of
the growth cycle, when operating leverage gains wear off. For 3Q,
standard deviation of growth/average growth is likely to be 4.5x, versus
1.4x in 2Q. Dispersion of growth within sectors is highest for oil & gas,
capital goods and power.
Where are the biggest swings? The autos, metals and oil & gas (state
owned) sectors will see a significant easing in YoY growth momentum, vis-à-
vis 2Q. Pharma, cement and telecom will see stronger growth/lower losses.
The biggest positive swings among stocks will be in Cairn India (CAIR IB -
RS341.6 - O-PF), ONGC (ONGC IB - RS1225.9 - O-PF), Ambuja Cements
(ACEM IB - RS133.4 - SELL). Tata Motors (TTMT IB - RS1259.0 - BUY),
Ranbaxy (RBXY IB - RS602.3 - U-PF) and Sesa Goa (SESA IB - RS343.1 -
SELL) will, however, see a significant deceleration in growth.
Overall growth healthy, but mixed trends. For FY12, our bottom-up
Sensex EPS forecast suggests a healthy 19% growth. However, our
analysts see greater risk of upside only for the metals, energy, IT and
pharma, given macro headwinds, base effect and rising competition for
others. We thus see market returns in 2011 limited to 11%, but metals, IT,
energy and industrials look to be outperformers. BHEL (BHEL IB -
RS2306.9 - BUY), Dr Reddy's Labs (DRRD IB - RS1716.3 - BUY),
Hindalco (HNDL IB - RS250.8 - BUY), IDFC (IDFC IB - RS168.3 - BUY)
and M&M (MM IB - RS769.9 - BUY) are our top picks.
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