Sharekhan Special Q3FY2011 earnings preview

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Sharekhan Special
Q3FY2011 earnings preview


Key points
The third quarter of FY2011 started on an extremely
positive note with the equity markets surging sharply
in September 2010 on the back of the continued
momentum in economic revival and strong foreign
inflows. However, the sentiments turned edgy by the
end of the quarter due to a series of negative news
flow (scams, political instability etc) and the
emergence of macro headwinds in forms of rising
commodity prices globally and stubbornly high food
inflation domestically.

On the earnings front, the news flow remains positive.
In spite of the higher base of the previous year and
the emerging macro headwinds, the cumulative
earnings of the Sensex companies in Q3 are estimated
to grow at a healthy rate of 21.8% (over Q3FY2010)
and the Sensex’ earnings (ex-oil companies) are
estimated to grow by 16.3% year on year (YoY).
The growth in the earnings of the Sensex companies
(ex-oil companies) would mainly be achieved on the
back of a relatively better performance in the oil &
gas companies (up 75.9% YoY); the automobile sector
(a 54.3% year-on-year [Y-o-Y] earnings growth) and the
metal sector (a 50.0% Y-o-Y earnings growth).
Meanwhile, the telecommunications (telecom), utilities
(power generation) and pharmaceuticals (pharma)
sectors are likely to be a drag on the Sensex’ earnings.
Within sectors, the stocks that will comprehensively
outperform their peers in terms of better Q3FY2011
results are Tata Motors, Tata Steel, Tata Power, HDFC
Bank, Tata Consultancy Services (TCS), Bharat Heavy
Electricals Ltd (BHEL) and ITC whereas the
underperformers would be Maruti Suzuki, Reliance
Communications, National Thermal Power Corporation
and Cipla.
Given the expectations of the Q3 report card, the
implied growth for earnings in Q4 works out to a steep

25-26% to achieve the consensus estimate for FY2011.
This leaves little scope for error. Consequently, it would
not be surprising if the Street downgrades the FY2011
and FY2012 earnings estimates marginally after the
announcement of the Q3 results especially given the
pressure on the input cost and the stressed liquidity
during the third quarter.
At the current level, the Sensex is trading at 15.5x
one-year forward earnings (on a rolling basis) which is
close to its long-term average multiple. The valuations
are not expensive anymore and would limit the
downside risk from the current levels.


Sectoral previews
Auto: Strong volume growth but operating environment
challenging
Strong volume led top line growth...: The automobile
industry reported record volumes during the festive
quarter of FY2011. Hero Honda Motors crossed the 5
lakh monthly mark in two-wheelers while Maruti Suzuki
created a new monthly record in passenger cars. We
expect the top line of the automotive companies under
our coverage to show a 27% Y-o-Y growth and a 3%
quarter-on-quarter (Q-o-Q) rise in Q3FY2011.
We expect the revenue growth to be largely volume
driven as the industry shied away from meaningful price
hikes during this quarter. For instance, tyre
manufacturers were price leaders in the previous few
quarters but remained laggards in Q3FY2011 in spite
of a spike in natural rubber prices. Similarly, leaders
such as Maruti Suzuki, and Mahindra and Mahindra
(M&M) restrained from price increases to protect their
market share as competition intensified. The industry,
however, took pricing action of 1-3% from January 1,
2011 and would see the benefit of the same coming
through in Q4FY2011 only.
...translating into a modest bottom line: We expect
our coverage universe to report a 13% Y-o-Y bottom
line growth but a 9.8% sequential decline for Q3FY2011.
Outperformance based on the Q3FY2011 earnings can
be expected from Bajaj Auto and M&M amongst the
original equipment manufacturers (OEMs) and Greaves
Cotton, SKF India and Fag Bearings in the ancillary
space.
What to focus on? For all OEMs we would see their
contribution per vehicle as the primary checkpoint of
quarterly performance as it would reflect the pricing
power of their business. We also expect higher volumes
to selectively yield favourable operating leverage.
Similarly, in the auto ancillary space, we would keep
an eye on the contribution margins. Overall, we expect
the Q3FY2011 contribution margins to decline by an
average of 50 basis points sequentially.


Banking: Strong growth despite hurdles
Strong growth despite hurdles: Banks under our
coverage are expected to post a strong growth in their
net income driven by a pick-up in the credit growth
coupled with an increase in the lending rates (prime
lending rate [PLR] and base rate). Despite a lower
treasury income and a rising credit cost, we expect
the banks to post a healthy growth in their profits (up
22% YoY and 3.1% QoQ ex-Union Bank of India [UBI]),
led by a strong growth in their net interest income
(NII) and the low base of the previous year.
Healthy operating performance: Led by a pick-up in
the credit growth (up 24% YoY vs a rise of 19% YoY in
Q2FY2011), an increase in the lending rates and
improved yields on investment, we expect these banks
to report a strong growth during Q3FY2011. We expect
the NII of the private banks to grow by 28% YoY on an
average (ex-ICICI Bank) and by 35% for the public sector
banks (PSBs). Sequentially, we expect an NII growth of
3.8% for the PSBs and that of 3.5% for the private banks.


Most of the banks have increased their PLR/base rates
by 100 to 150 basis points which would ensure a strong
growth in the top line.
Earnings—growth to sustain: Though the profit growth
is likely to get affected by lower treasury gains, rising
credit cost and increased operating expenses, we
expect a healthy growth in the profits. Tight liquidity
during the quarter led to an increase in the benchmark
yields, which resulted in lower treasury gains and
increased investment provisions during the period. In
addition, the operating expenses are likely to go up
(especially for the private banks) due to higher
employee expenses.
Margins and cost pressure likely: We expect the net
interest margin (NIM) to decline by about 10-15 basis
points sequentially due to a sharp increase in the
deposit rates. Most of the banks have increased deposit
rates by 150 to 200 basis points between October and
December of 2010 which is likely to affect the third
quarter’s margins. However, the impact of the rates
hikes will mostly get reflected in the ensuing quarters.
On an average, we expect the NIM to stabilise 25 to 30
basis points lower than the current levels. In case of
excessive monetary tightening by the RBI, there will
be greater pressure on the margins of these banks.
Asset quality: We expect the asset quality of banks to
remain largely stable in Q3FY2011, with some blips in
case of the PSBs. Slippages from restructured assets
coupled with system-based non-performing asset (NPA)
recognition had contributed to an increase in the NPAs
during Q2FY2011. While we believe the slippages from
the restructured assets have peaked and there could
be some slippages from sectors like small and medium
enterprises (SME) and real estate. Broadly we expect
the NPAs to improve in case of the private banks; the
PSBs may see NPAs in line with the Q2FY2011 level.
Outlook: Bank stocks have corrected significantly
following the steep increase in deposits rates, rising
inflation and eruption of several scams. As the inflation
rate continues to head northwards, the RBI may resume
monetary tightening which may lead to a higher
interest rate scenario and affect the credit growth over
time. However, we expect liquidity to ease in
Q4FY2011 led by government spending and better
deposit growth which will support the credit growth.
Further, the economy is back on growth path and most
of the sectors are contributing to the growth, which
lessens the impact on the asset quality of banks. Given
the macro environment, the banking sector is likely to
underperform in the near term. However, we are
sanguine about the medium-to-long-term growth story
in the sector and believe that the on-going weakness
would provide attractive entry point for investors.


Capital goods & engineering: Top line growth to pick up
on improved execution
Top line growth to perk up in Q3FY2011: We expect
most of the capital goods companies under our
coverage to report a pick-up in execution in Q3FY2011
and post a cumulative top line growth of 25.3% Y-o-Y.
This would provide the needed boost to their overall
FY2011 performance as their H1FY2011 results were
largely a disappointment on the execution front. In
H1FY2011, our capital goods universe reported a
subdued 16.5% Y-o-Y growth in the top line on account
of slower execution of projects, delay in pick-up from
the client side and sluggishness in global demand.
OPM to witness pressure: Most of the capital goods
companies under our coverage saw their operating
profit margin (OPM) improve in FY2010, especially on
account of margin expansion in H2FY2010. We have
seen their margins continue with the growth trend in

H1FY2011 on a yearly basis on the back of a higher
base of sales as well as a favourable commodity cycle.
Now, we feel that the impact of a rise in the prices of
commodities like copper and a higher base effect would
start reflecting in subdued margins. EMCO is one
company which requires to be very closely watched for
its operating performance in Q3FY2011. The company
reported an operating loss in H1FY2011 marred by severe
competitive pricing pressure in the transformer segment
and cost overruns in its project business.
…moderate growth in net profit: We have assumed
the interest expense of most of the companies to be
slightly higher for the third quarter compared with
H1FY2011 levels amid hardening working capital
requirements and rising interest rate scenario. In view
of the lower OPM on a Y-o-Y basis, we expect the
cumulative bottom line of the companies under our
coverage to grow by 16.6% YoY.
Outlook: The concerns over competitive pressure in
the wake of a slew of boiler turbine generator orders
won by Chinese power equipment manufacturers from
Indian power developers in the last two months have
aggravated. This has also led to the underperformance
of the capital goods index against the broad indices.
However, we feel that the concerns with regard to
competition are overdone as there are many more orders
expected in the power sector particularly from the state
utilities. Further, due to the impending closure of the
11th Five-Year Plan we are expecting accelerated
investment in the power T&D space. This would benefit
particularly the transformer companies like Crompton
Greaves and EMCO under our coverage. We also believe
that better than expected order intake and execution
would act as positive triggers for this space. Also, the
recent correction has provided a good entry point to
the investors in this space. Our top picks in the space
would be L&T, BHEL, Thermax and V-Guard Industries.


Cement: Poor volume coupled with cost pressure to dent
earnings
Prolonged monsoon disappoints cement offtake
during Q3FY2011: Due to the prolonged monsoon and
poor demand from the real estate segment, the cement
off take in the domestic market was severely affected
in Q3FY2011. The all India cement dispatches year till
date (YTD; April-Nov 2010) grew by around 6.1% as
compared to industry’s expectation of a volume growth
of 8-9% for FY2011. The performance of the industry
in terms of volume growth in Q3FY2011 is likely to
deteriorate as the volume growth for October-
November was restricted to just 5.1% on a Y-o-Y basis.
Particularly the volumes during the quarter have
declined for the companies operating in the southern
region. Thus, among the companies in the Sharekhan’s
cement universe, the south based ones like India
Cements, Madras Cements and Orient Paper &Industries
(Orient Paper) are likely to register a sharp decline in
their dispatches for Q3FY2011. Whereas JP Associates
is expected to post healthy volume growth.
Prices recovered due to supply discipline by
manufacturers: Cement prices were quite volatile
during Q3FY2011 as they underwent movement in the
southward as well as the northward direction. Due to
the unabsorbed impact of the price hike undertaken
at the end of Q2FY2011, the average price of cement
for Q3FY2011 is expected to register a sharp sequential
growth for the south based companies. Among our
coverage companies the realisation on a sequential
basis is expected to improve in the range of 6% to 15%.
Companies with higher exposure to the southern region
like India Cements, Madras Cements and Orient Paper
are expected to post a sharp sequential growth in their
realisations. As per the recent channel check, the prices
are stabilising and are set to increase in January with
a gradual pick up in cement offtake.
Cost pressure to offset positive impact of increase
in realisation: Given the poor volume offtake, the
revenues of most of the companies under our coverage
are likely to decline in the range of 1% to 8%. Further,
cost inflation in terms of higher coal/pet coke prices
and an increase in freight cost (due to increase in lead
distance and diesel price) are expected to offset the
positive impact of increase in realisations. The OPM
performance of companies under our coverage is likely
to be mixed with south based companies expected to
register an expansion in their margins in the range of
3 to 4 percentage points whereas other companies are
expected to show a contraction in their margins in the
range of 5 to 20 percentage points.

Poor performance at the bottom line: In addition to
the poor performance in top line and cost pressure,
the cement companies are expected to have faced
more pressure on their bottom lines in Q3FY2011 due
to a sharp increase in the interest and depreciation
charges due to capacity addition carried out in the
last one year. The bottom lines of India Cements and
Madras Cements are expected to grow by over 30%
due to the low base effect and a sharp price recovery
whereas the bottom lines of Grasim Industries (Grasim),
Shree Cement and Orient Paper are likely to decline in
the range of 30% to 77%. Further, the bottom line of
diversified JP Associates is expected to fall by 22.7%.


Construction: Execution picks up post monsoon but high
interest cost to dampen growth
Execution to pick up post-monsoon: With the monsoon
season over, we expect the execution of projects to
pick up. Thus, we expect the revenue of the
engineering, procurement and construction (EPC)
companies (ex-Punj Lloyd) in our universe to grow by
20% YoY. On the asset development side, we expect a
62% year-on-year (Y-o-Y) growth for IRB Infrastructure
Developers (IRB Infra) on the back of robust EPC
revenues as two to three of its projects commenced
construction during the quarter. We expect a 4%
quarter-on-quarter (Q-o-Q) growth for IL&FS
Transportation Networks (India) Ltd (ITNL; the Y-o-Y
figure is not available) as four of its projects that had
commenced construction in Q2 picked up momentum
in the third quarter.
Higher working capital during H1FY2011 to put
pressure on earnings: Poor execution during H1FY2011
had resulted in a surge in the working capital days across
the construction industry. This resulted in higher
borrowings which will lead to a higher interest cost
during the third quarter. Thus, despite a flat OPM YoY, a
higher interest cost will lead to a 16.4% Y-o-Y growth in
the profit after tax (PAT) for the EPC companies (ex-Punj
Lloyd). In case of IRB Infra, we expect a 14% Y-o-Y growth
in the PAT due to a lower operating margin on account of
a higher contribution from the EPC business. For ITNL we
expect a flat growth sequentially.
Sluggish order inflow in Q3FY2011, Q4 to see revival:
The order inflow for the whole of Q3FY2011 was muted
at Rs36,170 crore and saw a fall of 19% YoY and that of
23% QoQ. In fact, the order inflow has been consistently
falling since the last three quarters. We believe the
telecommunications (telecom) scam along with the LIC
Housing Finance scam resulted in weak momentum
during the quarter. However, the last fortnight of the
quarter (accounting for one-third of the total inflow
during Q3) showed a pick-up in the project awarding
activity and we believe the trend should continue in
Q4FY2011.
Watch out for execution, be selective: After
witnessing a slowdown in the project awarding activity
over the last two to three quarters, the order inflow
seems to be picking up recently. This will keep the
order book position for the construction companies
healthy, thus providing a strong growth visibility.
However, the pick-up in execution remains one of the
key variables and re-rating factors to watch out.
Normally, the second half of a fiscal is robust for
construction companies in terms of execution. Hence,
execution should pick up from Q3FY2011 onwards. Given
the recent steep correction and underperformance of
this sector, the valuations of the major companies in
this space have turned attractive. We like ITNL and IRB
Infra among the larger players and Pratibha Industries
among the smaller players.


FMCG: Volume-led top line growth; margin pressure
persists
Top line growth—largely volume driven: We expect
the top line growth of Sharekhan’s FMCG universe to
be at around 16.0% YoY, primarily driven by strong sales
volume in various categories during the quarter. The
strong volume growth can be attributed to buoyancy
in rural demand due to better monsoon, improved
consumer sentiments and sustained higher investments
on advertisement and promotional activities. Most of
the companies have implemented price hikes to cover
the sharp increase in the input cost during the quarter.
With improved macro parameters and consequential
pick-up in consumption, we don’t expect these price
hikes to have any significant impact on the sales volume
of the categories (except the highly competitive
categories such as soaps, detergents and shampoos).
In fact, it will add on to the overall value growth of
the companies in Q3FY2011.
Higher commodity prices continue to hurt margins:
The sharp increase in the key input prices and
sustenance of higher investments towards
advertisement and promotional activites would
significantly affect the operating margins of the
companies under the Sharekhan’s FMCG universe in
Q3FY2011. Although the companies have implemented
price hikes (in the range of 5-15%), these are not enough
to cover the spike in the input prices (especially palm
oil and copra). Hence we expect the bottom line growth
to be lower compared to the top line growth for most
of the companies in Q3FY2011.
Sector outlook: With the on-going festive season and
improved consumer sentiments, we expect the
sustenance of the strong sales volume growth in the
domestic market in the coming quarter. However any
further increase in the key input prices would continue
to hurt the margins going forward. Thus we expect the
companies to further increase the product prices in
the coming quarters. We expect these price hikes to
get absorbed by the market and would not have any
significant impact on the sales volumes of the
companies.
On the other hand, the longer term consumption story
remains intact and we expect all the FMCG companies
to continue to grab opportunities in the domestic
market. Further, most of the FMCG companies
(including Godrej Consumer Products Ltd [GCPL],
Marico and Dabur) have enhanced their focus towards
building up international portfolios and expanding their
reach into various international markets (especially
the growing economies). The international business
currently contributes around 20-30% to the overall
turnover of these companies. This augurs well for these
companies from the long-term growth perspective.
Top picks in the sector: With a de-risked business
model and strong earnings visibility over the long run,
we maintain our penchant for ITC in the large cap FMCG
space. On the other hand, with a recovery in the core
soap segment and expected strong performance by the
recent acquisitions, we like GCPL among the mid-cap
FMCG stocks.


Others
Indian Hotels—increase in occupancies and ARRs to
boost profitability: We expect Indian Hotels Company
Ltd (IHCL)’s top line to grow by 12.7% YoY to Rs493.6
crore. The double-digit growth is attributable to a
strong improvement in occupancies and an increase in
the average room rentals (ARRs). With a strong growth
in foreign tourist arrivals and buoyancy in domestic
tourism, we expect the occupancy ratio to stand at
73% and the average room rate (ARR) to increase by
more than 10% in Q3FY2011. Thus, we expect the OPM
to improve by 167 basis points YoY to 36.2% and the
operating profit to increase by 18.2% YoY. This along
with the expected lower interest cost would result in
around 25% Y-o-Y growth in the adjusted PAT.


IT: Expect to exceed expectations...
Revenue growth could surprise in a traditionally
weak quarter: The December quarter has traditionally
been weak for information technology (IT) companies
owing to a lower number of working days as compared
to the number of days in the other quarters. However,
this year we expect the IT companies to spring some

positive surprises on the revenue front led by the
continuity of demand traction from the previous
quarters and a demand uptick in the lagging sectors.
We expect the revenues of the top four IT companies
to show an average growth of 7% QoQ in this December
quarter. In terms of the demand outlook for FY2012,
the market will keenly monitor the management
commentary on client budget for CY2011 (which is
expected to be higher by 2-2.5% as per recent
consensus management expectations), the broad-based
recovery and the sustainability of the demand in
verticals other than the banking, financial services and
insurance (BFSI) vertical.
Margin performance could be better than the Street’s
expectations: The key differentiator for the top-tier
IT companies’ valuations in a strong demand scenario
would be their margin performance and their outlook
on the same. We expect the margin performance to
be better than the Street’s expectations, with some
significant outperformance from Tata Consultancy
Services (TCS) and HCL Technologies (HCL Tech); both
the companies’ managements had earlier hinted at
pressure on the margins for the December quarter.
Key things to watch out for...
Employee attrition (expected to remain stable, with a
marginal improvement).
The overall demand outlook, clients’ IT budgets for CY2011,
update on the European region, uptick in discretionary spend.
Pricing environment.
Update on hiring plans (lateral hiring plans).
Valuation—eye will be on margin hiring, demand
environment already in comfort zone: In the last few
quarters we have already witnessed some significant
revenue upgrades for the IT sector. We expect the
demand to get more broadbased and the uptick in the
pricing to further propel revenue upgrades for FY2012.
However, we still have concerns on the margin lever
execution for FY2012 on account of a higher people
related cost and fatigue in the existing margin levers
like utilisation. Nevertheless, we expect the consensus
earnings upgrades to continue in the coming quarters
with the sustained buoyancy in the demand. In recent
months the entire IT sector has ridden the growth
momentum and continued to outperform the broader
market indices. The current valuations of the tier-I IT
companies appear a bit stretched and we expect
consensus earnings upgrades for FY2012 which will
provide some cushion to the current risk-reward parity.
We remain positive on the IT sector and our top IT
picks remain HCL Tech and Polaris Software Lab
(Polaris).



Oil & Gas: Strong earnings growth for upstream
companies
Improved gasoline and naphtha crack spread led to
higher GRMs in Q3FY2011: The regional benchmark
Singapore gross refining margin (GRM) averaged $5.5/
barrel (bbl) in Q3FY2011 against $4.2/bbl in Q2FY2011
and $1.9/bbl in Q3FY2010. The strong Q-o-Q and Y-o-Y
GRM performance is mainly led by higher gasoline and
naphtha crack spreads.
Brent crude oil prices improve; Rupee appreciates:
Average Brent crude oil’s price increased by 13.2% QoQ
and 16.5% YoY to $87.7 per barrel in Q3FY2011. This is
likely to positively affect the earnings from the
exploration and production (E&P) businesses of the oil
and gas companies. The exchange rate of the Indian
Rupee (INR) against the US Dollar (USD) appreciated
by 3.8% on QoQ as well as YoY basis to $44.85 during
the quarter.
Light-heavy crude price differential improves
significantly in Q3FY2011: The Arab light-heavy
differential increased by around 10% QoQ to $3.1/bbl
in Q3FY2011 as compared to $2.8/bbl in Q2FY2011.
However, the same is up strongly by 107% YoY.
Petrochemical—polyester spread increases in
Q3FY2011: The polymer spreads were down by around
3% QoQ while the integrated polyester spreads were
up around 15% QoQ in Q3FY2011. As most of the new
petrochemical plants in the Middle East and China
started operations, we believe that the Asian
petrochemical markets would add some surplus
capacities going forward, thus putting pressure on the
overall petrochem margins. However, a strong demand
in the domestic market should protect Reliance
Industries’ (RIL) and GAIL’s petrochem margins.

Subsidy burden to increase by 51% QoQ: We expect
under-recoveries of Rs17,086 crore in Q3FY2011, which
is higher by 51% on a Q-o-Q basis, mainly on the back
of an increase in the international crude oil prices. On
the assumption that upstream would bear one-third
under-recoveries, we expect the upstream share of
under-recoveries to be Rs5,695 crore. The remaining
under-recoveries would be shared between the
government and the oil-marketing companies (OMCs).
However, as of now there is no exact clarity on the
government’s share in the under-recoveries.
Outlook: We mention in this note that the lack of clarity
on the subsidy sharing mechanism and the timing of
diesel de-regulation would remain an overhang on the
OMCs. Upstream companies (ONGC, OIL and GAIL) are
expected to report strong earnings growth in Q3FY2011
despite an increase in their burden of under-recoveries.
We expect refining margins to improve gradually while
the excess petrochemical capacity would keep the
petrochem margins under check in the near to medium
term. We expect GAIL to outperform the Indian oil and
gas space on the back of its strong earnings growth
outlook.


Others
Sintex
The revenue visibility in the monolithic business of
Sintex Industries continues to be strong, with the
current order book position pegged at approximately
Rs2,600 crore (3.6x FY2010 revenues), similar to the
levels seen at the end of Q2FY2011.
Aided by a strong execution-led growth in the
monolithic segment and increasing uptake from the
custom moulding segments, the company’s top line is
expected to post a growth a 17% YoY with a margin of
18.1% for the quarter and adjusted earnings growth of
19%. We estimate the top line figure at Rs978 crore
for Q3FY2011, with a strong 55% Y-o-Y growth in the
monolithic segment. For the quarter we expect a 70-
basis-point expansion in the margin from 17.9% in
FY2010.


Pharmaceutical: Another strong quarter
Steady growth continues in Q3FY2011: We expect
the pharmaceutical (pharma) companies to report a
steady growth in Q3FY2011. The growth is expected
to be driven by new product launches in the US, a
strong growth in India and a higher penetration in the
emerging markets. However the contract research and
manufacturing services (CRAMS) business would recover
gradually as demand is picking up at a snail’s pace. A
sharp pick-up in the abbreviated new drug application
(ANDA) approvals, updates on research and
development (R&D) pipelines and out licensing deals
would act as re-rating factors for generic companies
like Glenmark Pharmaceuticals (Glenmark), Cadila
Healthcare (Cadila), Lupin, Torrent Pharmaceuticals
(Torrent) and Sun Pharmaceutical Industries (Sun
pharma) under our coverage universe.
Buy Glenmark and Sun pharma to play on results:
We believe Glenmark and Sun pharma are result plays
with a possible strong YoY growth. Sun pharma is
expected to put up a strong growth due to the
integration of Taro, whereas midcap companies like
Cadila, Glenmark and Lupin are likely to put on a good
show with a better product mix and niche product
opportunities in the US generic market. Piramal
Healthcare (Piramal) completed its buyback after the
sale of Abbott India (Abbott) and the diagnostics
business during the quarter and hence the numbers
are not strictly comparable. The Indian currency
appreciated by about 4% against the USD during the
quarter which would slightly temper the sales for
companies like Opto Circuits (Opto; high growth seen
due to the inclusion of Cardiac Science numbers) and
Torrent among the companies under our coverage.
Although the pharma sector witnessed fair valuations
during the quarter, yet we believe any weakness around
the results will be an opportunity to buy. We adopt a
pick-and-choose strategy and find value in generic
companies with niche/ low competition products,
strong ANDA pipelines in the US, and strong momentum
in the domestic market


Sun pharma: Integration of Taro and contribution
from low competition products.
Glenmark: Improved base business momentum from
the US (Tarka sales) and the semi-regulated
markets.
Cadila: Growth driven by domestic and export
formulation sales; improved profitability from its
foreign subsidiaries.
Maintain positive bias: The BSE Healthcare index
continued its outperformance over the Sensex. We like
companies with niche/differentiating products having
prerequisites to build a strong generic business to drive
long term growth. Although some companies do look
priced in, yet we believe there is further upside in
select pharma companies with a host of product
launches (Para IVs, limited competition), joint
ventures, and mergers and acquisitions acting as rerating
triggers. We believe focusing on companies with
quality and visibility of earnings would be the recipe
to outperform the market, peers as well as the sector.



Real estate: Pick-up in execution and higher
realisation will lead to good results
With the monsoon season over and construction activity
ramping up, the real estate companies are expected
to post a good set of numbers for the third quarter of
FY2011. Many projects were launched in H2FY2010
revenues from which started flowing from Q3FY2011.
A pick-up in execution of these projects will result in
higher revenue recognition during the third quarter.
Further, the residential prices have risen by 10-20% in
this fiscal which has kept the realisations for the real
estate companies on an uptrend or firm. Even the
commercial sector has seen some firmness. Thus, the
Q3 OPM will see an improvement on a Y-o-Y basis as the
construction cost has not increased at a similar pace.
Volumes of the real estate companies are expected to
be healthy across India given the festive season during
the third quarter. However, in Mumbai the volumes will
see a decline given the steep price rise witnessed in
M9FY2011.
Mahindra Lifespace Developers: We expect Mahindra
Lifespace Developers’ revenues to grow by 5.8% YoY to
Rs115 crore on the back of the revenue booking from
the Aura and Splendour projects which were launched
in H2FY2010. Further, the company launched Aura
Phase II, Eminente Phase III and Aquality phase II during
H1FY2011 which will keep the volume intact. The net
income is expected to fall by 4% YoY to Rs26.7 crore.
Orbit Corporation: The volumes are expected to be
muted during the quarter, given that there had been
no new launches during the last three months. Thus,
only the launches that were done earlier in H1FY2011
will keep the volumes ticking.
We expect Orbit Corporation’s revenues to fall by 24%
YoY on account of a high base effect but expect it to
grow by 17% QoQ to Rs114 crore. We expect Orbit
Grand, Orbit Residency and Villa Orb Annex (the new
projects launched in the last fiscal) to meet the
revenue recognition criteria in this fiscal, thereby
driving the revenue growth. We expect the operating
profit to grow by 30% YoY on account of expansion in
the margin from 28.4% in Q3FY2010 to 48.5% in
Q3FY2011. The third quarter of FY2010 was one of the
quarters wherein the OPM was very low mainly on
account of an increase in the cost of a few projects,
which again improved from Q4FY2010 onwards.
However, despite a strong growth at the operating
level, a higher interest cost along with a higher tax
outgo will result in the Q3 PAT dipping by 39% YoY to
Rs19.5 crore. In the last fiscal the company had claimed
minimum alternative tax (MAT) credit which had
resulted in a tax write-back in Q3FY2010.



Retail sparkles—festive season perks up revenue and
margin
Retail counter continues ringing: The continued
consumer confidence on the back of sustained
economic buoyancy, the festive season (Diwali,
Chirstmas) that fell this time in the third quarter and
a strong winter across the country kept the retail stores
busy with increased footfalls and higher conversion.
The same-store sales growth momentum remains strong
in the high teens, with home retailing witnessing strong
traction along with the other lifestyle categories.
Core EBITDA margin strong: Despite rising employee
and certain other overhead costs, the reasonable
rentals (booked earlier) and sustained strong demand
environment led to booking higher full price sales and
continue to help the retailers earn high gross margins
and similarly decent operating profit margins.
Earnings growth to mirror or exceed operating profit:
We expect a strong earnings growth from the sector.
In our retail universe, we expect a 38.4% Y-o-Y earnings
growth for the quarter.
Kewal Kiran Clothing amongst our retail coverage is
likely to see a strong year-on-year earnings growth of
about 70% in the third quarter of FY2011.


Company Key monitorables
KKCL Road map and strategy ahead for achieving 5x
revenue target aimed by the company
Performance of brands, Integriti and Easies, and
success of accessories category
Provogue The occupancy and the revenue status of the
Aurangabad mall
The roadmap for site commencement of the other
projects
Check on inventory levels
Pantaloon Same-store sales across categories and business
environment post-festive season
Inventory rationalisation’s impact and working
capital cycle
Management’s thoughts on foreign direct
investment in the retail sector and strategic
investor induction in its newly formed Future Value
Retail business
Shoppers Cost structure and the strategy ahead for the
Stop Hypercity format
Titan Ind Performance of the eyewear segment and the
break-even period there
Asset turns in the jewellery segment and share of
studded jewellery in the total mix
Jubilant Same-store sales growth
Food Management guidance on the sustainability of the
same-store sales growth in the long term
Status and development of the inorganic plans
Page Ind Sensitivity of rising raw material prices on the margin



Telecom: Strong quarter on revenue front—led by frenetic
subscriber addition and strong traffic growth
Domestic mobile business expected to post a
sequential revenue growth of 3.1%: On the back of
the strong subscriber addition seen in the last quarter
and a buoyant festive season (more so with a soft base
of Q2FY2011), we expect the traffic momentum to be
strong. Hence, we have modeled a 9% sequential growth
in the traffic. With a stable tariff environment and a
good minute’s growth, we expect the mobile business
to show a 3.1% sequential growth in the revenues.
In the last three quarters, there has been a
considerable improvement in the domestic telecom
environment, which is now witnessing reduced
competitive intensity as is visible in the form of lower
tariff reduction and a strong volume growth. Along with
stabilising tariffs, there has been a strong upsurge in
the volume growth witnessed by the incumbent players
like Bharti Airtel in the last three quarters.
Increasing cost coupled with higher branding spent
and Zain consolidation to take a toll on margins:
Despite the strong revenue momentum and a relatively
benign competitive environment, the margins for the
quarter would be hurt by the increase in the network
operating cost and the surge in the selling, general
and administration expense due to the re-branding
exercise undertaken during the quarter. We expect the
quarterly margin at 33.4% as against 33.7% in
Q2FY2011.


African operations: The consolidated Q3FY2011
earnings of Bharti Airtel are not comparable on a
Y-o-Y basis. For Africa we expect a sequential revenue
growth of 3.1% and an EBITDA margin of 23%.
Key result monitorables
The sustainability of the improvement in the domestic
competitive environment and the company’s 3G roll-out strategy.
The financials and the cost structure of Zain Africa and Bharti
Airtel’s long-term operational strategy in improving the African
business.
The regulatory environment and management commentary on
the same.