Q3FY11 Result Review - dodge ball: Top line healthy ::Edelweiss

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Q3FY11 Result Review - dodge ball: Top line healthy but margin headwinds gather momentum

n  Rising cost pressures dent earnings growth

Q3FY11 earnings for our coverage universe (ex OMCs) came in at 23.1% against our expectation of 20.4%. However, a large part of the positive surprise was contributed by higher–than-expected earnings of ONGC (actual INR 71 bn versus expectation of INR 45 bn). Ex ONGC and OMCs, earnings growth stands at 16.8%, which is below our estimate. The biggest positive surprise came in oil & gas, IT, BFSI, retail, and media, while metals, telecom, and power surprised on the downside. For most stocks where earnings came in below our estimate, rising cost pressure was a determining factor. In our view, this phenomenon will intensify further in the coming quarters, thereby pressurising earnings.

n  Top line steady but margins negatively impacted across sectors

Revenue growth, though continues to be healthy, our coverage universe’s (ex OMCs) revenue, at 19.4% Y-o-Y, was almost in line with expectations, reflecting the robust demand scenario in the economy. Growth in the top line surprised on the upside for a mix of both global- as well as domestic-oriented sectors. Among global-oriented sectors, growth surprised on the upside in metals & mining, while within consumption-oriented sectors, positive surprise came from FMCG, media, and retail. 

EBITDA margins, meanwhile, continued to be under pressure, expanding a paltry 16bps Y-o-Y for our coverage universe (ex OMCs) versus our expectation of 81bps expansion. Margins remained under stress across the spectrum with both cyclical and defensive sectors facing the heat of increased cost pressure. A few sectors where margins came in below expectations include cement, telecom, real estate, pharma, metals, FMCG, and hospitality. 

n  Cost pressures set to intensify; downgrades outnumber upgrades

While overall demand environment remains robust, rising headwinds from cost pressures dented margins across sectors. Margins with in auto and capital goods declined on the back of rising commodity prices, while rising input costs (power, fuel) affected margins in the cement sector. Meanwhile, costs remained high in rate sensitive sectors such as real estate and construction because of rising borrowing costs. While the full impact of rising cost pressure is yet to be fully factored in, there have already been a slew of downgrades over the past three months with in our coverage universe. Major downgrades were in construction (HCC, Nagarjuna, JPA, IVRCL), real estate (DLF, Anant Raj) and power (Navabharat, Reliance Infra). This has also been borne out by consensus downgrades across these sectors as well.

n  Outlook: Earnings trajectory softens; focus shifts to FY13 estimates

Post Q3FY11 results, our earnings estimates for Sensex for FY11, FY12, and FY13 are INR 1,040, INR 1,264 and INR 1,486, respectively. Although we have downgraded our FY12E from INR 1,271 to INR 1,264, we believe there could be further downside risks to earnings estimates. Rising input costs continue to contribute to a tricky macro environment and in our view, the 18% Y-o-Y growth rate for FY13E will be severely tested as margins become more susceptible to cost pressures.