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India
Equity Research
Being stock selective in a difficult macro environment; 5 Buy and 4 Sell ideas
GS forecasting 7.5% inflation in FY 2012
Our ECS team has increased their forecast for
inflation from 6.7% to 7.5% for FY12. In this note,
we explore how inflation has impacted corporate
profitability and valuations in previous cycles and
seek to identify companies that could be shielded
in a difficult macro environment.
High inflation a harbinger of lower growth,
lower margins and compressed multiples
Previous periods of high inflation in India have led
to a 200bps compression in EBIT margins, 250-
300bps compression in net margins and a 15%
contraction to earnings multiples. Against this
backdrop, we note that consensus is forecasting a
70bps improvement to EBIT margins and a 30bps
improvement to net margins in CY2011E. Our
earnings forecasts for our coverage group are
10% below consensus in FY 2012. We expect
consensus earnings to decline in the months
ahead. In this note we seek to identify companies
that are relatively insulated from a dynamic of
decelerating growth, as well as those particularly
exposed to the same.
Scenario to 7.5% and 6.9% GDP growth
We have run two scenarios for our coverage in
India. The first assumes a further 75bps hike to
rates, oil prices of $115/bbl and GDP growth of
7.5% in FY2012. The second, more aggressive
scenario, assumes a further 150bps hike to rates,
oil prices of $130/bbl and GDP growth of 6.9% in
FY2012. Under the first scenario, we conclude that
our average earnings would be cut by 6.4% (taking
them 16% below current consensus) and under
the second scenario, our earnings would be cut by
12.4% (going to 22% below consensus).
We identify five ‘Buys’ and four ‘Sell’ ideas
based on a deteriorating macro backdrop
As a next step, we have screened our coverage
under both earnings scenarios and highlight ‘Buy’
rated stocks that trade below historical median
multiples (even at ‘Scenario Two’ earnings). We
highlight Bharti, ONGC, Tata Steel (all CL-Buy) and
Infosys, United Phosphorus (both Buy). Sectors
likely to get impacted negatively are construction,
real estate and cement. Our Sell ideas are ACC,
Hero Honda, SBI and Bank of India.
click on image to enlarge
click on image to enlarge
Summary of analysis
The GS ECS team have raised their inflation forecast for FY12 from 6.7% to 7.5% due to stronger than expected core inflation. The
Reserve Bank of India (RBI) has also hiked the repo rate by 50 bp and the reverse repo rate by 50 bp, in line with our ECS team’s
expectations. Going forward, our ECS team expects inflation to remain elevated in the first half of FY12, before moderating in the
second half.
Historically (over the past 15 years), periods of high inflation have resulted in the following:
Corporate EBIT margins compress during periods of high inflation by an average 200 bps and Net margins by 250-300 bps.
Valuations – expressed as earnings based multiples - compress during periods of high inflation (by an average of 15%)
Overall, periods of high inflation have coincided with downward revisions to Indian corporate earnings (GS forecasts for FY
2012 are – on average - 10% below consensus estimates)
While we are materially below consensus, we have conducted two scenario analyses in which we have explored a further
deterioration in macro conditions.
On a coverage wide basis, our analysts estimate a 12.4% reduction in earnings if crude oil price were to increase to US$130
per barrel and GDP growth for FY12 would reduce to 6.9% (from 7.8% currently). This would put our earnings 22% below
current consensus. Put differently, aggregate FY12E EPS growth for our coverage would almost halve from 22.4% to 12% in
such a scenario.
The Energy sector would benefit in this environment due to pricing benefits on increased oil prices (primarily driven by
Cairn Energy). Utilities would be shielded due to regulated revenue on increased input costs and Information Technology
and Healthcare would be insulated by their limited domestic exposure.
Revenues for Construction, Real Estate and Cement are likely to be negatively impacted as a result of reduced order inflows
and curtailed capital expenditure by corporate India. Automobile sales growth is also likely to get impacted in a high
interest rate environment.
On an earnings basis, the worst affected sectors are likely to be Construction and Real Estate due to high leverage and
consequently higher interest expense along with Cement and Consumer Staples due to higher input costs. Energy
companies with high oil leverage may see earnings growth in such an environment.
In our screens, we have examined P/E and sales multiples, based on bottom-up revenues and earnings forecast under
Scenario 2.
1. Our ‘Buy’ ideas are Bharti (Buy, CL), ONGC (Buy, CL), Tata Steel (Buy, CL), Infosys (Buy) and United Phosphorus
(Buy). We believe revenue and earnings for these companies are relatively insulated from a deteriorating macro
environment and the stock are trading at compelling valuations even if we assume “Scenario 2”.
2. Our ‘Sell’ ideas are ACC (Sell), Hero Honda (Sell), State Bank of India (Sell) and Bank of India (Sell) where there
would be significant revenue and earnings declines if ”Scenario 2” occurs and these stocks would trade expensive
to historical mean multiples in such a case
Scenario analysis
In our recent publication, Asia Economics Analyst:11-08 India: Raising inflation and rate forecasts, reducing GDP (Published April 20,
2011), our ECS team lays down estimates for major economic indicators at different oil price assumptions. In spite of the recent
sharp correction in oil prices, GS Commodities team continue to believe that the oil supply-demand fundamentals will tighten
further over the course of this year, and likely push prices back to recent highs by next year (refer Energy Weekly: Oil price plunge in
a major market correction, published May 6, 2011)
Against our current assumptions of US$ 105 per barrel of Oil, further rate hike of 75 basis points over the rest of CY11 and 7.8% GDP
growth, we stress test our revenue and earnings numbers for all sectors under coverage for FY12E against the backdrop of 2
scenarios based on these assumptions:
2) Scenario 1- increase in interest rates by another 75 bps for CY11E based on recently revised ECS forecasts; oil price estimate at
US$115 per barrel (vs. US$105 per barrel in a base case) and resulting in 7.5% GDP growth for FY12E (vs. current estimate of 7.8%)
3) Scenario 2- increase in interest rates by another 150 bps for CY11E (75 bps higher than Scenario 1); oil price at US$130 per barrel
(vs. US$105 per barrel in a base case) and 6.9% GDP growth for FY12E (vs. current estimate of 7.8%)
Sector Impact of higher Inflation/lower GDP/higher energy price - on revenue and earnings
Agriculture
Revenue: The companies under our coverage group derive about 25% of their revenues from India and the remaining 75%
from other geographies (primarily Europe and US). Revenues derived from India business, particularly soda ash business,
will get impacted with the slow down in India GDP growth. Earnings: As the balance sheets are not significantly leveraged,
and the businesses (soda ash and agri-chem) are not capex intensive, we do not expect margins to get impacted on account
of rising interest rates; higher input costs may impact margins.
Automobiles
i. Beyond a certain level, inflation and interest rates in India have an inverse correlation with auto demand cycle. ii. We
hence believe that demand growth should normalize going into FY2012E-13E to about 11% from >20% growth across
segments in FY2011.iii. In a worse case scenario assuming higher inflation and rates in the economy, we would expect
higher relative impact on companies with: (a) exposure to more sensitive segments like trucks (Ashok Leyland) (b) higher
operating leverage (TVS Motors) (c) higher financial leverage (Apollo Tyres)
Banks
i. Sector can be significantly impacted by any changes to the macro economic forecast in particular in FY13E from the
multiple impact on revenue and provisions, ii. As rates continue to rise the credit growth will likely come off in FY12E and
FY13E from current levels of 22%, iii. Margin could be impacted from lower credit deposit ratio, rising cost of funds and
banks inability to fully pass on rate hikes, iv. While banks may not show NPL increases in FY12E (either due to restructuring
or ever greening), the pressure could increase in FY13E as corporate India’s ability to make timely payment gets affected by
slower volume growth, EBITDA margin pressure and higher interest cost.
Construction
Revenue: Construction companies are likely to get impacted negatively due to reduced order inflow in a high interest rate
and low GDP growth environment which will impact earnings for future years; however, order book coverage of over 2x will
keep topline fairly strong for a couple more quarters. Expect greater impact in FY13E. Road BOT companies likely to benefit
as toll collections are linked to WPI; however, this is negated by lower traffic growth in a decelerating GDP environment.
Earnings: Construction companies margins to be impacted marginally due to operating leverage impact; no significant
impact of input cost as most is pass through; increase in interest rate to impact margins significantly due to high leverage.
Asset owners likely to be impacted due to high leverage business model as net margin erosion may be significant
Construction - Cement
With current capacity utilization levels at low levels of 75-80%, any slowdown in cement demand (which is a function of
economic growth/GDP) would have an impact on pricing. The extent of price weakness would be a function of suppliers
discipine. At the operating level, higher input costs would adversely impact margins, given that the companies would not be
able to pass on the higher costs in a weak demand environment. Higher interest rates would not have significant direct
impact, given that most companies are net cash (except India Cements and Ultratech)
Consumer Staples
i. ITC (cigarettes) and some key products by Nestle, Dabur and Marico are relatively price inelastic or enjoy a dominant
market position to offset short term inflation spikes. On the other hand HUL and Colgate have key products that are very
price elastic and are present in a relatively competitive category (detergents, soaps, toothpaste) and hence would be most
affected.ii. Inflation in fuel prices would also lead to increases in logistical costs as well as increase in cost of packaging,
which tends to be linked to crude prices. iii. Sustained inflation and lower GDP growth over a period of time could affect
volumes and margins for all the companies as consumers will move away from higher margin discretionary spends to lower
margin staples spends
Sector Impact of higher Inflation/lower GDP/higher energy price - on revenue and earnings
Energy
Revenue: Higher oil prices would lead to higher revenues for Cairn India and the Oil refining companies(RIL, HPCL, BPCL
and IOC). Revenues for ONGC and OIL would decline if oil prices rise significantly as their net realizations would go down
on account of higher subsidy burden. Earnings: Higher oil prices would lead to higher earnings for Cairn India but declining
profits for the Oil marketing companies. Also, the earnings of OMCs would be further negatively impacted due to higher
interest expense on account of increased borrowings for working capital requirements.Earnings of the state owned
upstream companies also would be marginally negatively impacted due to higher burden of under-recoveries.
Healthcare
i. The top-10 companies in the Healthcare space get around 70% of revenues from exports, which are immune to
inflationary pressures in India. ii. Also, with the patent expiry opportunity, we expect companies to have higher profitability
from one-off opportunities in the US over 2011-2013. iii. That said, any decline in GDP growth is likely to have a mild impact
on companies which have a higher degree (30%-35%) of exposure to the domestic market like Sun (Sell), Cipla (CL-Sell),
Lupin (Buy) and Cadila (Neutral). iv. We see Jubilant (Buy) and Aurobindo (Neutral) as companies with the highest gearing in
the sector and where any rise in interest rates could impact earnings growth for these companies.
Machinery
Revenue: Capital goods companies are likely to get impacted negatively due to reduced order inflow which will impact
earnings for future years; however, order book coverage of over 2x will keep topline fairly strong for couple more quarters;
expect greater impact in FY13E; Earnings: Margins to be impacted due to input cost increases but forward contracts and
older inventory to slightly shield the bigger companies. Given the cash rich nature of these companies, we do not expect
high interest rate to impact net margins
Media
Advertising revenue growth is closely linked to corporate profitability and hence GDP growth. Broadcasters are likely to see
lower advertising revenue growth in a scenario of lower GDP growth. This will be partially offset by the strong growth in
subscription income - driven by the push towards digital platforms, in our view. The broadcasters have low leverage ratios
and the impact of higher interest rates would thus be minimal. However, given Dish TV's higher debt levels, its profitability
will be significantly impacted by higher interest rates
Metals & Mining
For base metals, domestic pricing is linked to LME prices and India is a net exporter of all 3 commodities - aluminium, zinc
and copper. Our average commodity price assumptions for FY12E are about 10% below current spot prices - hence there is
upside risk to current margins and earnings. A potential slowdown in domestic demand will not impact volumes as net
surplus will continue to be exported, insulating base metals earnings from a potential revenue / margins downside.
However, higher input cost and interest rate to impact margins.
Real Estate
i. Higher borrowing costs could lead to lower residential demand in markets where pricing already appears stretched
(Mumbai, Gurgaon) but could be absorbed more easily by markets where properties are relatively more affordable
(Bangalore, Noida). ii. Higher inflation could also increase costs of construction, which would affect Banagalore based
developers more as they have lower margins. iii. Lower GDP growth could lead to lower demand for commercial space,
although at present most commercial demand is driven by the IT sector.
Sector Impact of higher Inflation/lower GDP/higher energy price - on revenue and earnings
Steel
While steel is a global commodity, the extent of premium/discount of domestic prices to global prices is a function of
relative tightness of the domestic steel market. We believe that any slowdown in GDP would have an adverse impact on
steel consumption and could result in softness in prices. At the operating level, margins would be impacted, depending on
the direction of coking coal prices (which is a function of global factors). In a weak demand environment, Indian steel
makers would not be able to pass on the additional costs, leading to margin compression.
Technology - IT Services
i. The sector is recovering from the margin pressures of 2010 – when it saw a combination of wage inflation + attrition +
Rupee appreciation in 2010 (vs. 2009). ii. We also forecast revenue momentum to be stronger this year, with an overall
improvement in pricing and attrition to come down. iii. All of this would be incremental tailwinds to the sector’s OPM, and
hence we expect margins to be stable.
Telecom Services
i. Impact of higher Inflation/lower GDP on telecom revenues should be relatively low as telcos spending is turning more into
a necessity and is becoming relatively difficult to curtail. ii. Impact on earnings due to higher interest rates should be
relatively greater given higher leverage of Indian telcos, though earnings impact from higher fuel prices should be limited
given fuel costs account for only c.5-10% of total operating expenses and outsourced nature of non-core activities.
Transportation - Railroads
& Logistics
Slower GDP growth would impact volumes negatively and hence lead to lower revenues for the container train operators.
Realizations are already under pressure in a highly competitive environment.
Higher fuel costs, would add to margin pressures that have already been negatively impacted by the hike in haulage charges
by the Indian Railways.
Utilities
Revenue: With India still short of power supply, we do not expect a significant impact in terms of revenue for the
companies under our coverage universe. While we expect the merchant rates to decline on account of slowdown in power
demand, we still believe the volume growth for the companies will remain intact as India will continue to have deficits till
FY13E. Further, some of the projects may be delayed or shelved due to unattractive IRR's, which will effect the volume
growth beyond FY13E. Earnings: Rising interest rates will have a material impact on margins due to high leverage (4:1
debt:equity) as interest costs constitute 25% of the total cost of power generation.
Source: Goldman Sachs Research
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India
Equity Research
Being stock selective in a difficult macro environment; 5 Buy and 4 Sell ideas
GS forecasting 7.5% inflation in FY 2012
Our ECS team has increased their forecast for
inflation from 6.7% to 7.5% for FY12. In this note,
we explore how inflation has impacted corporate
profitability and valuations in previous cycles and
seek to identify companies that could be shielded
in a difficult macro environment.
High inflation a harbinger of lower growth,
lower margins and compressed multiples
Previous periods of high inflation in India have led
to a 200bps compression in EBIT margins, 250-
300bps compression in net margins and a 15%
contraction to earnings multiples. Against this
backdrop, we note that consensus is forecasting a
70bps improvement to EBIT margins and a 30bps
improvement to net margins in CY2011E. Our
earnings forecasts for our coverage group are
10% below consensus in FY 2012. We expect
consensus earnings to decline in the months
ahead. In this note we seek to identify companies
that are relatively insulated from a dynamic of
decelerating growth, as well as those particularly
exposed to the same.
Scenario to 7.5% and 6.9% GDP growth
We have run two scenarios for our coverage in
India. The first assumes a further 75bps hike to
rates, oil prices of $115/bbl and GDP growth of
7.5% in FY2012. The second, more aggressive
scenario, assumes a further 150bps hike to rates,
oil prices of $130/bbl and GDP growth of 6.9% in
FY2012. Under the first scenario, we conclude that
our average earnings would be cut by 6.4% (taking
them 16% below current consensus) and under
the second scenario, our earnings would be cut by
12.4% (going to 22% below consensus).
We identify five ‘Buys’ and four ‘Sell’ ideas
based on a deteriorating macro backdrop
As a next step, we have screened our coverage
under both earnings scenarios and highlight ‘Buy’
rated stocks that trade below historical median
multiples (even at ‘Scenario Two’ earnings). We
highlight Bharti, ONGC, Tata Steel (all CL-Buy) and
Infosys, United Phosphorus (both Buy). Sectors
likely to get impacted negatively are construction,
real estate and cement. Our Sell ideas are ACC,
Hero Honda, SBI and Bank of India.
click on image to enlarge
Summary of analysis
The GS ECS team have raised their inflation forecast for FY12 from 6.7% to 7.5% due to stronger than expected core inflation. The
Reserve Bank of India (RBI) has also hiked the repo rate by 50 bp and the reverse repo rate by 50 bp, in line with our ECS team’s
expectations. Going forward, our ECS team expects inflation to remain elevated in the first half of FY12, before moderating in the
second half.
Historically (over the past 15 years), periods of high inflation have resulted in the following:
Corporate EBIT margins compress during periods of high inflation by an average 200 bps and Net margins by 250-300 bps.
Valuations – expressed as earnings based multiples - compress during periods of high inflation (by an average of 15%)
Overall, periods of high inflation have coincided with downward revisions to Indian corporate earnings (GS forecasts for FY
2012 are – on average - 10% below consensus estimates)
While we are materially below consensus, we have conducted two scenario analyses in which we have explored a further
deterioration in macro conditions.
On a coverage wide basis, our analysts estimate a 12.4% reduction in earnings if crude oil price were to increase to US$130
per barrel and GDP growth for FY12 would reduce to 6.9% (from 7.8% currently). This would put our earnings 22% below
current consensus. Put differently, aggregate FY12E EPS growth for our coverage would almost halve from 22.4% to 12% in
such a scenario.
The Energy sector would benefit in this environment due to pricing benefits on increased oil prices (primarily driven by
Cairn Energy). Utilities would be shielded due to regulated revenue on increased input costs and Information Technology
and Healthcare would be insulated by their limited domestic exposure.
Revenues for Construction, Real Estate and Cement are likely to be negatively impacted as a result of reduced order inflows
and curtailed capital expenditure by corporate India. Automobile sales growth is also likely to get impacted in a high
interest rate environment.
On an earnings basis, the worst affected sectors are likely to be Construction and Real Estate due to high leverage and
consequently higher interest expense along with Cement and Consumer Staples due to higher input costs. Energy
companies with high oil leverage may see earnings growth in such an environment.
In our screens, we have examined P/E and sales multiples, based on bottom-up revenues and earnings forecast under
Scenario 2.
1. Our ‘Buy’ ideas are Bharti (Buy, CL), ONGC (Buy, CL), Tata Steel (Buy, CL), Infosys (Buy) and United Phosphorus
(Buy). We believe revenue and earnings for these companies are relatively insulated from a deteriorating macro
environment and the stock are trading at compelling valuations even if we assume “Scenario 2”.
2. Our ‘Sell’ ideas are ACC (Sell), Hero Honda (Sell), State Bank of India (Sell) and Bank of India (Sell) where there
would be significant revenue and earnings declines if ”Scenario 2” occurs and these stocks would trade expensive
to historical mean multiples in such a case
Scenario analysis
In our recent publication, Asia Economics Analyst:11-08 India: Raising inflation and rate forecasts, reducing GDP (Published April 20,
2011), our ECS team lays down estimates for major economic indicators at different oil price assumptions. In spite of the recent
sharp correction in oil prices, GS Commodities team continue to believe that the oil supply-demand fundamentals will tighten
further over the course of this year, and likely push prices back to recent highs by next year (refer Energy Weekly: Oil price plunge in
a major market correction, published May 6, 2011)
Against our current assumptions of US$ 105 per barrel of Oil, further rate hike of 75 basis points over the rest of CY11 and 7.8% GDP
growth, we stress test our revenue and earnings numbers for all sectors under coverage for FY12E against the backdrop of 2
scenarios based on these assumptions:
2) Scenario 1- increase in interest rates by another 75 bps for CY11E based on recently revised ECS forecasts; oil price estimate at
US$115 per barrel (vs. US$105 per barrel in a base case) and resulting in 7.5% GDP growth for FY12E (vs. current estimate of 7.8%)
3) Scenario 2- increase in interest rates by another 150 bps for CY11E (75 bps higher than Scenario 1); oil price at US$130 per barrel
(vs. US$105 per barrel in a base case) and 6.9% GDP growth for FY12E (vs. current estimate of 7.8%)
Sector Impact of higher Inflation/lower GDP/higher energy price - on revenue and earnings
Agriculture
Revenue: The companies under our coverage group derive about 25% of their revenues from India and the remaining 75%
from other geographies (primarily Europe and US). Revenues derived from India business, particularly soda ash business,
will get impacted with the slow down in India GDP growth. Earnings: As the balance sheets are not significantly leveraged,
and the businesses (soda ash and agri-chem) are not capex intensive, we do not expect margins to get impacted on account
of rising interest rates; higher input costs may impact margins.
Automobiles
i. Beyond a certain level, inflation and interest rates in India have an inverse correlation with auto demand cycle. ii. We
hence believe that demand growth should normalize going into FY2012E-13E to about 11% from >20% growth across
segments in FY2011.iii. In a worse case scenario assuming higher inflation and rates in the economy, we would expect
higher relative impact on companies with: (a) exposure to more sensitive segments like trucks (Ashok Leyland) (b) higher
operating leverage (TVS Motors) (c) higher financial leverage (Apollo Tyres)
Banks
i. Sector can be significantly impacted by any changes to the macro economic forecast in particular in FY13E from the
multiple impact on revenue and provisions, ii. As rates continue to rise the credit growth will likely come off in FY12E and
FY13E from current levels of 22%, iii. Margin could be impacted from lower credit deposit ratio, rising cost of funds and
banks inability to fully pass on rate hikes, iv. While banks may not show NPL increases in FY12E (either due to restructuring
or ever greening), the pressure could increase in FY13E as corporate India’s ability to make timely payment gets affected by
slower volume growth, EBITDA margin pressure and higher interest cost.
Construction
Revenue: Construction companies are likely to get impacted negatively due to reduced order inflow in a high interest rate
and low GDP growth environment which will impact earnings for future years; however, order book coverage of over 2x will
keep topline fairly strong for a couple more quarters. Expect greater impact in FY13E. Road BOT companies likely to benefit
as toll collections are linked to WPI; however, this is negated by lower traffic growth in a decelerating GDP environment.
Earnings: Construction companies margins to be impacted marginally due to operating leverage impact; no significant
impact of input cost as most is pass through; increase in interest rate to impact margins significantly due to high leverage.
Asset owners likely to be impacted due to high leverage business model as net margin erosion may be significant
Construction - Cement
With current capacity utilization levels at low levels of 75-80%, any slowdown in cement demand (which is a function of
economic growth/GDP) would have an impact on pricing. The extent of price weakness would be a function of suppliers
discipine. At the operating level, higher input costs would adversely impact margins, given that the companies would not be
able to pass on the higher costs in a weak demand environment. Higher interest rates would not have significant direct
impact, given that most companies are net cash (except India Cements and Ultratech)
Consumer Staples
i. ITC (cigarettes) and some key products by Nestle, Dabur and Marico are relatively price inelastic or enjoy a dominant
market position to offset short term inflation spikes. On the other hand HUL and Colgate have key products that are very
price elastic and are present in a relatively competitive category (detergents, soaps, toothpaste) and hence would be most
affected.ii. Inflation in fuel prices would also lead to increases in logistical costs as well as increase in cost of packaging,
which tends to be linked to crude prices. iii. Sustained inflation and lower GDP growth over a period of time could affect
volumes and margins for all the companies as consumers will move away from higher margin discretionary spends to lower
margin staples spends
Sector Impact of higher Inflation/lower GDP/higher energy price - on revenue and earnings
Energy
Revenue: Higher oil prices would lead to higher revenues for Cairn India and the Oil refining companies(RIL, HPCL, BPCL
and IOC). Revenues for ONGC and OIL would decline if oil prices rise significantly as their net realizations would go down
on account of higher subsidy burden. Earnings: Higher oil prices would lead to higher earnings for Cairn India but declining
profits for the Oil marketing companies. Also, the earnings of OMCs would be further negatively impacted due to higher
interest expense on account of increased borrowings for working capital requirements.Earnings of the state owned
upstream companies also would be marginally negatively impacted due to higher burden of under-recoveries.
Healthcare
i. The top-10 companies in the Healthcare space get around 70% of revenues from exports, which are immune to
inflationary pressures in India. ii. Also, with the patent expiry opportunity, we expect companies to have higher profitability
from one-off opportunities in the US over 2011-2013. iii. That said, any decline in GDP growth is likely to have a mild impact
on companies which have a higher degree (30%-35%) of exposure to the domestic market like Sun (Sell), Cipla (CL-Sell),
Lupin (Buy) and Cadila (Neutral). iv. We see Jubilant (Buy) and Aurobindo (Neutral) as companies with the highest gearing in
the sector and where any rise in interest rates could impact earnings growth for these companies.
Machinery
Revenue: Capital goods companies are likely to get impacted negatively due to reduced order inflow which will impact
earnings for future years; however, order book coverage of over 2x will keep topline fairly strong for couple more quarters;
expect greater impact in FY13E; Earnings: Margins to be impacted due to input cost increases but forward contracts and
older inventory to slightly shield the bigger companies. Given the cash rich nature of these companies, we do not expect
high interest rate to impact net margins
Media
Advertising revenue growth is closely linked to corporate profitability and hence GDP growth. Broadcasters are likely to see
lower advertising revenue growth in a scenario of lower GDP growth. This will be partially offset by the strong growth in
subscription income - driven by the push towards digital platforms, in our view. The broadcasters have low leverage ratios
and the impact of higher interest rates would thus be minimal. However, given Dish TV's higher debt levels, its profitability
will be significantly impacted by higher interest rates
Metals & Mining
For base metals, domestic pricing is linked to LME prices and India is a net exporter of all 3 commodities - aluminium, zinc
and copper. Our average commodity price assumptions for FY12E are about 10% below current spot prices - hence there is
upside risk to current margins and earnings. A potential slowdown in domestic demand will not impact volumes as net
surplus will continue to be exported, insulating base metals earnings from a potential revenue / margins downside.
However, higher input cost and interest rate to impact margins.
Real Estate
i. Higher borrowing costs could lead to lower residential demand in markets where pricing already appears stretched
(Mumbai, Gurgaon) but could be absorbed more easily by markets where properties are relatively more affordable
(Bangalore, Noida). ii. Higher inflation could also increase costs of construction, which would affect Banagalore based
developers more as they have lower margins. iii. Lower GDP growth could lead to lower demand for commercial space,
although at present most commercial demand is driven by the IT sector.
Sector Impact of higher Inflation/lower GDP/higher energy price - on revenue and earnings
Steel
While steel is a global commodity, the extent of premium/discount of domestic prices to global prices is a function of
relative tightness of the domestic steel market. We believe that any slowdown in GDP would have an adverse impact on
steel consumption and could result in softness in prices. At the operating level, margins would be impacted, depending on
the direction of coking coal prices (which is a function of global factors). In a weak demand environment, Indian steel
makers would not be able to pass on the additional costs, leading to margin compression.
Technology - IT Services
i. The sector is recovering from the margin pressures of 2010 – when it saw a combination of wage inflation + attrition +
Rupee appreciation in 2010 (vs. 2009). ii. We also forecast revenue momentum to be stronger this year, with an overall
improvement in pricing and attrition to come down. iii. All of this would be incremental tailwinds to the sector’s OPM, and
hence we expect margins to be stable.
Telecom Services
i. Impact of higher Inflation/lower GDP on telecom revenues should be relatively low as telcos spending is turning more into
a necessity and is becoming relatively difficult to curtail. ii. Impact on earnings due to higher interest rates should be
relatively greater given higher leverage of Indian telcos, though earnings impact from higher fuel prices should be limited
given fuel costs account for only c.5-10% of total operating expenses and outsourced nature of non-core activities.
Transportation - Railroads
& Logistics
Slower GDP growth would impact volumes negatively and hence lead to lower revenues for the container train operators.
Realizations are already under pressure in a highly competitive environment.
Higher fuel costs, would add to margin pressures that have already been negatively impacted by the hike in haulage charges
by the Indian Railways.
Utilities
Revenue: With India still short of power supply, we do not expect a significant impact in terms of revenue for the
companies under our coverage universe. While we expect the merchant rates to decline on account of slowdown in power
demand, we still believe the volume growth for the companies will remain intact as India will continue to have deficits till
FY13E. Further, some of the projects may be delayed or shelved due to unattractive IRR's, which will effect the volume
growth beyond FY13E. Earnings: Rising interest rates will have a material impact on margins due to high leverage (4:1
debt:equity) as interest costs constitute 25% of the total cost of power generation.
Source: Goldman Sachs Research
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