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India Market Outlook
How will this key quarter pan out
Market seems to be ignoring macro headwinds, earnings may trigger a correction
For BNPP universe, we expect growth of 28% in revenue, 18.7% in EBIDTA, 17.3% in PAT
Divergence in earnings within the same sector
Downside earnings risks to select autos, financials and E&C companies
1QFY12 earnings season critical for near-term performance
After the recent rally, the Indian market appears to be ignoring some near-term macro
headwinds – growth slowdown, sticky inflation, monetary tightening and political uncertainty.
We believe the widening of valuation premium versus China and AxJ also leaves little room
for earnings disappointment. 1QFY12 earnings momentum, therefore, is critical for market
performance and may trigger a near-term correction, in our view.
Robust revenue growth defies slowdown fears…
For our India coverage universe, we forecast revenue growth of 28% y-y. Excluding
commodities (i.e. metals and oil & gas), we forecast revenue will grow at a robust 20.8% in
1QFY12, versus revenue growth of 26.6% y-y in 4QFY11 and 21.8% y-y in 3QFY11.
Notably, revenue growth prospects for domestic cyclical sectors – autos (20.9% y-y),
building materials (32.7% y-y), capital goods (21.7% y-y) and engineering & construction
(15.8% y-y) – remains solid, defying concerns of a sharp slowdown in growth.
…but margin pressures persist
We forecast EBIDTA for our coverage universe will grow 18.7% y-y (19.6% y-y, ex
commodities). EBIDTA margins could contract 27bps y-y (ex oil & gas). Margin pressure
could be particularly acute in sectors bearing the brunt of policy tightening – autos (-80bps yy),
cement (-288bps), and E&C (57bps) – or global slowdown and cost pressures – like
metals (291bps) and IT (113bps).
Profit growth to moderate
The double whammy of margin pressure and higher interest expense will put profit under
pressure for our universe. We project profit growth of 17.3% y-y in 1QFY12, versus
19.1% y-y for 4QFY11 and 19.2% y-y for 3QFY11. We see 2-3% downside risk to our
current Sensex EPS estimates of INR1,234 for FY12 and INR1,465 for FY13.
Companies that could grow the most…
We expect consumer auto companies to continue to show robust growth: Bajaj Auto
(+23.4% y-y) and Hero Honda (11.2% y-y). We estimate private-sector banks, particularly
ones with a strong liability franchise – Axis Bank (+39.5% y-y), HDFC Bank (29.2% y-y), and
ICICI Bank (36.9% y-y) – will deliver strong earnings growth.
…and the least
We estimate earnings growth laggards will mainly be: 1) investment autos – Ashok Leyland
(-26.8% y-y) and Tata Motors (1.8% y-y); and 2) construction – Hindustan Construction
(-79.5% y-y), IVRCL (-14.9% y-y), and Nagarjuna Construction (-31.4% y-y). PSU banks
could also witness earnings pressure from higher operating costs and loan-loss provisions –
Bank of India (-7.1% y-y), Union Bank of India (+0.3% y-y), and PNB (+10.8% y-y).
Where do we stack up relative to consensus?
We would like to highlight financials – public-sector banks, in particular – as a sector where
we are almost uniformly below Bloomberg consensus estimates for 1QFY12. We believe
that consensus may be optimistic about banks’ operating expenses and credit costs. Our
earnings estimates are below consensus for E&C as we are factoring in higher interest
expenses. We also believe that consensus may be too optimistic about margins of cement
and capital goods companies.
Markets looks critically poised
The Indian market has rallied over the past couple of weeks on the back of a revival in
the global risk appetite (see our note Making sense of risk appetite, 5 July 2011). Given
the numerous headwinds – sticky inflation, monetary tightening, and political uncertainty
– the market’s ability to sustain current valuation premium over China and AxJ is
predicated on continued strong earnings growth prospects. Any earnings
disappointment may trigger a correction, particularly as other headwinds (fiscal deficit,
political uncertainty) seem to be intensifying, in our view.
Winners and losers
Among the large sectors, we expect a sharp slowdown in earnings growth of autos due
to pressure on margins and volumes. The strong growth in financials’ earnings has
moderated, led by PSU banks, on higher credit costs and operating expenses. Falling
volumes and margin pressures will take a toll on real-estate earnings, in our view.
There seems to be a divergence of earnings growth among companies within the same
sector. For instance, we project private-sector banks will deliver robust earnings growth
(25-30% y-y), while public-sector bank earnings will moderate due to higher credit
costs. Similarly, earnings growth of ‘consumer autos’ (like Bajaj Auto and Hero Honda)
seems to be outperforming that of ‘investment autos’ (Ashok Leyland and Tata Motors).
Biggest risks
Our Sensex EPS estimates are INR1,234 for FY12 and INR1,465 for FY13. We believe
there is 2-3% downside risk to our Sensex earnings estimates, primarily from autos
(volume and margin pressures), financials (higher credit costs) and E&C (higher interest
costs and execution slippages). As such, the current valuations for the Indian market
(25-30% premium to MSCI AxJ) seem unjustified, in our view.
Where do we stack up relative to consensus?
We take a look at the stocks where our earnings estimates are significantly different
from those of Bloomberg consensus estimates.
We would highlight financials – public-sector banks, in particular – as a sector where we
are almost uniformly below consensus for 1QFY12. We believe that consensus is
optimistic about banks’ operating expenses and credit costs. Our earnings estimates
are below consensus for E&C, as we are factoring in higher interest expenses. We also
believe that consensus may be too optimistic about margins of cement and capital
goods companies.
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