IDFC Sec - Earnings Preview (July - September 2011)

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India Inc’s performance in Q2FY12 is expected to moderate yoy due to input cost pressures and repeated interest rate hikes by the RBI. We expect Sensex earnings to slump to a two-year low of 7.5% on the back of weak earnings momentum in Metals. Earnings of commodities are expected to be flat as 17% growth in Oil & Gas is likely to be offset by an 18% decline in Metals. Companies that are expected to clock strong bottom-line growth are L&T (26.9%), BHEL (20.9%), RIL (17.1%), ICICI Bank (21.7%) and Coal India. While Sensex top-line growth (ex Metals) is likely to remain strong at 21.5% yoy, higher commodity prices are expected to drag down margins by ~130bp. For the broader IDFC universe, earnings growth is expected to be 5.4% yoy.

While profitability of Indian corporates has nose-dived, demand drivers remain intact as reflected by strong top-line growth for the IDFC universe. We see commodity prices cooling off in H2FY12 due to the weakening global macro-economic environment. This should provide a much-needed respite in inflation and result in a more sanguine interest-rate environment. Lower commodity prices and a manageable interest burden should enable corporates to lever up their margins and bolster profitability. We believe these factors, coupled with policy triggers from the government, would trigger a revival in investment spend in H2FY12. Our revised Sensex EPS stands at Rs1130 and Rs1350 for FY12 and FY13 respectively. Given the global uncertainties, we believe Sensex is likely to remain range-bound in the near term. But expect a bounce-back once inflationary pressures recedes leading to a reversal in the interest rate cycle. Our index target is in the range of 19000-20000 (15x FY13E earnings) for the next 12 to 18 months.

Sectors likely to exhibit strong performance:

·         Cement: Strong revenue growth on the back of a 10-20% yoy increase in average realizations.

·         Consumer goods: Price increases and lower A&P spends have mitigated most of the commodity pressures.

Sectors likely to witness weaker earnings:

·         Metals: Weak earnings due to price correction, rising input costs and sluggish demand.

·         Real estate: Slower construction activity (monsoon quarter) and limited new launches expected to drag performance.

·         Petrochemicals and Oil & Gas: A weak quarter expected, with OMCs and Cairn India dragging down an otherwise robust performance from upstream, RIL and the natural gas universe.