Eye on India Facts are facts, but perception is reality :: Macquarie Research

Eye on India
Facts are facts, but perception is reality
Event
 Q1FY14 results beat estimates: 100+ stocks under our coverage reported
PAT 7% better than our expectation. Sales revenue was muted as expected
at 5% growth YoY, but operating margins surprised by 60bps. IT, Telecom
and Pharma were the key sectors to see earnings upgrades.
 Key changes to top 10 ideas: We replace Bharti with Idea, as Bharti’s large
USD debt is posing risks in the face of sharp currency depreciation while
Idea’s earnings have seen the highest % upgrades this earnings season. For
the list of other stocks with positive earnings revisions see Fig 17.
Impact
 Lowest quarterly revenue growth since Q1FY11 due to weak macro…:
The 5% revenue growth reflects the tough macro environment that companies
are operating in. Waning top-line growth is reflective of the sharp slowdown in
GDP growth to below 5% over the past couple of quarters.
 …but better than expected PAT growth: The 6% growth in PAT (ex-Oil
and gas) was 7% better than our estimates, driven by power, financials
and Tata Steel.
 PSU stocks were particularly weak: PSU stocks across financial and
energy sectors showed weak results. Excluding 6 PSU stocks in Sensex, net
profit growth was 9% yoy vs -2.7% yoy, led by a 120bps improvement in
operating margins.
 Operating margins have bottomed out…: EBITDA margins came in at
around 20.6%, which was up 20bps YoY but importantly higher than our
estimate by 60bps. This is likely as a result of moderating inflation trend and
stable oil prices during Q1FY14 that helped improve margins.
 …but may be at risk due to weakening currency: With INR touching all
time lows and crude prices inching up to US$110/bbl, the risk of input cost
pressures coming back has increased. Consensus is currently building in 11%
earnings growth for Nifty, driven by 5% revenue growth and 100bps
expansion in margins. While revenue assumptions are muted, margin
assumptions may be at risk given weak currency. However, as government
spending returns pre election, revenue growth has potential to surprise
upwards.
 Earnings revision ratio worsened; FY14 est downgraded further: The
ratio lost momentum in the last 3-4 months, as downgrades picked up with
falling demand. Earnings revisions are negative for most sectors barring IT,
Telecom and Media.
Outlook
 Market – what is left to say! It was mayhem that we saw, but the bright spot
was the bottoming out of the steel sector. Clearly domestic economy-related
sectors are coming under pressure and even the loved defensives are being
questioned. We would recommend following earnings upgrades as a prudent
stock selection criterion and be wary of stocks over owned by FIIs.

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Complicated macro leading to hazy earnings outlook
The recently concluded Q1FY14 earnings season couldn’t quite instil market confidence in an
improving earnings outlook. Though aggregate results were not as bad, with bottom-line growth
turning out better than expected, weakness in the broader economy was palpable in waning top-line
growth and currency weakness. At the sector level, details weren’t as encouraging as core sectors
such as autos, cement, industrials and metals continue to struggle. Despite decent overall results,
particularly from private sector banks, Financials too have come under the scanner post recent RBI
moves, though the impact will show up in next quarterly results.
Key Highlights:
 For our coverage universe (ex-Oil & Gas), revenue growth came in at 5% yoy (in line), while PAT
growth was 6% yoy, led by better than expected numbers at the operating level. EBITDA margins
(ex-oil, fin) came in at 20.6%, which was 60bps better than expected.
 Top-line growth was led by financials, with real estate and media also clocking growth in high
teens. The drag came from metals and cement, which recorded declines in revenue growth while
infra/capital goods saw flat revenue from a year ago.
 Better than expected PAT growth was driven by power, while others such as media, financials,
pharma, consumer, telecom and IT too contributed positively. The remaining saw declines in profit
growth.
 At the Sensex level (ex-PSU Oil & Gas), growth was particularly weak with 1.7% revenue growth
and 1.6% profit growth. Key stocks that dragged quarterly profits down were Tata Motors, SBI,
BHEL, Coal India, Sterlite and JSPL. On the other hand, key positive contributions came from
ICICI bank, HDFC Bank, TCS, ITC, Tata Steel, RIL and Sun Pharma.
 Weakness was particularly visible in PSU stocks across banking and energy. Excluding 6 PSU
stocks in Sensex, net profit growth was 9% yoy, led by a 120bps improvement in margins.

Margins showing stability as growth in expenses has slowed…
The big overhang on earnings is revenue growth, which has slowed significantly and historically has
been the major driver of profits. Though pressure on EBITDA margins has eased considerably over
the past few quarters, the faster decline in the rate of revenue growth has offset benefits arising out
of lower input costs. At the same time, interest costs have continued to increase, though at a slower
pace lately, thereby putting additional pressure on earnings. The risks however have gone up with
currency weakening further and recent tightening of liquidity leading to hardening yields and
expectation of lending rates going up. …however currency has played spoilt sport…
 Recent moves by the RBI to tighten liquidity and curb currency volatility is likely to have impacted
economic activity. At the same time, the INR hasn’t quite responded to these measures and crude
has inched back up to US$110/bbl, posing risks to stability of EBITDA margins by feeding into
input costs.
 Currency plays an important role in company earnings in many ways. It impacts the top line of
those companies with a high exposure to foreign currency earnings. Also, since India is a large
importer of commodities, it impacts prices of raw materials, thereby directly impacting operating
margins. At the same time, movements in currency impact companies with external debt as their
interest burden also changes accordingly. The slowdown in reported earnings growth since last
year is partly explained by the sharp depreciation of the rupee. Such large volatility in the rupee
has made corporate earnings quite volatile, particularly for those companies that have large
exposure to external markets.

…leading to further earnings downgrades
Earnings estimates have continued to see downgrades over the past two quarters. Consensus
estimates at the index level (Sensex, Nifty) now suggest 4-5% revenue growth (vs 8-9% earlier) and
11-12% PAT growth (vs 14-15% earlier), driven by 100bps expansion in EBITDA margins. While
revenue assumptions are muted, margin assumptions may be at risk given weak currency.