1QFY14 results recap - The good, the bad and the ugly : Antique

India's corporate sector posted dismal performance in 1QFY14. While a large
part of it was on expected lines, earnings decline in a few sectors was alarming.
Though companies under Antique coverage (ex-oil) posted revenue growth of
7.3%, which was in line with expectations, and similar to growth registered in
3QFY13 (9%) and 4QFY13 (7%), PAT grew by 3.6%, against our expectation of
growth of 6.2% YoY. Earnings growth is pulled down by autos, cement,
industrials and utilities. We see earnings trajectory to worsen in remainder of
the year, with rising costs and falling demand. We are cutting down our FY14
Sensex EPS estimate by 5% to INR 1295 (earlier INR 1365) and Sensex target to
19425 (15 x FY14e EPS). We remain defensive and believe that bottom-up
approach is the best strategy for beating market return. Among sectors, prefer
IT, pharmaceuticals, media, energy and auto.
Sharp earnings moderation across sectors
􀂄 Only Media and Financials posted 15%+ revenue growth during the quarter.
Pharmaceuticals, FMCG and IT posted reasonable growth of 11%, 12% and 13%, but
growth rates have been moderating meaningfully. Moderation is revenue growth is more
pronounced in FMCG sector, from around 17-18% a couple of quarters ago to 12% now.
With respect to our estimates, media and oil & gas sectors beat our revenue estimates
by over 5%, while industrials fell short by 10%. Most other sectors grew in line with estimates.
􀂄 Cement and industrials witnessed sharp compression in margins during the quarter, YoY,
while automobiles and oil & gas sectors saw margin expansion.
􀂄 Sectors that posted strong YoY earnings growth during the quarter are: FMCG (12%), IT
(15%), Media (18%), Pharma (13%) and Financials (11%). Oil & Gas sector performed
better than expected as a refineries cut down their losses during the quarter. Industrials
disappointed the most with 25% miss in earnings, as L&T and BHEL missed earnings
expectations by 24% and 40%, respectively. Utilities were another sector with 16% miss in
earnings. Auto, Cement, FMCG, IT, Pharma and Financials sectors performed in line on
aggregate basis, but with significant variations within respective sectors.
􀂄 Key large cap earnings beaters: Bosch, Sun Pharma, Zee, Bank of Baroda, HCL
Tech, BPCL.
􀂄 Key large cap earnings disappointments: Tata Power, Coal India, L&T, BHEL,
United Spirits, ACC, Asian Paints, Godrej Consumer, Dr. Reddys, Ranbaxy, Oil India, ONGC.

􀂄 Key mid-cap earnings beaters: Shree Cement, Jyothy Labs, IL&FS Transportation,
Spicejet, Gujarat Pipavav, Hexaware, Hathway, GSPL, Bank of India, HPCL.
􀂄 Key mid cap earnings disappointments: ABB, Voltas, KEC, Dish TV, Petronet, Union
Bank of India, Mahindra Finance.
Worsening economic outlook!
The Indian markets, after outperforming most of its peers in CY12, have declined 5.8%
since the beginning of CY13. Against expectations earlier that the Indian economy will start
showing signs of improvement, growth outlook has worsened in past 3 months. The Index of
Industrial Production remains depressed, and capex cycle refuses to pick up. While the
Government has tried its best to bring about certain substantial reforms, such as increasing
diesel prices and raising FDI limits in several key sectors, the impact of these have been
limited on the industry and the economy. Another big worry is high current account deficit,
which is playing havoc with the currency. Currency at INR 63 / $ is at all time low, and has
fallen by 15% in the year so far. Rising oil prices and falling INR will significantly impact the
Indian industry in the next few quarter, thereby putting a lot of pressure on profitability of
Indian corporate sector, which are staying away from making fresh investments. On the
other hand, interest rates have started showing signs of rising yet again. Yields on the 10-
year benchmark bond hit a five-year high of 9.24 percent. A clear political landscape,
sharp focus on reform and concerted effort to stem fall in INR are key requisites for reviving
sentiments going forward.
Sensex to grow 8%: Prefer bottom-up, balanced approach
We cut our FY14 Sensex EPS targets by 5.1% to INR 1295, on the back of 3.5% cut in
4QFY13. This implies 8% YoY Sensex earnings growth in FY14. Given meaningful slowdown
in industrial output, possible demand moderation in the consumer space, and likely cost
push due to falling INR, a farther downside to current estimates cannot be ruled out. We set
out Sensex target at 19425 based on 15x FY14e Sensex EPS. We continue to believe that
India will remain bottom-up market in CY13 - 14.
We broadly maintain our sectoral preferences. Our preferred sectors include IT,
Pharmaceuticals, Media, automobiles, energy and select private sector banks. We remain
cautious on PSU banks, Industrials, infrastructure, metals, cement and select oil refineries.

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Automobiles: Neutral
Clearly, we are smack-dash in the middle of the volume down-cycle (across all segments,
excl tractors). Till a month back, it was popular belief that we were still in an easing rate/
liquidity cycle and hence this period was assumed to be the fag-end of the pain. However,
recent RBI measures have blown those assumptions off completely. We’ve noticed that an
uncertain macro re-rates 2Ws (over cars/CVs) as these are better businesses owing to their
higher return ratios/asset turns/FCF yields. Hence, till the macro gets more sure-footed, we
prefer the defensives (2Ws) within the Auto space (even while they aren’t our top-picks). For
industry volumes overall, we maintain our cautious stance as we don’t see any trigger for a
big-bang revival in demand. Going into FY14, the only foreseeable catalyst that could
bring the buyer back meaningfully is the next festive season, which could compliment tailwinds
like a good monsoon (could make or break the year).
Preferred picks: Maruti Suzuki, Tata Motors, Eicher Motors. While Maruti might
not be the flavour of the season, FY15 should be a glorious year for them and hence we
believe it is a must-have for anyone taking a 2-year view. For Tata Motors, JLR’s product life
cycle in a very sweet spot while the domestic business is near its trough. We have recently
upgraded Eicher Motors, Hero MotoCorp and Exide Industries to BUY. For Eicher, we have
always been ardent fans of all of Eicher’s segments (particularly RE and MDEP) and the
recent cool-off in the stock (down ~14% from recent peak) is the opportunity we’ve been
waiting for. For reasons mentioned above, we like the 2W space in the current environment
and between the two biggies we prefer Hero over Bajaj owing to the valuation mismatch
(with the former being ~10% cheaper, even though it has historically traded at a premium).
For Exide, we believe that it is a superb hedge against a prolonged OEM slowdown, and
the management’s newfound focus on margins calls for a re-rating.
Cement: Neutral
Subdued demand environment and weak pricing scenario continued to impact the
performance of the cement sector from December 2012 quarter onwards and the trend
continued for June 2013 quarter as well. Cement demand during the quarter rose by 3.3%
(Source: Office of Economic Advisor). Weak demand coupled with new capacities coming
onstream impacted prices, which declined by 2-3% on an all India basis. Additionally, a
high base of June 2012 quarter (industry benefited from delayed monsoons) further
depressed the current quarter's performance on a YoY basis. Most of the companies posted
a decline in EBIDTA/mt and profits on a YoY basis.
Except western region, particularly Gujarat, prices remained stable to positive in other
regions on a QoQ basis. On the costing front, while the companies witnessed savings on
the power and fuel cost front, freight costs continue to rise on account of higher diesel
prices. Volume growth for companies under coverage remained subdued with ACC, Ambuja
Cements, Shree Cement and UltraTech Cement posting a growth of 1.2%, -2.9%, -6% and -
0.8% respectively. Margins contracted by 540bps to 21.1% on account of weak prices and
higher operational expenses.
While there are no signs of a recovery in demand due to absence of corporate capex and
low infra spend, companies will need to further improve efficiencies in order to minimize the
impact of weak cement prices. Additionally, with cash flows being impacted in the near term
due to challenging macro environment, there will be a slowdown in new project announcement
especially from regional players. Preferred pick: Shree Cement.
Financials (Banks): Neutral
Private and public sector banks under our coverage universe continued to report divergent
trends, with private banks outperforming positively and PSU's disappointing negatively on
asset quality front. NII growth for PSU banks under our coverage universe continued to remain
dismal at 6%YoY on back of slower credit growth, interest reversal coupled with higher cost of
deposits thereby impacting the margins (compression 5-10bps).Credit cost elevated on back
of high slippages and CDR related restructuring. However, earnings of most of these PSU
banks were cushioned from higher trading profits arising from easing G-sec yields . On the
other hand, private sector banks reported strong earnings growth on back of steady NIM,
stellar growth in non interest income, and stable performance on asset quality ratios.
Post the recent RBI measures announced on 15th and 22nd July, immediate focus for the
central bank is to contain the volatility in the currency with growth-inflation dynamics taking
a back stage for a while. The immediate impact of the various measures announced by the
RBI is negative for the banking sector. Clearly easing rates cycle is not playing out in FY13-
14 given pressure on currency. G- Yields have rallied by 150bps since July (currently at
8.97%). Hence Borrowing costs for whole sale funded banks and NBFC's which had declined
by 50-100 bps in 1Q are likely to reverse to some extent and wholesale funded private
sector banks could run a significant liquidity risk. The impact of these measures would be
more pronounced in the bank's performance from 2QFY14 onwards.
Our View: Hence we maintain our cautious outlook on the sector with a
preference for HDFC Bank.

Financials (NBFC): Positive
The NBFC coverage universe continued to witness strong asset growth over Q1FY14 while
margins and asset quality were largely stable (except the seasonal variations in Repco &
MMFS). Used CVs, tractors, air-conditioners and housing loans witnessed robust growth for
the quarter. Although margins were largely stable, we have lowered our estimates for FY14
and FY15 across the board to account for the recent spike in interest rates. Specifically,
Bajaj Finance, MMFS, Repco Home and Gruh Finance remain well poised to navigate the
current environment due to niche customer segments, pricing power on asset side and well
capitalized position. PFC & REC have multiple risks - declining loan growth, moderating
margins and higher provisions while Chola & Shriram Transport will likely witness sharper
margin compression vis-à-vis peers. Preferred picks: Repco Home Finance, Bajaj
Finance and Mahindra Finance.
FMCG: Neutral
Slowdown across the FMCG sector was clearly visible during 1QFY14 primarily led by a
lower realisation growth on a high base. We believe that the realisation growth would further
fade in the coming quarters with lack of price hikes. However, in line with our expectations no
incremental deterioration was seen in the volume growth rates across companies. Consolidated
sales growth of Antique consumer universe was at 12% during 1QFY14 with sales of HUL,
Marico and United Spirits growing in low single digits. Nestle too witnessed a continued
subdued growth in domestic sales growth of 9%. GCPL and Colgate Palmolive India Ltd were
the key outperformers on the sales front (GCPL witnessed a domestic sales growth of 19% and
Colgate Palmolive India Ltd's net sales grew by 16%).
Across majority of the consumer companies, benign raw material prices provided respite to
profitability. This provided them the scope to spend on advertisement to spur growth in sales
and competitive price cuts for activation of demand. Gross margins for Antique's consumer
universe improved by 42bps to 49.6%.
One cost component, which broadly affected margins across FMCG companies, was the
inflation in power & fuel cost and freight cost. This could be attributed to the shortage of
power supply across the country and hence use of alternate sources of power supply like DG
gen sets. Additionally the increase in fuel rates also added up to the increase in manufacturing
and distribution cost.
Despite the correction in stock prices, valuations across consumer companies continue to be in
the higher end of their historical trading band. However, the re-rating of the sector in view of
its resilience in an uncertain economic environment cannot be undermined. We therefore
have factored in re-rating in valuations across our consumer coverage. Post 1QFY14 results,
ITC and Marico are our preferred picks in the sector. Preferred picks: ITC, United Spirits.
Industrials: Neutral
Most of capital goods companies reported disappointing results in 1QFY14, with sharp
deterioration in revenue growth and profitability margins. Revenues were impacted due to
poor execution, which also impacted margins. Ordering remain subdued, with the exception
of Larsen & Toubro (LT). During 1QFY14, LT managed to report 28% YoY growth in order
inflow to INR251.6bn. The company had 70% orders from Infrastructure segment at
INR175.8bn, registering growth of 14% YoY, with major contribution from transport
infrastructure, heavy civil infrastructure and building and factories. BHEL reported order
inflow decline of 73.7% to INR14.69bn during the quarter, while Siemens’ order inflow
declined by 3% to INR26.2bn.
The margin pressure was visible in BHEL, Siemens, Voltas and LT during the quarter. EBITDA
margin for BHEL declined to single digit at 6%, lowest since 1QFY05. LT reported 50bps
decline in margins to 8.5% in 1QFY14. Margins for Cummins were impacted by re-set of
currency for export contract and cross service charges. Voltas’ margins were impacted due
to loss in international EMP business. For Crompton Greaves, operational loss in overseas
subsidiaries reduced from INR831m in 4QFY13 to INR638m in 1QFY14. Company reported
strong set of numbers in domestic business with sequential margin improvement. On positive
side, Havells and Siemens managed to report margin improvement by 110bps and 60 bps
YoY respectively. Overall aggregate profits for companies under coverage declined by
27.8% YoY during the 1QFY14. Outlook continues to be poor due to stagnating capex
cycle. We prefer companies with diversified business portfolios. Preferred Picks: L&T,
Crompton Greaves and Cummins.
IT: Positive
We expect growth rates for the sector to rebound in 2HFY14E led by deal closures and
ramp from these deals. Companies are seeing increasing traction from Europe and witnessing
increasing deal pipeline from US markets as well. As witnessed in FY13, growth rates are
likely to diverge for players under our coverage. Even TPI, outsourcing consultant cited
potential improvement in discretionary spends in key sectors such as BFSI, Healthcare and
utilities segment. Our preferred picks are TCS and Wipro amongst large caps and
Tech Mahindra amongst mid caps.
Our preference for TCS is led by our view that the company has made significant investments
in tapping emerging geographies and have strong presence in high growth segments such
as infrastructure management & BPO. For Wipro, we believe risk reward is favorable and
closure of large deals should help re-rate the stock. Our bullish stance on Tech Mahindra is
led by our view that revenue visibility post recent deal wins from KPN has improved and
growth rates is likely to be robust. Satyam , we believe has witnessed improved deal pipeline
and should be able to meet industry level growth rates by FY15E. Preferred picks : TCS,
Wipro & Tech Mahindra/Satyam.
Infrastructure & Ports: Neutral
The project awarding by NHAI in FY13 was been very subdued with award of only ~1,116km
worth of projects against the initial target of 9,300km. While NHAI had set a target to
award 2,000km each for BOT and EPC projects over the next two quarters, it awarded only
479km of projects in April to July 2013 period. Stressed financial position of players, low
estimated traffic density for many stretches on offer and delay in project clearances were
the key reasons for subdued awarding. While even FY14e is likely to witness project award
missing estimates, companies with reasonable strong balance sheets will participate in
upcoming bids as lower competition will enable them to bid conservatively. On policy front,
the Cabinet Committee on Economic Affairs has allowed concessionaires in ongoing and
completed National Highway projects to completely divest their stake in the project. However,
differences over valuations may limit the potential buyers from buying these projects.
The freight rates index in tanker and bulk segment reported decline on YoY basis due to
continued oversupply of tonnage. On QoQ basis Baltic Drybulk index (BDIY) showed the
recovery of ~11.3% while Baltic Dirty Index and Baltic Clean Index declined by 5.9% YoY
and 14.4% YoY respectively. We expect challenging freight rate scenario to remain in short
to medium-term. We believe GE Shipping would be the strongest play in weak and volatile
market in shipping due to its strong balance sheet with cash balance to capitalize on fall in
asset price. For port sector we continue to believe the private players would benefit from
cargo diversion from major ports due to capacity constraints and better logistic network and
service. Preferred Pick: Adani Port.
Sectoral Strategy
Media: Positive
Our positive bias for Media stocks are driven by likely pick up in ad spends and
improvement in subscription revenues for key stake holders i.e. broadcasters and multi
system operators. We believe industry dynamics is likely to change significantly post
implementation of digitalization in the country. In the long term we prefer broadcasters
given de risked revenue model (advertisement and subscription) and would recommended
Sun TV in the space. Amongst content distributors we prefer Hathway.
For Sun TV we expect earnings to grow at CAGR of 21% (FY13-FY15E) vs decline
reported over last two years. With subscription revenues now likely to see uptick led by
cable TV digitalization in Chennai and Phase II locations, we see scope for margin
expansion. For Hathway, our view that collections for the company is likely to improve
over next 2-3 quarters and company is likely to benefit from consolidation opportunities
in Phase II/ III locations. Estimated subscriber base for Hathway now stands at ~10.5mn+
and could reach ~12mn over the next 15-18 months. For Dish we believe company’s
focus on improving ARPUs, reducing churn and reducing subscriber acquisition cost
should help increase FCF for the company. We believe Phase III/ IV with nearly ~50mn
subs does provide a good opportunity for Dish to improve its penetration levels. Retain
BUY, with DCF led target prices of INR 70. Preferred picks: Sun TV, Hathway
Cable & Dish TV.
Oil & Gas: Positive
The quarter saw surprise profit of INR1.5bn by BPCL against losses by peers IOCL and
HPCL. BPCL delivered superior performance in both refining (at USD4.1/bbl GRM) and
marketing (27% jump in marketing margins vs. FY13). Despite 91% compensation (INR153bn
from upstream and INR80bn from Govt.), OMC numbers as a whole were poor due to FX
losses as the INR depreciated over INR5/USD between quarter ends. PSU upstream
companies bore the brunt of lower oil prices as subsidy being fixed at USD56/bbl resulted
in ~USD10/bbl QoQ fall in net realizations. This was coupled with employee provisions
and lower crude sales by ONGC and Oil India. Private explorer Cairn India posted good
numbers due to higher FX income. Average Singapore GRM declined ~25% QoQ which
led to correction in refining earnings. RIL and Essar Oil saw 17-23% QoQ decline in GRMs
though PSU refiner MRPL witnessed improvement due to pre-commissioning volatility. Gas
transmission companies saw volumes bottom out in 4QFY13 and QoQ reported numbers
were flat. However, GAIL suffered from higher subsidy burden of INR7bn. Conversely GSPL
continued to enjoy better tariff from new tariff order and take or pay income. Petronet LNG
missed estimates due to lower spot volumes and margins. Preferred picks: BPCL, ONGC
and GSPL.
Pharmaceuticals: Positive
Pharma stocks have been witnessing a strong earnings upgrade cycle for the past 8 quarters.
Post this quarter also Sunpharma, Ranbaxy and Ipca has seen meaningful upgrades while
we cut our estimates meaningfully for Cadila & marginally for DRL and Glenmark. . We fail
to discern major sectoral tailwinds for the operational performance for 1QFY14 except U.S
new product approval slowing down.
There was also a sharp increase in costs related to GDUFA filing captured in higher G&A
costs. Management commentaries and guidance however don't seem to be factoring huge
currency benefits which in our view imply conservatism and upside risks to estimates for
FY14 &FY15.
The companies under our coverage universe reported a robust set of numbers with momentum
witnessed both at revenue as well as profitability level. Ex- non recurring earnings drivers,
numbers from Sunpharma, Ranbaxy & Ipca surprised positively while Cadila surprised
negatively. Revenues, EBITDA and Adjusted Net Profit were up 11%,12% & 13% yoy were
broadly in line with our estimates.
BSE HC Index has outperformed the broader market by 21%. However we believe that this
is accompanied by a strong earnings upgrade cycle and therefore don't find valuations
demanding. The downside earnings risk in our view is concentrated on Glenmark and
Cadila. Preferred picks: Lupin, DRL & Ipca.
Utilities: Positive
1QFY14 saw capacity addition of 2512MW, led by high participation by the private sector
(92%). During the quarter we have seen utilities having outperformed the IPP's despite
further correction in imported coal prices due to unviable non-escalable tariffs, lower than
anticipated coal supply from Coal India and project delays leading to cost-overruns. Profitability
of IPPs have also been lowered on account of a 10% depreciation in the INR which has
offset the gain on account of lower imported coal prices and have increased interest cost
due to dollar dominated borrowings. However, due to a good hydro season, the energy
and peak deficit has reduced to less than 5% from 9 % earlier. We expect some demand to
pickup in the coming quarters as SEB restructuring will fund more buying in the backdrop of
central and state elections.
PSU generating companies have outperformed in terms of utilizations levels and profitability
as they have received higher quantity of coal than the ACQ. This reflects preferential treatment
by Coal India towards PSU's. However, after the positive step initiated by the government
on the SEB restructuring package and Coal India showing a 5% YoY growth in offtake, we
expect the ground situation to improve. Due to their safe business model we are positive on
state utilities as against IPPs which are exposed to high earnings risk led by risks of a
depreciating INR/USD, lower merchant prices (INR 2.5-3.0/kWh), inflexible tariffs in PPAs
and greater dependence on imported coal. The financial performance of the IPPs is too
much dependant on favourable regulatory judgments which increases risks on the investment
thesis. Preferred picks: PGCIL, NTPC and PTC India.