With the fourth quarter (January to March) results of 2007-08 tickling in, analysts feel that profits margins of many companies would grow at a lower rate then the previous quarters due to rising input costs, a stronger rupee and high interest rates. And some brokerages have already downgraded their fourth-quarter or annual earnings estimates.
In fact, the markets seem to have sensed the coming weak earnings performance in Q4FY08. After having risen by 55.2% for the first three quarters of FY08, the Indian market declined by 22.9% in Q4FY08. The decline has been much sharper in India than other emerging markets, largely due to the relatively high valuation enjoyed most of the year.
Says Apurva Shah, head, research (Institutional Equities), Prabhudas Lilladher Pvt Ltd, ?After having scaled 22.2% YoY growth in Q3FY08, net profit growth of companies under our coverage could drop to a modest 18.2% YoY in Q4FY08.? He feels that healthy earnings are likely to come from the real estate sector, pharmaceuticals, telecommunications, construction and shipbuilding. The worst performers, he says, are likely to be cement, auto ancillaries and non-banking financial corporations and capital goods.
S Ranganathan, head of research at LKP Shares, echoes a similar view. ?As such we are not expecting any positive surprises in the Q4 earnings season. We expect some of the infrastructure and construction companies to deliver good results for the quarter on a YoY basis despite input cost pressures.?
Apart from the rise in input costs, analysts also blame the mark-to-market losses being booked by Indian companies on their derivatives positions as one of the main reasons for the drop in profits. Says Kaushal Sampat, chief operating officer, Dun & Bradstreet India, ?There could be some negative surprises in results of those companies that derive a higher proportion of their revenues from the global market or have exposure to global financial markets. It is also possible that companies report losses on account of derivative transactions.?
In fact, the Institute of Chartered Accountants of India has suggested early adjustment of mark-to-market losses on quarterly results, after some companies revealed losses from their exposure to foreign exchange derivatives products.
With the US economy in the midst of a slowdown, the Indian IT sector faces challenging times. Moreover, performance of the dominant BFSI segment will be closely watched this quarter for signs of impending trouble resulting from the turmoil in the US financial sector.
The profits of IT companies, which have been growing at well above 30% anually for the last three to four years, are expected to slow down. The signs of the slowdown were evident when IT majors like Infosys, Wipro and TCS reported lower than expected profit. The appreciation in rupee against the dollar and the defaults in high risk loans had an impact on the profit margins of these companies.
Shah feels that the subprime crisis and the looming recession in the US will impact the IT sector results. However, Ranganathan feels that the IT sector should be able to deliver a sequential growth of 6% to 7% in revenues and investors would be keen to get a sense of clarity on the IT budgets and spending of large clients of the top IT majors. Sampat of Dun and Bradstreet feels that volume growth and stable billing rates will enable a sequential quarter-on-quarter revenue growth of around 4% to 6% for companies in the IT sector. ?The relatively stable rupee-dollar exchange rate in the fourth quarter would have provided some cushion to the IT sector,? he says.
In the banking sector, loan growth remained at 22% YoY as there was no major pick-up in credit during the busy season. Deposit growth continues at 23% YoY, while money supply growth rate is up 21% YoY. Ranganathan feels that banks should be able to sustain their margins. ?With moderation in credit growth during the quarter, the lower treasury profits could keep the results subdued for the quarter.?
However, in the automobile sector, rising prices of steel and aluminium and higher interest rates continue to restrain the sector. Steel alone has gone up by as much as 15% in Q4FY08. As major OEMs have entered into long-term supply contracts with their suppliers, they are not expected to be impacted during the quarter ending March. However, once these contracts are renewed, players will start being impacted by raw material cost-push.
The Union Budget 2008-09 has provided the much-needed respite for the automobile sector by extending excise duty cuts from 16% to 12% for small cars, two-and three-wheelers and bus chassis. Responding to the excise cut in the Union Budget, most OEMs slashed their product prices and passed on the entire benefit to the end consumer in order to drive demand. While car industry majors have reduced prices in the range of 3-5%, two-wheeler manufacturers like Bajaj Auto and Hero Honda have slashed prices in the range of 3-9% on some models over and above the excise duty benefit.
Despite these price cuts, analysts feel that there have been no signs of demand revival as yet, with automobile manufacturers reporting miniscule volume growth in Q4FY08.
?Sectors such as 2-wheelers that are sensitive to interest rate hikes could post disappointing numbers. The steady rise witnessed in commodity prices is expected to place margins under pressure for the automobiles and auto components industries,? says Sampat. Discounts and higher input costs during the quarter, according to Ranganathan, would put pressure on gross margins of auto companies and auto component companies.