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The pressure is building... - Views on News from Equitymaster
 
 
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  • Nov 1, 2004

    The pressure is building...

    Now that the results season is over (not that the market has had enough time to digest the slew of results), it is time to take account of the future course of action. If the performance in the September 2004 is any indication, for some sectors, tough times are ahead.

    As our Results Monitor shows, the topline growth continues to remain encouraging. Though some sectors like FMCG are going through difficult phase, the combined topline of nine automobile companies is up 26% in the September quarter. Barring TVS Motors, most of the top rung companies posted impressive growth in the topline. However, as compared to the topline growth, the net profit growth was slower as compared to June quarter. This was on account of two reasons. One, raw material costs as a percentage of sales was higher, which in turn subdued the expansion in margins. Secondly, since competition is intense, companies were unable to pass on the rise in cost to consumers. Besides these two factors, the cost incurred towards the launch of new model is yet to show at the topline level.

    Net profit grows slower
    (% YoY change) Sales Net profit
    Tyres 13.5% -42.8%
    Financial Institutions -10.0% -40.4%
    Consumer Products 1.5% -29.1%
    Textiles 10.1% -16.0%
    Banks 6.3% -3.4%
    Pharma 10.8% -1.6%
    Energy 15.1% 2.3%
    Fertilisers 26.6% 20.2%
    Aluminium 32.4% 26.7%
    Software 37.4% 35.1%

    The table above lists the sectors that saw a lower growth in net profit as compared to the topline. Textiles, banking and consumer product companies have actually witnessed a decline in net profit in the September quarter. While first half is a lean season for textile companies, there has been a fundamental change in the operating environment for banks. With interest rates increasing (as is reflected from the 10-year benchmark yield), the other income component that typically forms more than 30% of net profit (depends on the bank), witnessed a decline. In the last four years, banks made significant trading profit from treasuries that enabled them to clean up their balance sheets. But this cushion has evaporated. Though the decline in other income will be arrested in the remaining quarter, as banks have shifted their bond portfolio on a long-term holding basis, we believe that the sharp rise in net profits that we have seen over the last five years is unlikely to continue. However, the fact remains that certain banks will outperform others.

    Net profit grows faster
    (% YoY change) Sales Net profit
    Chemicals 16.6% 19.9%
    Energy 10.4% 22.0%
    Auto ancillaries 30.2% 46.0%
    Paints 12.1% 49.7%
    Media 17.0% 58.9%
    Engineering 19.6% 60.4%
    Shipping 18.5% 63.7%
    Cement 15.9% 73.1%
    Telecom 13.4% 117.2%
    Steel 31.7% 181.7%

    The reason for the slower growth in net profit for other sectors (barring software) can be largely attributed to the increase in input cost (raw material including fuel, packaging materials and so on). With crude prices continuing to trade higher in the global markets, manufacturing companies are likely to face pressure in the near-term. In this context, there could be surprises on the downside in the forthcoming quarters. Clearly, the pressure is building on India Inc.

    What to expect?

    1. There will be companies that will outperform the sector trend on a consistent basis. It is important to identify these stocks and build a portfolio around the same.

    2. There are exiting stories in the mid-cap level as well. However, the risk attached to the same is higher. In a portfolio, investors should ideally look at having a mix of large-cap and mid-cap stocks with large-caps acting as pillars to the portfolio.

    3. We believe that the impact of higher crude prices will reflect even more in the coming quarters on the margins. To that extent, one has to exercise caution.

    4. And more importantly, any investment decision in equities at the current juncture needs to be in staggered manner.

       

       

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