Q4 toplines seen firm, but profitability may be crimped

India Inc is expected to report the slowest profit growth in seven quarters, reeling under higher base of the corresponding year-ago quarter and margin pressures across sectors.

Market experts see the aggregate earnings for Sensex companies growing at 15-19% for the quarter.

In the fourth quarter  of the previous fiscal, Sensex companies had reported a 66% yoy growth.

As for margin pressure, experts see a drop of almost 100 basis points, or one percentage point, in operating profit margins during the quarter.

“We expect earnings for Sensex companies to grow at 19% while the topline sales growth is likely to be at 26%. The earnings growth would be supported by big growth in financials, contribution from Tata Motor’s overseas Jaguar Land Rover operations and a decent 20% kind of growth in IT and FMCG companies.

However, we are seeing margin pressures creeping in as earnings before interest, tax, depreciation and amortisation (Ebitda) margins are likely to drop by 100 bps both on yearly and sequential basis” said Rajat Rajgarhia, director - research, Motilal Oswal Securities.

The growth in revenues or topline numbers would continue to remain in double digits, led by robust demand environment across sectors.

However, the rising costs of commodities and higher interest rates are likely to take a toll on operating margins. This quarter is expected to see operating margins grow at a substantially lower pace than topline numbers after almost six quarters.

Barring a few sectors, such as power, capital goods, consumer and autos, almost all the sectors are expected to report margin contraction. Metals and pharmaceuticals are expected to see a reduction of 200-400 bps in Ebitda margins. Sectors like IT and telecom are also unlikely to be spared.

“Most of the sectors are expected to witness pressure on margins due to higher raw material prices, which companies have not been able to pass on fully. Moreover, higher attrition and salaries are expected to hurt margins of companies in sectors like IT,” said Dipen Shah, senior vice-president (private client group-research) at Kotak Securities.

Though interest costs do not affect Sensex companies, the mid-caps may  have been hurt badly by high interest rates in the March quarter, thereby lowering their net profit margins.

On a broader level, the sectors leading net profit growth in the March quarter would be oil & gas (excluding oil marketing companies), financials, capital goods, IT and automobiles.

While the oil and gas sector would report around 55% growth in bottomline due to significant rise in crude prices and refining margins, the financials are expected to report profit growth in the range of 27-36%, driven by lower base and robust credit growth.
The companies in capital goods space would see their profits grow on faster execution at around 33-37%. On the other hand, sectors like telecom, metals and pharmaceuticals are likely to be a drag on earnings at the aggregate level.    
 
Driven by domestic concerns like rising interest rates and higher input costs, analysts have already revised Sensex earnings estimates for fiscal 2012 downwards by almost 2% to 1250 levels. Going ahead, they see further downward risk to earnings.

“We continue to think that the outlook for earnings for FY12 remains muted. Commodity prices are at new highs and a large part of raw material cost pressure is yet to be felt by companies given the inventories and forward covers. Similarly, interest cost pressure is likely to intensify in the coming quarters. High inflation and inherent shortages of labour would translate into further margin pressures this year through higher wage costs. Further, a supply-constrained economy implies that benefits from operating leverage are not there to be reaped.” wrote the analysts Prabhat Awasthi, Nipun Prem and Sanjay Kadam of Nomura Financial Advisory and Securities (India) in their earnings preview report dated April 8, 2011.

“We are expecting 18-19% earnings growth for Sensex companies in fiscal 2012, driven basically by three factors. Financials that contribute significantly to Sensex earnings will continue to do well. Also Sensex companies with global business model and global- oriented sectors like IT and metals would reap the benefits of improving global growth. However domestic plays pose a risk to earnings.” said Rajgarhia.

Despite the quarterly earnings being seen as decent, experts believe that the earnings alone may not significantly help the markets to move up from current levels until the headwinds on domestic side ease off.

“Markets would remain range-bound with risk of correction in near term if the results do not meet the expectations. We expect markets to start their uptrend once these concerns get sorted out and reforms process start.” said Shah.

“We do not see valuation expansion taking place till the companies with domestic business model, which are facing headwinds start doing well.” said Rajgarhia.