Q2 Results – How the old economy is likely to fare?

The Q2 season began with both the leading technology companies, TCS and Infosys, giving an earnings growth warning. The message was very clear; IT growth is likely to be constrained by cross currency headwinds and margin compression as clients bargain for better pricing. However, Reliance was a beacon of hope as it managed to report an all-time high gross refining margin (GRM) as well as strong petchem margins. As the Q2 season progresses, it is time to look at how the old economy sectors and stocks are likely to perform.

Automobile story…

The overhang of the Volkswagen story and its impact on demand for diesel cars is likely to continue. The heavy vehicles segment is likely to outperform the overall auto segment like the last few months. However, auto stocks will get the benefit of lower input costs which will help their profits to grow by around 20%. Within the auto pack, Bajaj and Hero Moto are likely to benefit the most from the cheap commodity story as it will directly boost their bottom-lines. Within the four-wheeler space, Maruti is likely to lead with its brand launches and ability to cater to all customer segments. The largest auto company, Tata Motors is likely to have a weak second quarter due to a mix of weak car sales as well as the impact of Jaguar sales in China.

Banks will remain under pressure…

While PSU banks are overall likely to show a negative profit growth, private banks are likely to continue to grow. Lower interest rates will benefit the private banks more than the PSU banks. For PSU banks the problem of low loan growth and high NPAs is likely to continue. In fact, the slippages in the restructured assets are likely to increase as troubles at more industrial groups come out into the open. The rate cut by the RBI may have one lasting benefit as treasury profits may save the day for this quarter.

Oil’s not well for the energy sector…

The 3 principal oil extraction companies viz. ONGC, OIL India and Cairn are likely to report lower profits this quarter due to the impact of cheap crude prices globally. While this will be partially offset by a weak rupee, the impact will still be negative. The two PSU oil extractors will also have to share the subsidy burden of kerosene and that will also hit their profitability. Among the oil marketing and refining companies, both BPCL and HPCL are likely to take a hit due to weak refining margins. They still have a good chunk of their dollar payables un-hedged and that will continue to be an overhang. Reliance results have been outstanding and that may be the one stock that may provide leadership in the energy space, outperforming the rest of the pack.

Are Capital goods at a tipping point?

For too long both the key capital goods companies viz. L&T and BHEL have given a lacklustre performance. In fact, the last quarter was specifically dismal for both the companies. The wait for a revival in the capital cycle seems to be getting longer and that is not great news for both these companies. One redeeming feature for both L&T and BHEL could be that they could finally start seeing sustained growth in order book positions and top-line revenue. However, margins are likely to remain under pressure.

Metals and alloys will continue to disappoint…

The pressure on the ferrous and the non-ferrous segment is likely to continue this quarter and they are likely to post one of the worst performances compared to other sectors. For steel makers, the burden of cheap Chinese imports and slack demand is proving to be a double whammy. In fact, steel valuations are at a 25-year low in India but that is more because of the pathetically low operating margins that these companies are generating. Most of the non-ferrous items like aluminium and zinc have seen price fall to the extent of 14-15% and that is likely to weigh on their earnings.

In a nutshell, there may be pockets of outperformance with select old economy sectors like auto, capital goods and oil. Metals and cement are likely to seriously underperform. The revival seems to be still some time away.

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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