What was the gist of the second quarter results?

The results for the second quarter ended September 2015 is substantially in the public domain and it is time to look at the key indications and messages from the quarterly results. On the positive side, there has been the advantage of cheap oil and low price of commodities. Also falling interest rates and low inflation have worked to the advantage of most industries. But on the negative side, bank credit has been sluggish in its growth. Corporate profits have also been hit by weak rural demand which determines demand for a variety of key industries like banks, automobiles, FMCG etc.

Overall earnings and top line were below expectations…

Net profits for the Sensex companies were actually down by 2.4% for the quarter. While Reliance, Infosys and NTPC were the stand out performers, most of the other companies across industries disappointed this quarter. The more worrying metrics is that the Earnings before Interest, Depreciation and Tax (EBITDA) actually shrunk by almost 7%. This means that the operating economics of most companies has taken a negative hit in this quarter. On the operational front, most companies faced higher wage and salary costs but the benefits of lower raw materials could not be retained. Weak demand, both in urban and rural areas, forced Indian companies to pass on lower cost benefits to the end users.

The sectoral picture of quarterly results…              

As stated earlier, the real issue was the operating profits weakening in the quarter. Most of the sectors saw their operating performance turning out worse than estimated. Surprisingly, the big disappointments came not from the cyclical sectors but from the so-called defensive sectors. That was a major negative surprise in these quarterly results. For example, among the FMCG space, both Hindustan Unilever and ITC reported operating profits lower than estimates. This was largely due to the impact of weak rural demand and margin pressures. In the automobiles space, both Tata Motors and Maruti reported below expected operating profits. While Tata Motors had some good news from China, overall demand remained weak. Maruti also faced the pressure of slowing top line numbers.

In the hydrocarbons space, ONGC and GAIL underperformed estimates largely due to weak output prices. That is likely to sustain. Both L&T and BHEL continued to be underperformers in the capital goods space. With weak off-take and a tepid order book position, they were the expected laggards. The surprise element came from stocks like Lupin. Slower FDA approvals and weak sales in the US led to Lupin reporting disappointing operating numbers. Thus in a nutshell, the sectoral picture was bleak across the board. Quite surprisingly, many defensive stocks faced operational pressures in this quarter.

It was an extraordinary quarter, pun intended…

Ok that was a pun. We are calling it an extraordinary quarter because quite a few companies benefited substantially from extraordinary incomes not arising from the normal course of operations. In the absence of these extraordinary items, the actual position of net profits could have been much worse. In fact, it is these extraordinary items that brought the net profit growth to respectable levels despite operating profits disappointing. Let us consider a few such instances.

Telecom giant, Bharti, benefited to the tune of Rs.760 crore due to the sale of its tower assets in Africa. Larsen & Toubro reported a special profit of Rs.310 crore by selling its stake in L&T Finance. This managed to improve its net profit position partially. Tata Steel had a major extraordinary profit this quarter as it gained Rs.2240 crore from the sale of its holding in Tata Motors and Titan. Even Hindalco had a special income of Rs.100 crore from a partial sale of assets. These probably saved the day for a lot of these companies.

Toning down future projections…

The biggest casualty of this quarter will be that brokers will be forced to serious tone down their growth projections for next year. Income growth figures for FY 2016 have already been downgraded from 15% to closer to 7%. The actual growth may be still lower. Similarly, the 20% projection for 2017 is yet to be downgraded but that seems to be a logical conclusion. These could have serious implications for valuations. For example the Sensex EPS is already downgraded closer to Rs.1400 for 2016 and may end up closer to the 1390 mark. That will make the current markets fairly expensive based on 1-year forward returns. Secondly, the P/E advantage that India enjoyed with respect to 2017 valuations will also cease to exist if there are further downgrades. There will have to be a toning down not only of revenues but also of operating profits and net profits.

To sum it up, this quarter has been disappoint to say the least. More so, on the operating front! The next couple of quarters may give a clear picture of whether corporates can turn around to higher growth. That will have a positive impact on future valuations of India Inc.

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

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