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This is an archive article published on January 12, 2009

Tepid performance to continue

As Q3FY09 results begin to trickle in,investors will watch them carefully for a feel of the corporate sectors state of health.

As Q3FY09 results begin to trickle in,investors will watch them carefully for a feel of the corporate sectors state of health. The results will also determine how the stock markets fare this year: whether they get back on the road to recovery or continue to languish.

Most analysts are expecting a slowdown in revenue growth,a contraction in margins,and a negative growth in earnings growth all year-on-year. See table for estimates by various securities companies. The exact estimates,of course,vary from one agency to another. This may be attributed to the difference in their coverage universe 8212; i.e.,the stocks they track and the difference in their outlook.

According to market experts,the impact of Q3 results,which investors expect will be poor,has already been factored into the prices. Says Amitabh Chakraborty,president equity,Religare Capital Markets: The worst results are expected from sectors such as auto -59 per cent decline in PAT,oil and gas -40 per cent,real estate -37 per cent, and metals -25 per cent. The price correction in these sectors is already in the range of 35-60 per cent. On the other hand,the three best-performing sectors like IT,Pharma and Banking have corrected much less at 16-24 per cent.

While the markets have already corrected sharply,one cant completely rule out a further decline. Says Hitesh Agrawal,head of research,Angel Broking: Poorer-than-expected results could lead to further downward adjustment in earnings and consequently the stock price.

Meanwhile,investors concerns have changed between the time when Q2 results were expected and now. Says Dipen Shah,head of research,Kotak Securities: Earlier,investors were concerned about falling margins,but now their concern has shifted more towards how badly the economic slowdown will affect revenue growth.

Slowing revenue growth

As said,the major concern now is slowing revenue growth and how long this will last. Much will depend on how the fiscal stimulus packages work out. If domestic spending from the government increases,we could see demand coming in. It will also depend on improvement in the global economic situation. Export growth has slowed down. Only when the global situation improves will export growth stabilise. When we see how things pan out over the next quarter on these two fronts,we will know how soon the slowdown in revenue growth will end, says Shah.

Shrinking EBITDA margin

Over the last two quarters,concern has centered around contracting margins. In Q3,too,EBITDA margin is likely to contract. This is the result of high raw material costs during 2008,which companies were not able to pass on completely to consumers, says Shah.

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Concern regarding EBITDA margin will,however,abate in future because of the sharp decline in commodity prices. Cost-cutting exercises initiated by companies will also begin to show up.

And falling profit growth

Profit growth is also likely to decline. Says Agrawal: Higher depreciation charges as corporates continue towards project

completion,and higher interest charges,which are the result of high debt levels,are expected to curtail any significant improvement in profit growth. While interest rates moderated in Q3,they are expected to moderate even further in Q4. So again,high interest cost will not be a cause for concern in future.

Further,mark-to-market losses on foreign currency loans,and IT companies mark-to-market losses on currency hedges,both of

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which are the result of the depreciation of the rupee,are also expected to impact bottomlines. Both these will lead to lower other income and in turn affect profit growth.

Finally,if you are an avid investor,pay close attention to the management commentary that accompanies the results. This could provide you with clarity about the likely course of corporate results over the next couple of quarters,and hence the likely direction of the stock markets during 2009.

Sectors expected to do well

FMCG

Strong performance this quarter due to inelastic demand,strong cash flows,and low leverage. Players passed on higher input costs to customers. Decline in input costs will raise margins in Q4.

Banks

Cut in deposit rates will lower cost of funds,but the benefits will come with a lag,once old deposits mature. Drop in lending rates will lead to contraction in net interest income this quarter. Treasury gains expected to offset increasing NPAs.

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Depreciation of the rupee protected revenue growth this quarter. But global economic slowdown and disarray in financial services sector expected to take a toll.

Pharma

Forex losses expected to hit pharma companies. Stick to companies with strong balance sheets without FCCB conversion risk and low debt. Go with companies having free cash flow. Short term slowdown in CRAMs expected.

Capital goods

Sales growth strong due to strong execution ability of players like BHEL and Lamp;T. Margins under pressure due to high raw material costs in past. High interest cost to affect margins this quarter due to working-capital intensive nature. Companies supplying equipment to power sector to do well. Positive impact of falling prices to become evident from Q4. In future,economic slowdown could affect demand unless government spending revives demand.

Sectors expected to do poorly

Auto

Economic slowdown resulted in lower demand,especially for commercial vehicles. High interest rates affected demand for both passenger and commercial vehicles. High raw material costs raised costs.

Realty

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Fall in demand due to high prices and high interest rates. Companies over-leveraged. Falling interest rates,price discounts and move towards lower-cost housing could revive demand.

Mining and metals

Slowdown in world economic growth leading to declining prices and volumes.

Cement

Slowdown in construction and real estate impacting demand. Supply outstripping demand because of recent capacity additions,hence unable to increase price. Higher costs of coal and power in past. Need to send cement to distant markets also leading to higher costs and affecting profitability.

Media

Slowdown in advertising revenue affecting revenue. Margins affected by high operating costs. Advertising revenue could slow down further in future. Subscription revenue may increase due to increased penetration of distribution.

Who is expecting what in Q3

Estimates from Kotak Securities

Kotak universe 90 companies Growth Rate

Revenue growth 22.0

PAT growth excluding banks NBFCs 12.0

PAT growth for all 5.5

EBITDA margin ex-banking -100 bps

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Kotak does not cover all Sensex companies and hence does not have Sensex-related estimates

Estimates from Religare Capital

Estimates for Sensex companies

Sales growth 4.0,