4Q FY07 Results Preview - Merrill Lynch

Slower earnings momentum reflects expected trend
Sensex earnings growth in this quarter, though strong at 30%, is losing momentum and is the slowest in FY07 (MSCI is much lower due to the oil PSUs). This is despite a low base (Q4FY06 was the second slowest growth in last 12 quarters). Our call has been that earnings will slow to the 20-22% level in Q1FY08 and 15-17% in FY08, a view that is now gaining favor with consensus.
Healthcare, cement – strong growth but slowing in FY08
Healthcare has a strong growth for this quarter mainly due to a low base. For FY08, growth in the sector is expected to slow to under 20%. Similarly, cement shows a very strong growth for this quarter but we have a sell on most stocks, given Government measures to reduce prices.
Telecom, IT, industrials – Sustainable growth; O/W
Telecom and industrials should sustain strong earnings growth next year. However, Larsen & Toubro is likely to report slower growth in this quarter and could underperform near term. Again in IT we like the strong earnings growth story but expect weakness ahead of the Infosys guidance.
Autos, consumer staples and oil PSUs – weak growth; U/W
We are U/W sectors like autos, consumer staples and oil PSUs that are expected to report the weakest growth amongst our universe.
Top Potential Result Outperformers: Dr Reddys, State Bank, Bharat Forge, Bhel, Jet
Top Potential Result Underperformers: HLL, Bajaj Auto, Hero Honda, Cipla, L&T
Top Mid-Cap Potential Outperformers: Panacea, IVRCL, Sasken, Educomp, Colgate, GSPL.

Sector Highlights
Automobiles
Potential Result Outperformers: Bharat Forge, M&M
Potential Result Underperformers: Hero Honda
> We expect the sector to exhibit a mixed performance, with four-wheelers and component companies doing better than two wheelers. This is a repetition of the past few quarters, and an indication of more acute margin pressures, and relatively slower demand in the two-wheeler sector.
> Within commercial vehicles, we expect Ashok Leyland to post a stronger YoY performance on the back of strong sales and steady margins, as should M&M, driven by strong performance in the autos segment. Maruti and Tata Motors should continue to grow at a reasonable rate, although profit growth will likely be restricted by lower margins. Reported profit for M&M should, however, be lower YoY due to an extraordinary gain of Rs1.67bn last year. Tata Motors’ reported growth will be lower due to last year’s forex gain of Rs221mn.
> Within the two-wheeler space, we expect both Bajaj Auto and Hero Honda to register severe contraction in profits, due to muted top-line and lower margins. We believe that margins will be marked down substantially, impacted by the World Cup cricket tournament (for Hero Honda) and Rs3,000 price discounts on Platina (for Bajaj Auto). TVS Motor will continue to be squeezed by the leading players, thereby likely registering a sharp decline in profits once again.
> Amongst the auto components companies under coverage, we expect Bharat Forge to register the strongest performance, aided by domestic four-wheeler sales, and steady exports. Automotive Axles too should likewise register a strong quarter. Rico Auto is expected to disappoint again due to high power costs, as well as increased depreciation and interest expense.

Airlines
Potential Result Outperformers: Jet Airways
We expect Jet Airways to report significantly improved financial performance this quarter, with adj. PAT of Rs699mn (up 23% YoY) as compared to YTD loss of Rs2.1bn. Previous year reported profit, though, included post-tax gain of Rs1.7bn from sale and leaseback. This performance would be the result of stronger than expected load factors mainly in international routes, steady oil prices, and full benefit of congestion surcharge (imposed in December).

Banks and Financial Services
Potential Result Outperformers: SBI
> Bank earnings may come in 4-5% lower than expected owing to margin compression arising from a mismatch in rise in funding cost and lending rates. In particular, govt. banks have not raised lending rates at the same pace as deposit rates. The margin compression would have been higher but for the one-off interest banks are to receive on the CRR in this quarter.
> Loan growth could, however, surprise on the upside as sector growth sustains at +28%. We had been expecting a moderation in growth during the 4QFY08. In particular, govt. banks could see stronger growth led by SME and farm.
> The key variable to watch will be provisions. While we do see higher credit costs as banks seek to provide for a likely uptick in NPLs, the extent of provisions and the NPLs will be critical. We also see some mark to market hit as bond yields rise v/s 3Q levels (and some banks had written back provisions during the previous quarters). Fee income is, however, estimated to remain strong for private banks (+35%); government banks that are leading on technology implementation could sustain fee income growth of 15-20%.
> Amongst banks, ICICI Bank could see much slower growth (at <20%) owing to higher general provisions of Rs3.0bn. The key for IBank, however, will be the qoq uptick in gross NPLs. SBI could be a positive surprise given its excess SLR and the high CASA. HDFC Bank and UTI Bank could sustain earnings growth of 28-30%yoy.
> SBI's net profit growth, at 72% YoY, is exceptionally high owing to a much lower hit on its bond portfolio and lower taxes (SBI had accounted for whole year’s fringe benefit tax in 4QFY06). We expect the pre-provisional profits to grow at a moderate 15% YoY. We however think that at the operating level SBI could surprise on the upside owing to its high CASA, which could result in stronger than expected top line growth.

Cement
Potential Result Outperformers: None
Potential Result Underperformers: ACC, Gujarat Ambuja, Shree Cement, India Cements
Result Expectations – Key Highlights
> We expect the cement sector to deliver strong profit growth for the quarter ended Jan-Mar ’07. Sector profits will likely rise ~83% YoY and 14% QoQ. Margin expansion, on the back of higher cement prices and flat-to-lower costs, will be the primary profit driver.
> We believe Jan-Mar ’07 will mark peak EBITDA margins for the cement majors. This reflects the industry’s recent commitment to the government that it will cap cement prices at current levels for a year, regardless of possible increase in input costs.
> In Jan-Mar ’07, cement volumes for our coverage universe are forecast to be flattish, up 2% YoY & 4% QoQ. This compares with the industry’s volume growth of ~ 7% YoY during Jan-Feb ’07 (March data is awaited).
> Net price realization (excluding excise) for our coverage universe is estimated to be up ~26% YoY and 1% QoQ. Operating costs are forecast to be up 11% YoY and down 3% QoQ, on average. EBITDA/ton is forecast to average ~Rs1200/ton, up 71% YoY and 7% QoQ.
> Among the pure plays, we expect India Cements to post strong profit growth (+56% QoQ), driven by seasonal recovery in volumes (+14% QoQ) and consequent lower costs (-4% QoQ). In the Mar quarter, Gujarat Ambuja & UltraTech should also post strong QoQ EBITDA growth helped by flat-tolower costs and modest rise in cement prices.

Consumers
Potential Result Outperformers: Colgate
Potential Result Underperformers: HLL, Nestle
We expect aggregate consumer sector profit to grow 17% in the Mar Q. This is slightly better than 14% growth in the Dec Q but still lower than the 20-21% growth reported in Sep and Jun quarters. We forecast sector sales to grow 16% and EBITDA to grow 24% this Q.
HLL – We expect HLL’s profit to grow 16% this Q, better than the 11% growth in the Dec Q. We expect revenue growth of 9% and a higher EBITDA growth of 15%. We see a 70bps improvement in EBITDA margins due primarily to base effect. We see high downside risk to our estimates.
ITC will likely report numbers in line with past trends. We expect profit to grow 19% led by turnover growth of 17% and EBITDA margin expansion of 220bps. We expect gross cigarette turnover to grow 16% and margin to expand 130bps. In the case of non-cigarettes, we look for turnover increase of 27% and EBIT increase of 58%
Colgate in Mar Q should stand out as the company with most improved performance on a yoy basis. We expect profit to grow 35%, better than the 10% growth in the first 9 months of the year. While forecast sales growth is 13%, EBITDA will grow 37% led by favorable base effect on advertising cost timing. We expect a 330bps improvement in Colgate’s EBITDA margin in the current Q.
Asian Paints should also have a strong quarter with pre-tax profit growth of 26% led by domestic business growing 20% and international businesses growing faster led by base effect. We expect post-tax profit growth to be faster at 38% as the previous year was hit by higher tax provisions in the international businesses.
For Tata Tea, we expect the March Q to be the second consecutive quarter of profit decline. We forecast Mar Q profit to fall 7% Y-o-Y owing primarily to high interest costs for funding recent large acquisitions.
Nestle – We expect Nestle to disappoint with EBITDA growth of merely 12% despite revenue growth of 18%. Higher milk and coffee prices will likely hit EBITDA margins. We expect profit growth of 8% due to the effect of writeback of provisions of Rs125m in Mar Q last year.
Dabur – We expect Mar Q results to be in line with past trends. We look for EBITDA growth of 20% led by topline growth of 18%, led by high growth in fruit juices and home care, and rejuvenated Chyawanprash portfolio.

Energy
Potential Result Outperformers: RIL, GSPL
Potential Result Underperformers: IGL, Petronet LNG,
Gujarat Gas
> Oil prices: Price of ONGC’s marker crude Bonny Light is down 6% YoY and 4% QoQ to US$59/bbl.
> Refining margins: Singapore refining margins based on Dubai crude stayed flat QoQ at US$5.75/bbl in 4Q FY07. On a YoY basis, margins are down US$0.5/bbl (9%).
> Subsidies: We expect under-recoveries (ie subsidies) in 4Q at Rs85bn to be 20% YoY lower due to a steep decline in auto fuel under-recoveries. Underrecoveries on LPG/ SKO in 4Q are also down 12% YoY.
> Subsidy upstream companies will bear in 4Q uncertain: The extent of subsidy upstream oil companies like ONGC will bear in 4Q is still uncertain. We have assumed that upstream companies will bear Rs29bn of subsidy in 4Q (ie 35% of subsidy). Upstream contribution would be higher at Rs35bn if it is made to bear 41% of subsidy.


Media
Potential Result Outperformers: Zee Telefilms
We expect strong PAT growth trend among media companies in 4QFY07 and continued improving outlook.
We expect the Indian Media Sector, represented by Zee & Balaji, to report sales growth of 17%YoY but PAT growth of 56%YoY, mainly led by Zee.
> For Zee: We expect 4QFY07 to mark modest topline growth despite the ongoing Cricket World Cup on a competing channel. Driver of the anticipated 17%YoY topline growth will be the monetization of advertisement rate hike announced last year. We expect 161%YoY growth in EBITDA given its startup investments are approaching breakeven and lower content cost as
compared to 4QFY06. This should lead to a 57%YoY rise in reported PAT. This rise in PAT is largely factored in the stock price, and hence, we do not see much impact on the stock.
> Balaji should show improvement, with estimated sales growth of 16% YoY, EBITDA growth of 50%YoY, and Recurring PAT growth of 54% led by improved operating matrix in terms of higher realization (Star Price hike effective 2QFY07) & lower cost of production. However, YoY growth in EBITDA and PAT is not comparable, as the company has started providing managerial remuneration on a quarterly basis v/s 4Q till last year.

Software
Potential Result Outperformers: Educomp, Sasken
Potential Result Underperformers: Infosys, Patni Could strike a note of caution

Given the uncertainty on the US economic outlook, surge in the Rupee, and lack of clarity on imposition of Fringe Benefit Tax on ESOPs, we believe companies may strike a note of caution on the FY08 earnings growth outlook. Bellwether Infosys will set the tone when they kick off results season on Apr 13 and provide guidance for the coming year. While this could pressure stocks near term, we currently see no structural change to the offshoring trend, and maintain our positive stance on the sector.

Infosys guidance could disappoint Given the uncertain US economic outlook, Rupee appreciation and certain clientspecific uncertainties, for e.g. with respect to ABN Amro (in potential merger talks), we believe EPS growth guidance could be in the early 20% range, disappointing the market. We and consensus are forecasting a 30% FY08 EPSg, which could see a downward revision of 3-5%. While we see this near-term risk, we retain our Buy rating, given our view that Infy can achieve at least a strong 25% EPS growth.
Q1 guidance tempered by wage hike, Rupee and high base
Last Q1 benefited from sharp Rupee depreciation, significant volume strength from some large clients like in Infosys. Thereby given a high base, Rupee appreciation and annual wage hike, Q1 guidance would be expected to be dull. US economy a concern, pricing commentary key to watch
We believe the Indian IT industry is concerned over a possible US slowdown. In case of a slowdown volume growth may slow before picking up, as clients review spending priorities. Discretionary spending will get impacted the maximum, whereas there would be pricing pressures on the rest of the business. In our view, a 1% change in price assumption could hit FY08 earnings by 2% to 3%. Rupee appreciation to impact FY08 margins The Rupee/USD appreciation of 2% in 2 weeks has taken all by surprise and has been likely the result of the central bank abstaining from steadying the Rupee in a likely bid to manage rising inflationary pressures. Moreover, hardening interest rates in India may not help ease the situation on the Rupee front. If we assume that the Re could move to Rs42 by Mar 31, 08, it could hit FY08 earnings by 1.5% to 3%. Impact of budget proposals not completely clear yet Budget 2007 imposed Fringe Benefit Tax (FBT) on ESOPs. As we await details on this, its complete impact on the bottom lines of IT companies is not completely certain. Moreover, most companies are likely to pass on the tax to the employees.
If it were not passed on, it could impact profits by as little as 1% to as much as 15% for companies under our coverage. Also, since companies have encouraged employees to exercise options prior to Mar 31, it can be expected to result in EPS dilution next year.
Mar qrt likely modest
The quarter itself will likely be modest, driven by seasonally weak revenues until new projects ramp up. We believe forex losses could be modest, where companies will probably gain on hedging but net lose on translation. However, given the Rupee movement is more modest, at 2% vs 3.8% in previous qrt, the forex losses would be lower than last year.
Strong results expected
TCS: Likely to show margin expansion of almost 90bps given beneficial impact of large deals ramping up, likely offshore shift, and S,G&A efficiencies. TCS is our favorite large-cap pick going into the quarter.
Sasken: Expect revenues to grow by 13% qoq, largely driven by sharp growth in product revenues. Expect product losses to reduce from Rs102mn to Rs42mn. Expect profits to grow by 20% qoq driven by lower losses in product business. Update on E series signup the key to stock rerating in the short term.
Educomp: Expect revenues to grow by 78% yoy driven by 149% yoy growth in Smart_Class revenues. Expect profits to grow at 66% yoy. Full year guidance key to rerating in the short term.
Weak results expected
Infosys: is likely to report a mere 4% qoq PAT growth due to seasonality. Guidance could disappoint, as discussed.
Patni: As guided, we expect Patni to report a 10% qoq decline in profits on muted revenue and likely increase in investments in building a bench and SG&A. The guidance for 2Q will likely be muted given the likely annual wage hike.



Mid Caps
Triveni Engineering
>Sugar production for this season is estimated to be around 25mn tonnes, with consumption estimated to be around 19mn tonnes. The sugar prices for this quarter have declined by 19% (Y-o-Y basis) to Rs.15.56/kg (data accumulated from NCDEX). We expect the sugar prices to remain under pressure due to the oversupply situation.
> Following the dire state of sugar mills, the government has declared various support measures for the industry in the form of buffer stocks (2mn tonnes), open exports and export subsidies. However, approval of the same is awaited from the election commission as Uttar Pradesh has elections this year. In spite of all these measures, we expect the industry to report bad numbers at least for another 3-4 quarters.
> In Q4FY07, we expect Triveni’s revenue to grow 24.6% on the back of the strong growth in the engineering division. However, the EBITDA is expected to decline on the back of the continuing margin pressure in its sugar division due to declining sugar prices. The profits for the quarter are thus expected to decline by around 76%.

Greaves Cotton
> In Q3FY07, we expect Greaves’s revenue to grow at 41% on the back of strong growth in both its segment of engines (36% Y-o-Y) and infrastructure (60% Y-o-Y). We expect EBITDA margins to be stable at 15.3%. Profits for the quarter are thus expected to improve by 50% on an adjusted basis to Rs.301mn.