4QFY07 earnings preview

FY07: a record year
> For 4Q FY07, while YoY profit growth for Sensex will slow from 34% in 9m, we see 27.4% YoY growth.
> Adjusted for exceptional items, growth will be higher, at 30% YoY.
> Growth for the CLSA Universe (-0.1% YoY) will be dampened by adverse comparisons for oil companies (bunching in oil-bond issuance in 4Q FY06), but excluding-oil & gas, growth will be 25.3% (41.9% in 3Q FY07).
> Three sectors - software, telecom and banks – will together account for 58% of incremental earnings growth. Cement sector earnings should rise 42% YoY, on the back of higher cement prices.
> Strong demand momentum will reflect in 54% YoY (pre-excep. basis) growth in profits for Telecom, 23% for capital goods, 45% for Software. Pharma should see +69% growth off a low base (losses for Wockhardt, Dr Reddy in 4QFY06).
> Ex oil & gas, ebitda margin will rise 114bps YoY led by margin improvements in cement, telecom, pharma and consumer sectors.
> For Power, Autos and Metals, we see decline in margins on a YoY basis.
> Our forecast of slowdown in Sensex EPS growth to 12-17% in FY08-09 is driven by lower profitability in commodities, following a slowdown in global growth, and moderation in growth in Autos, Pharma and Petrochems.
> Slower earnings growth and tighter domestic liquidity will be challenges for market performance in 2007, after two years of +40% annual returns.
> Industrials, Consumer staples, Utilities and Infotech are our key Overweights. Energy, Materials and Financials are our key Underweights. We will, however, review our tactical U-WT on banks in the next few weeks, based on indications on inflation and asset quality of banks (reflected in 4Q results).
> With rising pressures on input costs, growing execution challenges, we believe bottoms-up stock selection will become more critical for outperformance.

Automobiles
> We expect 19% sector revenue growth in 4Q07, which will be led by the four wheeler companies which have seen robust volume growth (Maruti 4Q07 car sales up 30%YoY; Tata Motors CV sales up 19%), while two-wheeler sales have remained subdued in 4Q07.
> However, high 4Q06 base, coupled with aggressive discounting in two-wheeler companies and adverse product mix among some four-wheeler companies will keep margins under pressure. We expect margin pressures seen in 3Q07 (sector margins down 191bps) to continue in 4Q07. Consequently, ebitda growth at 2% will sharply lag revenue growth with sector margins forecast to decline by 200bps.
> We expect sector pre-exceptional PAT growth to be at a higher 17% on account of higher non-operating income, (largely forex gains from rupee appreciation as well as higher interest income from rise in interest rates in 4Q07).


Banks and Financials
> Indian financials are expected to report a healthy 19% growth in earnings in the current quarter as well despite the increase in general provisions on certain loans and higher reserve requirements.
> Volume growth in the sector continues to be robust with loans up 29%YoY and deposits up 24%.
> The two lending rate increases which typically feed through faster than deposit cost rise are expected to help PSU banks report a moderate expansion in their margins during the quarter. While, higher reserve requirement will be a dampener, RBI decision to pay interest on cash reserves with retrospective effect will offset the impact in the current quarter.
> With benchmark bond yields up 50bps during the quarter mark to market provisions will also dampen earnings; however this will not have a large impact on reported YoY growth as banks had witnessed a similar 30bps rise in rates during Jan-Mar ‘06.
> We expect private banks to continue to maintain a higher earnings growth trajectory though the impact of deposit cost and general provision increase is higher at these banks. Strong rise in non-interest income will help banks partly offset these.
> Asset quality trends will be the key to watch for in these results as with rising interest rates, the asset quality cycle may also be reversing.

Capital Goods
> BHEL's FY07 net profit at Rs24bn, up 42% YoY, was in line with our estimates. Order booking for the year at Rs363bn was 14% higher than our expectations. Revenues were 3% lower than our expectation, indicating better than expected margins. The strong order backlog of over Rs540bn, provides high visibility to FY08 and FY09 earnings. BHEL is our top pick in the engineering sector and among Indian large caps.
> We expect 25% growth in L&T's 4Q FY07 pre tax profits on the back of strong revenue growth. Growth in reported profit will be around 10% due to higher tax rate and some one-time gain in 4Q FY06. Ebitda margins for the E&C divisions are likely to be down marginally versus 3Q (3Q margins were higher than usual). L&T has sustained its order booking momentum in the fourth quarter too.
> ABB's strong growth streak is likely to continue. We expect +40% revenue and profit growth in 1Q 2007.
> Crompton Greaves 4Q FY07 net profit growth is likely to be negligible, though we expect 25% YoY growth at the pre-tax level. For full year FY07 we expect 9% profit growth for Crompton Standalone. At the consolidated level the growth will be negligible due to consolidation of loss making Ganz. We are positive on the business and expect 55% profit growth in FY08, followed by 31% for FY09. FY07 profitability has been impacted by sharp increase in material cost and tax rates. Both these factors will be favourable in FY08.
> Top picks - BHEL, Crompton

Cement
> Cement demand growth has slowed down to 8% in the first two months of the quarter compared to 10%+ in the previous quarter. Volume growth in the major cement companies has been constrained by capacity. ACC reported a decline in its February volumes of 7% as it undertook some maintenance work in its key plants. We expect cement volumes to have expanded by 8%+ in March as well.
> Cement prices in the North rose by 1-2% while those in the South rose by 3-4% during the quarter. Overall average cement prices moved up by nearly 2-3% during the quarter and the current average cement price is at around Rs225/bag. However this includes the impact of excise duty hike done in the budget. Considering the price freeze and the government pressure, we do not expect any major movement in cement prices in the next quarter.
> Due to lower allotment of coal to cement companies by the mine operators, cement companies had to resort to higher amount of open market purchases of coal. This is likely to put some pressure on the margins.
> Ebitda/MT for the cement companies is expected to rise by 3-7% QoQ to Rs1100 – 1,300/mt. Grasim’s VSF business will realise the full impact of price increases and we expect segmental Ebitda to be up 42% YoY to Rs2.21bn.


Consumer
> Macro economic conditions continue to favour the consumer sector. We expect companies to report +10% growth in revenues. Most of the companies have taken price increases to pass on increase in raw material prices and this may lead to margin expansion in select companies.
> After the weaker growth performance in 4Q, we expect HLL to return to +10% revenue growth in 1Q2007. Higher EBITDA margins due to increased sales of personal products and price hike impact in key product lines will likely drive an earnings growth of 20%.
> In case of ITC, with VAT on cigarettes being implemented from April onwards, we will likely witness a stronger volume growth in 4QFY07 due to preponment of cigarette sales. Loss in ‘other FMCG’ segment will be another key number to watch out for.
> Colgate is likely to benefit from a combination of lower ad-spends and price increases. Topline growth will be strong at +12%, Ebitda will likely increase by +25% as margins increase by over 175bps YoY.
> Nestle is likely to report a strong topline growth of c.15% YoY. However margins are expected to be lower as key Milk & SMP prices have moved up again in the Jan-Mar quarter though YoY impact will be lower due to high base. We expect EBITDA margins to improve by 100bps over the previous quarter.

Metals
> Aluminium prices were cut twice during 4Q FY07 - in January and in March. Realisations during 4Q FY07 are likely to be lower by around 4-5%. This will impact Ebitda margins of the aluminium business. Profitability on alumina sales should be higher due to firming up alumina prices during the quarter. We expect negligible profit growth for Hindalco in the quarter and Nalco's profits are likely to show some decline/remain flat on YoY basis.
> Tata Steel should report a strong YoY earnings growth and around 10% sequential earnings growth on the back of higher sales volumes during the quarter. Cost of Corus acquisition may be reflected in 4Q results.

Oil & Gas
> With oil prices ($59/bbl) largely flat QoQ, retail losses were also flat (Rs85bn) despite the reduction in auto fuel prices in Feb.
> Oil bonds for 4Q (Rs49.8bn) have already been paid by the government to the oil marketing companies.
> GRMs firmed up $2-3/bbl QoQ and with expected inventory gains and moderate losses on retail fuels, 4Q should be a strong quarter for R&Ms. Strong GRMs will also make 4Q a strong quarter for Chennai Petroleum.
> We expect ONGC’s profitability to moderate and reflect $43/bbl net realisations. We are building in exceptional gains from insurance payments related to the Mumbai High fire and also an impact due to the contingent liability on the disputed profit sharing on the Ravva asset in the quarter.

Petrochemicals
> Reliance will benefit from a YoY stronger petrochemical quarter and a QoQ improvement in refining margins.

Pharma
> Companies such as Ranbaxy, Sun, Wockhardt, Jubilant, and Aurobindo with outstanding FCCBs will benefit from a marked-to-market gain because of rupee appreciation.
> Margins on base business across companies will be weak because of rupee appreciation.
> MNC Pharmas might benefit marginally from rupee appreciation
> Dr. Reddy’s expected to report a strong quarter because of Ondansetron exclusivity. Worsening profitability of Betapharm is a key risk.
> Strong growth in domestic formulation sales expected to sustain. Formulation exports to developing markets will remain strong.

Power
> NTPC should be the best performing power company in 4Q, with volume growth and improvement in operating efficiencies. Higher generation (around 90%PLF) should help the company earn higher efficiency incentives. There is potential for upside to our earnings estimates.
> MERC's Oct-06 order, of deduction of Rs2.6bn from Reliance Energy's revenue requirements, is likely to have continued negative impact on the profitability of the company this quarter too. Other income could be the major swing factor in earnings.
> We expect 10% growth in Tata Power's pre-exceptional net profit in 4Q FY07. However, at the reported level there could be an earnings decline due to exceptional income in 4Q FY06.

Software
> Rupee appreciation, ESOP dilution have already reduced expectations from Infosys guidance – the flagship event of the quarter on 13th April. While markets seem reconciled to the negative impact of these factors on the company’s outlook, we expect EPS forecasts to continue their correction course from high, extrapolative, levels of +32% to the 28-30% range.
> So far, strong demand has been assured in techs, but recent data points suggest some softening – (Please refer our 5th April note on IT Services). The banking and financial services vertical, which comprised 43% of TCS and 39% of Infosys revenue, is of special interest. Company commentary has remained bullish across all vendors but we expect a mixed view post the result season. E.g. Sector frontliner Cognizant may not be able to repeat its superior June quarter performances this time.
> We added TCS to the CLSA model portfolio at the expense of Wipro. TCS does not give guidance and a slew of deal wins implies that at least topline visibility is assured for the time being. Heading into numbers, Satyam remains our #1 pick, as we see low consensus EPS expectations of 22%YY growth in FY08 – imparting some earnings strength to the stock. Disappointing commentary could emanate from Infosys, some mid-caps and also perhaps from Cognizant (when seen relative to high expectations from the stock).

Telecoms
> 4Q07 mobile net adds have been impacted to some extent by lower net-adds in March-07 (on account of disconnections due to verification procedures at cellcos). Roaming rate cut, implemented in mid-Feb'07 will also impact mobile ARPUs. However, overall volume growth has remained strong and momentum to remain healthy for both Bharti (revenues +9%QoQ) and RCom (+10%QoQ)
> We see downside risk to our MTNL revenue forecasts, considering pressures on fixed-line business. However, we also note that 4Q is also typically an adjustment quarter, especially on the taxation front, which could impact reported earnings growth.

Aviation
> Revenues of Rs18,110m (+11.4% YoY, down 6.4% QoQ).
> Compared to 3QFY07, yields will likely be lower impacting Ebitda margins.
> Per ASKM fuel expenditure expected to decline by 5% QoQ due to lower ATF prices in 4Q
> Loss of Rs497m at PBT level (profit of Rs137m in 3QFY07)
> Jet expected to write of Rs1.8bn as charges related to the Air Sahara deal; We forecast net loss of Rs2.3bn for 4QFY07.
> Key things to watch out for: Performance of the international business, which was near break even in 3QFY07; trends in selling & distribution expenditure and salary costs; Further profits from sale and lease back of aircrafts; total debt and company's plans to raise equity linked funds.

Retail
> Pantaloon Retail is expected to report sales of Rs8.9bn during 3QFY07, a growth of 95% YoY and 18% QoQ. Net profit will increase by 50% YoY to Rs244m. Ebitda margins are expected to be at 7.2%, 120bps lower than 3QFY06 due to higher share of value retailing. Further store additions during the last two quarters mean that fixed costs will be higher.
> During the quarter, we estimate that the company has added over 0.5 msqft to its shelf space. A large part of this addition has been under the Big Bazaar and Food Bazaar formats.
> Key things to watch out for: addition to shelf space, trend in employee costs and trend in inventory