SHAREKHAN SPECIAL

SHAREKHAN SPECIAL

Q2FY2009 IT earnings preview

Key points

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The top line of frontline information technology (IT) companies is expected to grow in the range of 5.6-9.3% quarter on quarter (qoq) in Q2FY2009. The revenue growth would be primarily driven by the depreciation of the rupee against the US Dollar, which is likely to boost the top line growth by 4-4.5% on a sequential basis. In dollar terms, the revenues of these companies are expected to grow in the range of 1.5-5.2% on a sequential basis backed by a moderate volume growth and flat pricing.
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On the margin front, Satyam Computer Services’ (Satyam’s) operating profit margin (OPM) is expected to decline by 200 basis points sequentially during the quarter on account of the wage hike implemented during the quarter. HCL Technologies (HCL Tech) and Wipro have also given wage hikes to a part of their work force. Hence, we expect their OPMs to decline by 60 to 70 basis points qoq during the quarter. On the other hand, Infosys Technologies (Infosys) and Tata Consultancy Services (TCS) are expected to show healthy improvement in their margins, as these companies had already given wage hikes to their employees in the previous quarter. Furthermore, the depreciating rupee is also likely to have a favorable impact on the OPM of these companies.
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On hedging front, Infosys and Satyam are going to benefit from the depreciation of the rupee during the quarter, as their hedge position were lower at the end of Q1FY2009. On the other hand, Wipro and HCL Tech had higher hedge position. In case of TCS, the forex losses would be limited on account of higher portion of options in its hedge position.
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The US Dollar has appreciated by 8.5% and 8.9% against the Euro and Great Britain Pound (GBP) respectively at the end of the quarter. This is likely to have an adverse impact on the financial performance of IT companies under the US GAAP, as IT companies bill 25-30% of their revenues in GBP and Euro. This has led to concerns that some of the frontline IT companies may not meet their Q2FY2009 revenue guidance in dollar terms and, in fact, may have to revise downwards their full-year FY2009 revenue guidance. However, this seems to be already discounted in the current valuations.
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Apart from the possible revision in US dollar term guidance, the street would be keenly watching the management commentary on indicators such as demand environment, pricing scenario and any revision in hiring targets.

Q2FY2009 Capital Goods earnings preview

After consistent underperformance in the previous few quarters, capital goods stocks outperformed the market convincingly in Q2FY2009, with the BSE Capital Goods Index registering a gain of 8.6% as against a 0.8% decline in the BSE Sensitive Index.

After a lacklustre performance in May and June, the Capital Goods Index in the Index of Industrial Production (IIP) rose by 21.9% in July 2008 (vs a growth of 3.4% in May 2008 and of 8.3% in June 2008), thereby improving sentiment towards capital goods stocks. We, however, hasten to add that such a strong performance is unlikely to be repeated in the coming months due to the very high base of the last year (a 30.8% growth in August 2007 and a 20.9% growth in September 2007).

Q2FY2009 Pharma earnings preview

Key points

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Pharmaceutical companies under our coverage are expected to report a 23.4% increase in their revenues for Q2FY2009. The revenue growth would be driven by a steady growth in the domestic market, the new product launches in the regulated markets, a strong growth in the contract research and manufacturing services (CRAMS) businesses and the consolidation of the acquisitions made in the previous year. Further, with exports accounting for over 50% of the pharmaceutical industry’s revenues, the weaker rupee (Indian Rupee has depreciated by around 8% over the last one year) would also aid the top line growth only partially as most companies have hedged their outstanding receivables at around the Rs41-42 level. Sun Pharmaceutical Industries (Sun Pharma) would be the biggest beneficiary of the weaker rupee, since it has not hedged aggressively at the higher levels of the rupee, relying more on the natural hedge mechanism.
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The operating profit margin (OPM) of the companies under our coverage is expected to expand by 170 basis points, largely driven by exclusivity revenues (Sun Pharma). On the other hand, we expect the rising input cost (due to a supply crunch of active pharmaceutical ingredients [APIs] and intermediates in China) and the higher power and fuel cost (due to higher crude oil prices) to negatively affect the margins of most of the companies under our coverage. Lastly, we believe that Wockhardt, Cadila Healthcare (Cadila) and Opto Circuits would feel pressure on their margin on account of the consolidation of the low-margin acquisitions.
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Despite a strong top line growth and a robust operating performance, the reported net profit of the companies under our coverage would decline by 2.2%. This would be because of the marked-to-market (MTM) losses (on account of the ~10% depreciation of the Indian Rupee against the US Dollar) recorded by companies like Ranbaxy Laboratories (Ranbaxy), Orchid Chemicals and Pharmaceuticals (Orchid) and Ipca Laboratories (Ipca), which have outstanding foreign exchange (forex) liabilities. Higher interest and depreciation costs (due to acquisitions) would also affect the reported profits in the case of Wockhardt, Cadila and Opto Circuits. On excluding the forex impact, we believe the adjusted net profits of the companies under our coverage would grow by 37.7% in Q2FY2009.
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Our top picks include Sun Pharma, Glenmark Pharmaceuticals (Glenmark) and Lupin, which are expected to deliver strong top line and bottom line growth. On the other hand, companies like Ranbaxy, Wockhardt, Ipca and Orchid could surprise negatively due to higher than anticipated forex losses.
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The key risk to our estimates for Q2FY2009 is companies reporting MTM losses on hedging instruments or on foreign currency derivatives. We believe companies like Ranbaxy and Wockhardt will have outstanding foreign currency hedges on which they could incur certain losses.

Q2FY2009 Auto earnings preview

The automobile sector has reported mixed sales volumes for Q2FY2009. Sales of two-wheelers recovered whereas that of passenger cars as well as commercial vehicles (CVs) remained weak during the quarter. The higher cost of raw materials is expected to have maintained pressure on the profitability of the automakers in Q2FY2009. Due to the price increases undertaken in Q1FY2009, some improvement is expected in their profitability on a sequential basis but on a year-on-year basis, the profit margin is expected to be lower.

STOCK UPDATE

Bharat Electronics
Cluster: Apple Green
Recommendation: Buy
Price target: Rs1,610
Current market price: Rs889

Rs570-crore capex plan for modernisation

Key points

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Bharat Electronics Ltd (BEL) has announced a capital expenditure plan of Rs570 crore to modernise its manufacturing plants in the next two years. This capital expenditure will be over and above the expenditure incurred during the course of the year for new projects. The company would spend around Rs260 crore in the current financial year and Rs360 crore in FY2010 to modernise the offset business.
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The company’s order book stands healthy at Rs9,450 crore. The management is confident of getting more orders during the course of the year.
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Every year BEL signs a memorandum of understanding with the defence ministry stating its revenue target for the year. The revenue target for FY2009 has been pegged at Rs4,800 crore. However, in FY2008 the company had for the first time fallen short of achieving its annual revenue target. In quarterly terms, the performance of the company is typically very volatile depending on the execution of the orders in a particular quarter.
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For Q2FY2009, we expect the company to record sales of Rs864 crore, that is a year-on-year growth of 21.9%. The profit margins are expected to decline due to an increase in the staff cost following the implementation of the recommendations of the Sixth Pay Commission. The profit after tax is expected to grow by 7.9% to Rs132.6 crore. Traditionally, the first half of a financial year tends to be weak for BEL with most of the growth being back-ended.
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At the current market price of Rs889, the stock trades at 8.1x FY2009E and 7.1x FY2010E earnings estimates respectively. We maintain our Buy recommendation on the stock with a price target of Rs1,610.

SECTOR UPDATE

Automobiles

Signs of revival?
Automobile sales grew at an extraordinary pace during September 2008 inspite of rising interest rates and credit crunch. The two-wheeler segment, which has shown a decent growth right from the start of the financial year, continued its growth in the month also. The car segment also did well during the month. The sales growth can be attributed to the onset of festive season and the inventory pile-up by the dealers to meet the increased demand during the festive season