Earnings Review

First Q1FY2009 Earnings surprise

· The Sensex' earnings (adjusted for the one-time items) grew by nearly 17% in Q1FY2009 on the back of the strong performance from capital goods companies (earnings up 33% year on year [yoy]), telecom companies (earnings up 29.5% yoy) and oil & gas companies (namely, Oil and Natural Gas Corporation [ONGC]). However, the Sensex (excluding the oil companies) saw an earnings growth of 12.5% yoy during the quarter and the same is largely in line with our estimate of an 11.6% earnings growth for the quarter.

· Notably, the revenue growth for the Sensex companies (ex-oil and banking companies) was healthy at 29.1% yoy. However the same could not translate into an equally good operating performance largely due to a 181-basis-point contraction in the earnings before interest, tax, depreciation and amortisation (EBITDA) margin. The margins in most sectors were affected by the rising input and capital costs. The margin contraction was more pronounced in case of cement, automobile, real estate (read DLF) and fast moving consumer goods (FMCG; namely, ITC) sectors. On the other hand, metal and pharmaceutical companies registered an impressive expansion in their EBITDA margin on an annual comparison basis. The margin expansion in the metal sector was largely aided by strong commodity prices whereas pharmaceutical companies benefited from the weakness in the rupee.

· In terms of company-specific performance, L&T, Bharti Airtel, Grasim Industries, ONGC and HDFC Bank have surprised positively by reporting a better than expected performance. On the other hand, Reliance Communications, National Thermal Power Corporation (NTPC), ITC and DLF have surprised on the negative side.

· While the first quarter's earnings growth is ahead of expectations, the signs of moderation became more evident during the quarter. Moreover, continued challenges at the macro level (hardening interest rates, double-digit inflation etc) will continue to have a strong bearing on the earnings momentum of India Inc going forward. Importantly, the coming quarters would reflect the fuller impact of the rising capital cost and the other myriad macro challenges. The business sentiment survey conducted by the RBI prior to its quarterly monetary policy review clearly indicated a distinct moderation in the business optimism.

· On the brighter side, the recent easing of the rally in the prices of commodities (especially crude oil) could partially mitigate the cost pressures and limit the downside risk to our estimate of around an 18% growth in the Sensex' earnings during FY2009. Our top investment ideas in the large-cap space are: Bharti Airtel, L&T, Reliance Industries, TCS and Sun Pharmaceuticals. In the mid-cap space we prefer Crompton Greaves (CG), Tata Chemicals, Shiv-Vani Oil & Gas, Glenmark Pharmaceuticals and Opto Circuits.

The Sharekhan Research Team