Vijay Kumar Gaba

May this auspicious transition of Sun God may empower the universe with divine energy and light and protect humanity from all demonic forces.

Happy Earning Season

Technically the quarterly result season starts from first day of every calendar quarter. However, the formal festivities begin with the IT Services major announcing their quarterly performance 10-13 days later. This season, perhaps for the first time in history, the top three IT service players chose to kick start the festivities together on 12^th January. Obviously it was an auspicious start to what is popularly anticipated to be an extremely fruitful earnings season.

Near consensus on corporate performance

There is near consensus on corporate performance during 3QFY22 in particular and FY22 as a whole in general. Post 2QFY22 a majority of brokerages have upgraded their earnings estimates for Nifty for FY22 and FY23.

Sector wise also, there is near unanimity on (a) continuing strong earnings momentum in IT Services and chemical sectors; (b) compression of spreads and decline in profitability for metal companies; (c) strong growth in BFSI segment with further improvement in asset quality and NIMs; (d) sequential improvement in auto numbers even though overall performance may be weak; (e) lackluster performance of pharma and consumer staples and (f) sequential improvement in consumer discretionary.

The following excerpts from brokerage commentary on quarterly performance are noteworthy:

Nifty PAT to grow 20% yoy (Kotak Institutional Equities)

We expect net profits of the Nifty-50 Index to increase 20% yoy and 3% qoq; and estimate EPS of the Nifty-50 Index at Rs726 for FY2022 and Rs844 for FY2023.

Sector wise - (1) banks (steady sequential decline in slippages, lower provisions, better performance of large banks), (2) metals and mining (higher realizations and volumes on a yoy basis, but weaker sequentially), (3) oil, gas and consumable fuels (higher qoq and yoy realizations for upstream companies, improved marketing and refining margins for downstream companies sequentially) and (4) retailing (strong volume growth led by increase in footfall and operating leverage-led margin expansion).

Expect decline in the net income of (1) automobiles (production issues, RM headwinds) and (2) construction materials (weak demand environment, higher fuel and power costs) sectors.

Earnings strong but breadth weak (MOFSL)

After two strong quarters of earnings growth, we expect MOFSL Universe to register another healthy quarter of 22% YoY growth in 3QFY22 on a high base of 33% YoY growth in 3QFY21. While the aggregate growth is impressive, it is narrow and driven by just four sectors – Metals, BFSI, O&G and IT. Two-thirds of the incremental growth is steered by Metals and Oil & Gas (O&G) sectors, with the Financials sector driving the remainder. However, the breadth of earnings remains weak with 42% of companies likely to post YoY decline in earnings while 38% are expected to post>15% earnings growth. The key 3QFY22 drivers are: a) Metals – likely to post 60% YoY profit growth and contribute 35%/35% to incremental MOFSL/Nifty earnings growth for 3Q, respectively; b) O&G – high Brent crude prices and demand led to higher GRM’s and volumes for OMCs; c) BFSI – higher loan growth due to improved economic activity and lower slippages leading to asset quality improvement and d) IT – strong demand backed by multi-year growth tailwinds on Cloud migration to drive topline growth. The key inhibitor is Autos – likely to drag down the earnings aggregate as it is impacted by semiconductor shortages for PVs amid demand concerns for 2W and tractors.

Nifty FY22E EPS has seen an upgrade of 2% to INR743 (v/s INR730), while Nifty FY23E EPS has remained almost unchanged at INR872 (v/s INR873). We introduce FY24E earnings and estimate Nifty FY24 EPS to be at INR993.

IT Services – growth to defy seasonality and remain strong (MOFSL)

The strong demand environment is expected to continue in 3QFY22, with Tier II players again outgrowing Tier I companies within our coverage universe.

Despite adverse seasonality, Tier I companies should deliver revenue growth in the 3.2-4.8% QoQ CC range, while Tier II players will have a wider band of 3.6- 7.1% (excluding PSYS, which will benefit from inorganic growth).

We expect a strong initial outlook for FY23E, with companies maintaining their view of multi-year growth tailwinds on the back of Cloud migration. Guidance for 4QFY22 is also expected to be positive on the back of continuing deal wins.

We see margins for most companies (excluding company-specific factors) to be in a narrow range as supply pressures (attrition and hiring) are offset by operating leverage. Among Tier I players, EBIT margin will be in a tight (-20bp to +40bp QoQ) range, although they will see a steep decline v/s 3QFY21 profitability.

Critical quarter for BFSI sector (Axis Securities)

The Banking sector will continue to deliver growth driven by a growth in the retail segment. Moreover, asset quality is expected to remain under control and challenges should further moderate on a QoQ basis. NIMs are likely to remain stable and might even see marginal improvement on a sequential basis. Moving forward, key focus areas will be growth prospects and fueling the corporate segment which is currently seeing some sluggishness. We will watch the top four banks very closely for growth guidance. The smaller banks are expected to continue focusing on maintaining asset quality in light of significant deterioration seen during the last one year. NBFCs will also be closely watched for asset quality. At this juncture, we

believe Q3FY22 will be similar to Q2FY22 for NBFCs and funding costs will remain manageable. Overall, earnings prospects should improve for the BFSI sector during the quarter and management commentary on growth would be a key monitorable.

Cement – demand recovery and softening costs (Emkay Equity Research)

Industry EBITDA/ton declined 11% YoY in Q3CY21 and remained under pressure in Q4CY21 due to input cost inflation and soft demand. However, cost inflation should ease off from early CY22E with a softening in input prices (down 15-40% from recent peaks). After a ~50% increase in the past two years, industry EBITDA/ton is expected to remain flat in CY21 but is likely to increase by 4-5% in CY22E.

Expect demand to likely grow by 8-9% YoY in CY22E (vs. 6-7% long-term historical average), driven by higher infra spending, pick-up in the housing segment and revival in urban real estate activity. The South and West regions should see 8-9% growth on a low base, while the North regions may clock 6-7% growth. While demand has been impacted in the past few months by heavy rainfall, construction bans in North, sand mining issues in East and limited labor availability, it should pick up in the coming months with the onset of a busy construction season and easing inflation in construction costs.

Maintain our positive view on the sector based on robust earnings compounding and a structural RoIC reset, with medium-term demand growth visibility and calibrated supply additions.

Speciality Chemicals – strong underlying trend

Estimate our chemical coverage universe revenue to grow at 42% YoY (7% QoQ) during Q3FY22 on sharp rise in prices due to input cost inflation. However, gross profit is also expected to grow 29% YoY which indicates strong underlying trend.

Steel – Margins to normalize (Prabhudas Liladhar)

Expect EBITDA of steel companies under our coverage universe to fall sharply by 19% QoQ due to lower volumes and contraction in margins. Sales volume is expected to contract by 6.5% QoQ due to subdued domestic demand. Steel realisations would increase by 2.5% QoQ/Rs1,500/t, falling short of expected rise of 10% QoQ/Rs4,500/t in costs on account of higher coking coal cost. Owing to higher costs partially offset by increase in realisations, EBITDA margins would fall by 14% QoQ/Rs3,130 to Rs19,880.

Chinese steel demand is estimated to fall by 4.7% YoY in CY21e at ~955mnt due to weakness in housing and auto sector, compounded with little support from Govt’s spending.

Margins came off sharply QoQ in Q3FY22e due to 2x increase in coking coal cost and soft realisations coupled with weak demand in both domestic and exports market. Factoring US$50 drop in steel prices offset by US$15/t lower coking coal prices, we expect EBITDA/t to stabilise at normalised level of Rs15,000/20,000 for non-integrated/integrated producers in Q4FY22e. Even after the fall, normalized margins are 33% higher over the historical average.

Capital Goods – Mixed bag (IIFL Securities)

While short-cycle industrials continue to lead with healthy growth, the pace of rebound in the long-cycle portfolio has remained soft in 3QFY22, partially marred by headwinds in construction activities and by inflation. Recovery in government ordering has been muted, resulting in bunch-up for 4QFY22, with likelihood of slippages; yet, overall inflows have increased QoQ. Investment sentiment across private & infra projects remains positive and will not be deterred by Covid 3.0.

Inflationary headwinds and resultant delay in order finalisation from the govt. sector persisted in 3QFY22 too, adding risks of order slippages to 1HFY23. Ordering in Defence, Metro, O&G pipelines and the water segment was better, while remaining muted in rail, road and T&D. Private-sector ordering in both, short-cycle as well as projects in B&F, FGDs, WHR, data centres and manufacturing sectors, continued to show an uptick.

Real Estate – affordability remains high, demand robust (HDFC Securities)

3QFY22 seems to be promising for the Tier 1 developers. Despite an inauspicious period, holiday season toward Dec-21 second half and emergence of Omicron, 3QFY22 presales remained healthy. Whilst Jan-22 second half was expected to be launch heavy, we believe that Omicron driven COVID-19 wave three will push back the launches towards end of Q4FY22.

Our recent channel checks with leading real estate channel partners suggest that demand momentum remains strong and Tier 1 developers continue to gain market share. Affordability driven demand, rising income levels and near low mortgage rates are some of the factors contributing to the sales. Whilst globally interest rates are expected to harden, a 25-50bps increase may not result in demand destruction. Developers remain accommodative on pricing as most of them are holding historical land bank besides commodities prices are off highs. Whilst we expect property prices to re-rate it may be on the back of more sustained economic recovery and positive sentiments on consumption.

We expect the aggregate revenue/EBITDA/PAT for the coverage universe to grow sequentially by 2/2/5%. The impact of commodities’ prices will smoothen over the project completion period as companies will take the hit once projects complete. Overall, taking price hikes may derail recovery and developers may not go ahead with the same.

Auto – Weak due to demand and raw material headwinds (Nirmal Bang Equities)

We expect 3QFY22 earnings of Auto & Auto Ancillary companies in our coverage universe to be relatively subdued due to sustained input cost headwinds and muted demand (weak festivals, supply chain constraints and moderating rural growth). We anticipate gross margin contraction of 10-40bps on a QoQ basis due to continued RM cost pressures. However, with major commodities showing signs of stabilizing/moderating prices at current levels, we note that further impact on gross margins could be limited. EBITDA margins should witness softer trends on YoY basis, but will be partially supported on a QoQ basis by positive operating leverage, price hikes and tight cost controls across most companies. We surmise that current issues of supply chain constraints and rising covid cases are dynamic, but we see them leading to subdued demand and weak profitability in 4QFY22 too. For 2Ws, narration on demand revival and electrification transition efforts would be a key monitorable while a sustained demand recovery in 4QFY22 is critical for CVs.

Chart for the day

 

Thought for the day

“Common sense is the collection of prejudices acquired by age eighteen.”

—Albert Einstein (German Physicist, 1879-1955)

Word for the day

Skookum (adj)

Large; powerful; impressive.

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