Good stock bets in a choppy market -- Prism Cement, Religare Enterprises, Mukta Arts

With all the companies having reported their numbers for the third quarter of 2011-12, another results season is out of the way. As expected, the margin pressures have continued in this quarter— the aggregate net profit remained flat despite a decent increase of 25% in the topline.

However, things are not as bad as they seem and there may be a silver lining in this dark scenario. The aggregate results are slightly better compared with those in the previous quarter.

The total sales growth was 25%, an improvement over the 22% clocked in the second quarter. The difference becomes clear if we compare the bottomlines. Though a flat growth in net profit may not seem impressive in an independent analysis, it is better compared with a 37% reduction in net profit in the second quarter.

“The 25% sales growth demonstrates that there is still hope. The current stress is only because of high inflation and interest rates and both these negative factors should ease in the coming quarters,” says Chokkalingam C, group CIO, Centrum Wealth. Though the interest cost continues to be a major drag for India Inc, the speed at which it was increasing has started moderating.

This cost has gone up by 47% in the third quarter, lower than the 50% increase in the second quarter. With the interest rate structure expected to come down in the coming quarters, this trend may continue.

Besides, several companies could reduce the interest burden during this quarter (see Stocks that reduced interest outgo). Though the recent stock market performance in India can be traced to the huge global liquidity, the better-than-expected corporate performance has also played a major role.

“While only 20% of the company results went below expectations, nearly 80% reported numbers that were above expectations,” says Abhay Aima, director, HDFC Securities. How did corporate India surpass the expectations by such a huge margin?

The answer lies in the disappointing second quarter numbers, after which the analyst community had slashed their estimates for the quarter. “Street expectations were clearly very low this time,” says Ambareesh Baliga, COO, Way2Wealth Securities.

However, one should not miss the financial jugglery behind this performance.

The mark-to-market losses in the forex position was the main reason that had dragged down the other income in the second quarter. Since the Indian rupee depreciated against the US dollar in the third quarter— from Rs 48.93 per dollar on 30 September to Rs 52.27 per dollar on 31 December—the forexrelated losses should have been much higher this time.

However, most companies decided to use the modified accounting provision that allowed them to keep these losses in abeyance. Several companies have also written back the losses provided in the first and second quarter.

“Since many companies have written back the previous quarters’ forex-related losses, they could show better results this time,” says Kishor P Ostwal, CMD, CNI Research.

This also explains how the other income component in the third quarter zoomed by 71%, compared with a fall of 48% in the second quarter.

Now, the Indian rupee has rallied back to Rs 49.25 per dollar, and even without this accounting rule change, things would have improved in the fourth quarter. Sectoral performance While most sectors have performed poorly in this quarter, there were pockets of strength as well. Cement and cement products continued to report good numbers as the market had low expectations due to the prevailing oversupply.

However, the continued pricing discipline helped them achieve a decent topline and bottom line. Prism Cement also turned around during this quarter (see Turnaround stocks). The oil and gas sector also reported decent numbers in this quarter, mostly because of the better-than-expected numbers from the oil PSUs.

Other strong sectors, such as FMCG, IT and banking and financial services, also continued to show a decent growth in this quarter. “Since banks deal with the entire economic spectrum, they can be used as a leading indicator. If banks can maintain their margins and the NPAs are not shooting up, it shows that the overall economy is doing well,” says Aima.

More importantly, the banking performance is not just triggered by very strong new generation private sector banks like the HDFC Bank.

“Several public sector banks like Syndicate Bank and Andhra Bank also controlled the spiralling NPAs,” says Sandeep J Shah, CEO, Sampriti Capital. Even though other sectors have not done well, there were some bright spots within these as well. For example, while Maruti India showed weak numbers, Tata Motors delivered fantastic figures mostly because of the above-average performance by Jaguar Land Rover. Similarly, while Bhel disappointed the market with very low order inflow, Larsen & Toubro showed a good order inflow. There are several other stocks that have shown a continued strong performance during the quarter.

Muted expectations As of now, the expectation for the fourth quarter is muted. “The final quarter numbers are also expected to be along similar lines. While these will be down on a year-on-year basis, they may be mildly positive on a quarter-on-quarter basis,” says Baliga.

This is because the two important factors—inflation triggered by high commodity prices and interest rates—that were acting as pressure points in the third quarter may play spoilsport in the next quarter as well. While domestic inflation has started to fall due to the increased food production, global commodity prices are on an upswing once again because of the increased liquidity.

The global crude oil prices have already shot up to $119 per barrel, and if this trend continues, the inflationary pressures may return to haunt the economy soon.

Another factor that is masking the domestic inflation is that oil companies have not been allowed to increase the prices of several petroleum products due to the ongoing assembly elections. If oil prices are raised after the elections, there will be a sudden spike in inflation.

While the upcoming budget is expected to be growth-oriented, the tight fiscal situation may force the finance minister to reverse some of the stimuli (reduction in excise duty/service tax, etc) announced earlier.

Since the increase in excise duty and service taxes are passed on to the end-consumers almost instantaneously, this will also result in an immediate spike in inflation.

Besides, even if the expected interest rate cut is enforced by the RBI during this quarter, its impact on basic numbers will be evident only after two to three quarters. A similar situation is expected in the next financial year.

As is clear from the Sensex EPS estimates chart, the Sensex’s consensus EPS estimate for 2012-13 has come down from Rs 1,498 a year ago to Rs 1,285 now, a fall of 14%.

The expected growth rate has also fallen during this period and the expected growth rate is now placed at 14% compared with the expected growth rate of 19% a year ago. There may be more downward revisions based on the weak fourth quarter numbers.


However, don’t ignore the positive aspects among this gloom. Since the expectations are very low, the chances of companies reporting better-than- expected numbers in the coming quarters are also high.

And if the economy weakens further, the RBI may step in with faster rate cuts. “As of now, I expect a 12% growth in earnings for 2012-13. However, the growth rate can go up to 15%, if the RBI cuts rates aggressively,” says Ostwal.