This could probably be the first quarter, where corporate performance will be under pressure from all sides. Sales growth is expected to be sluggish on account of the subdued volumes and lack of pricing power, whereas operating profits will be hit due to higher costs.

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The rise in interest cost indicates that combined net profit of India Inc would be substantially hit. After many years in the history, combined revenues of the 30 Sensex companies for the quarter ended December 2008 (Q3) is expected to grow by just 4-5 per cent while net profits may fall by 3-6 per cent on a yea-on-year basis (y-o-y). In short, the pressure would largely be felt on account of weakening demand, high input costs and firm interest rates.

The biggest damage could be seen in the industrial or manufacturing sector including metals, cement, automobile and real estate. Besides domestic woes, the growth and profitability of many companies are dependent on the export markets, which have been under pressure on account of the global financial crisis.

Indian exports were down between 9-12 per cent in October and November 2008. Analysts, thus, expect sectors like textiles, IT, hotels and export-oriented companies to feel the heat on these counts. Positively, financial and banking, healthcare, telecom and to the some extent oil and gas, engineering and power utilities are likely to report decent numbers.

Going forward, the year 2009 is likely to see consolidation as factors, which caused the damage, are showing signs of receding. For instance, interest rates are on a downtrend and liquidity is improving, which are necessary to boost demand.

The falling commodity prices will also ease out worries on operating margins for user industries. However, these may take a few quarters to reflect in corporate performance. Read on to know how the top sectors, and within them the top companies, are expected to perform in Q3.

Auto

The auto sector is one of the worst affected in the current economic downturn with companies cutting back on production or closing plants. For Q3, while car sales barely moved up (1.8 per cent), two wheeler sales were down 10 per cent. While Hero Honda saw its sales drop 4 per cent, Maruti recorded a 14 per cent drop, Bajaj Auto (30 per cent), TVS Motors (10 per cent), M&M (25 per cent) and Tata Motors (32 per cent).

These numbers would have been much worse, but for the numbers on the export front–two wheeler and car sales were up 44 per cent and 96 per cent in Q3. The gloomy outlook in the domestic markets had its impact on margins (fell between 100-800 bps) as auto makers doled out higher discounts even as the cost of raw materials and higher inventory took their toll.

The biggest impact of the downturn has been the medium and heavy commercial vehicle (CV) segment with volumes for Q3 down 58 per cent y-o-y. Drop in freight rates is forcing truckers to delay purchases and cut costs to survive.

The situation is unlikely to improve in the short term for the two leading players, Tata Motors and Ashok Leyland, more so for the latter as it is operating only in the CV sector. While there are positives in the form of lower commodity prices and cut in excise duty, it is unlikely to bridge the gap created by falling demand and lack of credit. Not a sector you would put your money on for the near term.

Banking

Despite the slowing economic growth in Q3, business growth (deposits and advances) was 22.3 per cent. Even as credit growth slipped from its highs of 30 per cent in November, it was robust at 24.5 per cent. During Q3, RBI announced several measures including cuts in cash reserve ratio (CRR), repo and reverse repo rates (350 basis points (bps), 250 bps and 100 bps, respectively), paving the way for improved liquidity and lower interest rates.

In fact, the 10-year government bond yields came-off by over 320 bps, which will help banks deliver strong trading profits in Q3. The public sector banks (PSB) including SBI, BOB and UBI would benefit from this and a possible reversal in mark-to-market provisions on bonds (as bond prices have risen), leading to a jump in profits.

The cut in CRR would provide cushion to margins, as these funds would have been deployed at better rates for lending to corporates. Thus, NIMs are likely to remain stable, even as banks have cut their prime lending rates (PLR) ahead of cutting their deposit rates.

Profits growth would be robust on the back of strong loan growth and higher treasury gains. Although, banks have been cautious in their lending practices, expect provisions for loans to rise due to weak economic conditions. ICICI Bank’s profits are seen declining due to higher provisioning for loans and decline in fee income. Apart from PSBs, private banks like HDFC Bank and Axis Bank should report good numbers.

Cement

This sector is grappling with a situation of oversupply coupled with weak demand. While output grew by 7.6 per cent during Q3 to 44.1 million tonne (mt), consumption grew by 4.2 per cent to 41.4 mt due to the slowdown in housing and construction sectors. Shree Cement and UltraTech are expected to post better sales growth due to addition of new capacity.

However, flat cement prices versus 9-10 per cent rise in operating costs on a y-o-y basis, would drag profit margins. And, while imported coal prices have fallen by over 40 per cent during Q3, the benefits will reflect only from Q4. A sharp increase in interest and depreciation charges due to capacity expansion will also impact the bottom line of cement companies. Thus, net profit for the sector is expected to decline by an average 15 per cent y-o-y.

Going forward, the several steps taken by the government during Q3 (excise duty cut, higher infrastructure spending) have created a positive sentiment, but, the gains will be limited as, for instance, excise cut has been passed on to customers. Likewise, focus on low-cost housing and the easing of liquidity are long drawn processes.

Construction & Infrastructure

Despite strong estimated revenue growth of about 30-35 per cent in Q3, net profit growth in the construction sector will only be about 8-10 per cent. This is primarily on the back of higher cost of funds of about 13-14.5 per cent compared to 11-12 per cent earlier. Like in the case of Jaiprakash Associates, while revenue growth is expected to be 45 per cent in Q3, net profit growth is seen at just 9 per cent, thanks to an estimated 70 per cent increase in interest costs.
 

Additionally, the construction sector's operating margins could come down by about 50-60 basis points on account of higher commodity prices. Going forward, investors need to watch order flow as Q3 was relatively subdued as companies were reluctant or selective while bidding for projects. Also, the impact of economic slowdown and election was seen on various segments.
 

Meanwhile, there is enough visibility in the sector given the order book of 3-3.5 times FY08 revenue. Also, as interest rates are on a downtrend and liquidity is improving, the funding and visibility of the projects could improve. Lastly, the lag effect of lower commodity prices should reduce the pressure on the margins in the coming quarters.

Engineering & Capital Goods

Despite odds, engineering companies may report revenue growth of 25 per cent, on the back of strong order book (1-3 times their annual sales). However, margins need to be watched as the growth in operating profit could be relatively slow at 20-21 per cent as operating margins may shrink by 150-250 basis points in Q3.

The impact of higher commodity prices (inventories) will be seen in this quarter; the gains from the recent correction in commodity prices will be felt from Q4 FY09. The impact on operating margins along with higher interest cost (30-50 percent growth) for the sector, suggests that net profit growth would be even lower at about 15-16 per cent.

Beyond Q3, analysts estimate that companies will be able to borrow at lower interest rates, which along with lower commodity prices indicate better days ahead. However, demand could still prove to be a concern in some segments like industrials, given the falling industrial production numbers and delay in industrial capex.

Companies like ABB (38 per cent), L&T (42 per cent) and Siemens (37 per cent) have a high exposure to the industrial segments in terms of pending orders. On the positive side, there may not be any visible slowdown in government projects and from the power sector. Companies like BHEL are seen relatively insulated as 80 per cent of its current order book is from the public sector.

FMCG

Here, companies are expected to churn average revenue growth of about 18 per cent on the back of price hikes and higher volumes. Says Anand Shah, analyst, Angel Broking, “We expect the FMCG space to report a robust topline growth of 15-18 per cent y-o-y.”

Rising rural incomes and increased salaries of the government employees would support volume growth. Greater spends on advertising and promotion (A&P) along with product launches while translating into revenue growth is likely to put pressure on margins. Also, prices of several agri-commodities have remained firm due to increase in Minimum Support Price to farmers and lower production of some crops. Thus, average profit growth is pegged lower at 14 per cent.

While the cool-off in palm oil prices would benefit soap makers like GCPL (over 50 per cent of raw material costs) and HUL, several companies have also implemented measures to cut costs. ITC is expected to witness a 2-3 per cent volume decline in cigarettes business due to its exit from non-filter cigarette segment, and its hotels business could come under pressure.

For Tata Tea, high tea prices and forex losses could shave off some margins, while high cash in hand will reduce interest outgo. Nestle is expected to be the fastest growing company in terms of profits, driven by strong sales growth and better pricing power.

IT

The December quarter is traditionally a weak one for Indian IT, with the holiday season leading to a lesser number of billing days. However, weak volumes on account of challenging demand environment (spending freeze, dip in project renewals) and adverse cross-currency movements are likely to make things worse.

The pricing pressure, which was till now largely seen in BFSI, is likely to spread to other sectors as well. In dollar terms, the front-line IT companies are expected to report q-o-q decline in revenue by 2-4 per cent, with the dollar appreciating by 17 per cent against the pound and 12 per cent against the euro in Q3. Tech Mahindra is likely to be the most affected, as over 65 per cent of its revenue billed in pounds.

In rupee terms, the topline of the top-4 IT companies is expected to grow in the range 6-7.7 per cent q-o-q in Q3, primarily driven by 11.4 per cent depreciation (q-o-q) in the rupee against the dollar. EBITDA margin for the sector is expected to slip by 13 bps to 25.1 per cent on lower utilisation. Unlike Q2, the MTM loss on forward contracts will also be lower, allowing PAT growth to be higher for Q3 for the top-4 IT firms.

The street would also keenly look at Infosys’ FY09 dollar revenue guidance, which analysts are expecting be cut by 1.0-1.5 per cent (from 13.1-15.2 per cent guided in previous quarter) for FY09. They would also be watching other key indicators like volume and pricing trends, vendor rationalisation, project pipeline and hiring plans.

Metals

The real impact of the lower prices and soft demand on the metal sector will be seen in Q3, wherein, companies are expected to report a significant drop in margins and earnings. On an average, the top three steel companies are likely to see their operating and net profits plunge by 48-50 per cent in Q3FY09 as compared to Q3 last year.

Analysts attribute this to the recent fall in steel prices, thanks to the slowdown in global and domestic demand. Thus, revenue growth is expected at just two per cent in Q3. The good news is that domestic steel prices are expected to stabilise, if not recover. Additionally, the lower raw material prices (coke and iron ore) should ease the pressure on margins in the coming quarters.

There are similar concerns for non-ferrous companies as volumes are likely to be hit on account of slowdown in the demand, while margins are expected to be lower due to the decline metals prices by 50-60 per cent from their recent peaks.

Oil & Gas

Crude oil prices came off their highs in Q3, correcting 53 per cent on an average, as compared to Q2 (down 37 per cent y-o-y). The decline would affect realisations for upstream companies like ONGC. Nevertheless, the share of its subsidy overhang would also stand reduced. The decline however, has enabled oil marketing companies (OMCs) like HPCL, BPCL, and IOC to earn profit on the sale of petrol (Rs 15/litre) and diesel (Rs 3/litre), despite the cut in their retail prices in December.

Their loss on the sale of kerosene and LPG has also declined, with losses pegged at Rs 50 crore a day. In the meanwhile, inventory losses (due to fall in crude oil prices) are likely in the refining business, where the fall is gross refining margins (GRM) (to about $3/barrel levels in December) would add further pressure.

The GRMs of Reliance Industries (RIL), although superior, are also expected at $10/barrel levels, compared to about $13 in Q2. The lower petrochemical prices would also put pressure on RIL’s performance in Q3. The start of operations of Reliance Petroleum in December would boost volumes going forward.

Pharmaceuticals

Despite the setbacks on the FDA front, cancellations of licensing deals for Glenmark and the key Western markets slowing down, expect revenues in this sector to grow by about 20 per cent in Q3. The robust growth is largely due to higher sales to unregulated/mature markets and new product launches.

The key concern dogging the sector continues to be the FDA warnings issued earlier to Ranbaxy, and now to Sun Pharma. While the FDA action cost Ranbaxy a chunk of revenues and forced it to source drugs from alternative plants, the impact on other drug makers was less severe.

With a large number of companies getting a sizeable chunk from exports, the depreciation of the rupee against the dollar (23 per cent) and the euro (14 per cent) over the last one year is a welcome relief. The MTM losses sustained by companies are expected to come down as the rupee stabilises, but for Ranbaxy (hedges aggressively) the losses could be higher.

For Q3, Dr Reddy’s is likely to benefit due to the launch of Imitrex, an authorised generic to treat migraine with estimated sales of $60 million for FY09 as would Sun Pharma (Protonix launch in US, $60 million sales) and Cipla (export growth). Expect Ranbaxy to have a muted sales and profitability growth due to the FDA issue, delay in launch of Imitrex and forex losses.

Power

On the back of higher tariffs, analysts expect a stable revenue growth of 10-20 per cent for power utilities. Though revenue growth is expected to be healthy, operating profit for the sector could remain flat on account of lesser capacity addition and lower PLF.

Capacity addition and PLF has been lower in many cases on account of the availability of the feed stock such as coal and higher input prices. For instance, NTPC's PLF is estimated at 87 per cent in December 2008 as compared to 91 per cent in corresponding period last year. Overall, this will also have impact on the sector's net profit translating to a moderate growth of about 5-7 per cent.

For Tata Power, however, revenue growth is estimated at 34 per cent, primarily on account of the increase in generation capacity. Going forward, concerns hover on account of slow addition of generation capacity and non-availability of feed stock. However, falling interest rates and commodity prices are good news.

Telecom

Unlike most others, volumes aren’t the issue in the telecom sector. Over the last few months, the sector has been adding over 9 million new wireless customers every month (total base now at 350 million). It is this explosive growth that will result in a 30 per cent plus revenue growth in Q3. But, profit growth may not keep pace.

For the top three listed wireless players, Bharti, RCOM and Idea, average monthly revenues per user (ARPUs) have been coming down steadily (3 per cent q-o-q, 10 per cent y-o-y) as revenues per minute (5 per cent q-o-q, 20 per cent y-o-y) have fallen faster.

The entry of a slew of new operators is expected to bring them down further and impinge on margins. RCOM’s ARPUs, on the back of the launch of GSM services across the country at attractive rates, is likely to fall the most in Q3 and Q4. The fall in subscriber usage metrics is not the only negative.

The high cost of 3G services rollout, mobile number portability, saturation levels in urban centres and the high proportion (90 per cent plus) of prepaid customers are all worrying factors for the telcos. Bharti seems to be the best placed as it has the least leveraged balance sheet and widest reach. While both RCOM and Idea will record high growth rates due to their rollouts, the short term is likely to be a painful one due to competition and higher investment requirements.

Clarification
This article has been modified to include Lupin's clarification that it had received from the US FDA "observations of non-compliance with current good manufacturing practices" (FDA 483) for its Mandideep facility, and not a warning letter as was reported in this report. 

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