Staying afloat
Falling demand, lack of credit and investor risk aversion continue to dog the laggards of 2008
While companies had lined up massive expansions plans in expectation of continuing growth, the rapid fall in demand and a severe credit crunch has forced some of them to drop prices, sell assets and restructure debt. In the backdrop of pressure on sales, operating margins and earnings, The Smart Investor looks at what went wrong for these sectors, its prospects and performance of top companies in the sector.
While the BSE Power Index should also have found a mention on the list, it has been left out as it shares many of the constituents with the Capital Goods Index. With the country heading into the election season and the fiscal measures probably the only way to boost employment and stimulate demand, analysts believe it would take at least two quarters before clarity emerges on the investment front.
Though share prices of companies in these sectors (see table: Struggling for growth) have come down substantially and a few developments like lower interest rates and input prices are some positives, a weak demad outlook continues to cast a shadow on the prospects of these sectors. Hence, a selective approach is desired.
AUTO
The lack of cheaper financing options and the economic slowdown are responsible for the underperformance of this sector. While interest rates have dropped over the last five months, banks have been reluctant to lend aggressively. Though encouraging sales numbers in January 2009 point to the some impact of the stimulus measures, the sector, according to analysts, is likely to underperform over the medium term.
The least impacted of the three major segments is likely to be two wheelers as the competitive pressures are the least in it with three major manufacturers sharing almost the entire pie. The car segment which has been hit by job losses, high interest rates and falling disposable incomes could see a revival due to softening of interest rates and launch of new models in the second half of 2009.
The commercial vehicle (CV) segment which is the most sensitive to the changes in the macroeconomic environment has been affected the most with sales volumes dipping 15 per cent to under 2.5 lakh vehicles for the 10months ended January 2009.
TATA MOTORS : Tata Motors has not had anything going right for it over the last one year. The credit crunch limited its options to pay for its $3 billion JLR acquisition, the launch of its small car has been delayed by over six months and an economic slowdown has crimped CV sales.
While the soft launch of Nano and stimulus measures (accelerated depreciation for CVs bought before March 31, 2009) could help, the near-term looks rather bleak if January sales numbers (down 30 per cent) are anything to go by. Apart from the repayment of the JLR loan (by June 2009), arresting the rapid fall in sales of its marquee brands across the world remain as the biggest concerns.
MARUTI SUZUKI: Robust sales in the A3 segment (Swift Dzire, SX4) and recovery in its bread-and-butter A2 segment (Alto, Wagon R, Zen, Swift and A-Star) helped Maruti register January sales volumes of 71,779 units, its highest in over a year. The company's EBIDTA margin worries on the commodity and volume front should be alleviated going ahead.
A hike in prices of SX4, Swift Dzire, Swift and A-Star by Rs 5,000-Rs 10,000 a unit should also help improve realisations. Ramping up production of the Swift Dzire and normalisation of A-Star supplies should improve volumes and market share. While Maruti has cash worth over Rs 100 per share, a slowdown will aggravate working capital requirements and reflect on the numbers in the coming quarters. The stock can be considered on dips.
HERO HONDA: Despite a slowdown in the sector, Hero Honda has been increasing market share, revenues and earnings over the last one year. Increased rural demand and less dependence on finance-aided sales have helped improve its sales volumes by 10.5 per cent in the current fiscal and market share to 67 per cent in January 2009. Operating profit margins have also improved (by 50 bps) in Q3 due to soft commodity prices, improved realisation (better product mix) and higher output at its tax free facility. Going ahead, expect the company to sustain market share, steady growth in numbers and higher margins on the back of six launches for the year.
CAPITAL GOODS
High economic growth, rising consumer demand and easy access to funds led many companies across sectors like auto, cement, oil and gas, metals and power undertake expansions. Thus, the capital goods sector did well for almost five years. Order books were growing at over 30 per cent and provided good earnings visibility thus, leading to high stock valuations (PE) ranging 40-70 times.
But, as things reversed (inputs costs increased, liquidity reduced, interest rates firmed up and demand waned), industrial production and capex cycle slowed down. Growth rate in new orders have now slipped to 15-20 per cent and many projects have been delayed or cancelled. These factors along with increasing investor risk aversion have significantly dented stock valuations.
While the concerns still exist, falling interest rates and lower commodity prices provide some comfort. Hopefully, the government's stimulus packages and liquidity easing moves should provide some support. The pains could last for another 3-4 quarters, before which domestic demand is unlikely to revive in a visible manner. The recovery in the global demand could take even longer.
The investors could however, look at companies having exposure to power and infrastructure segments as these are still witnessing activities due to the governments focus. The better visibility in these segments also means that stock valuations are relatively higher.
ABB: The decline in ABB’s share price is primarily due to the slowdown in its industrial business (37 per cent of revenues), which sells process automation solutions to industries like oil and gas, metals, paper and pharmaceuticals. While transmission and distribution (T&D) equipments account for the rest, it has also been impacted due to delay in T&D expenditure by the customer segments.
During Q3 CY08, ABB’s order inflow grew by just 13.2 per cent, whereas revenues grew by 10.3 per cent. Also, net profit declined by 9.4 per cent to Rs 104 crore led by a 370 basis point (bps) fall in operating margin to 8.9 per cent. Overall, the slowdown in the industrial capex cycle could impact ABB’s prospects in the medium term.
BHEL: The power sector, mainly government-sponsored projects, accounts for 80 per cent of BHEL’s order book and indicates good visibility at relatively lower risk. With rising investments in power generation, BHEL’s order inflow has been strong; up 38 per cent y-o-y in Q3 FY09. Thus, its order backlog stood at Rs 113,500 crore (up 46 per cent y-o-y), or 7.2 times its FY08 revenues.
This along with lower commodity prices should help BHEL's earnings grow at 25-30 per cent over the next two years. And, operating margins (18.7 per cent in Q3) could expand by 250-300 basis points in FY10. Little wonder, the stock trades at a premium to the broader markets.
L&T: About 40-45 per cent of Larsen & Toubro’s (L&T) order book is from the industrial sector (including large exposure to real estate and metals). The capex slowdown in the domestic and international (10 per cent of order book) markets, especially in the hydrocarbon sector, could pose challenges for L&T. In fact, its order book in Q3 FY09 grew by just 12.3 per cent as against 30 per cent for nine months of FY09.
Though the order book is still healthy at Rs 68,800 crore, the concern is over incremental flow of orders. L&T’s acquisition of Satyam Computer shares may also require it to book mark-to-market losses (acquisition price of about Rs 80 per share). Overall, its diversified order book (visibility for six quarters) and superior engineering and execution skills should provide some downside support.
METALS
A demand slowdown in key markets like China and developed countries led to inventory levels shooting up to historical levels at the LME; aluminium was up by 11 per cent, copper by 68 per cent and zinc by 10 per cent. Global crude steel production, too, fell; it was down 24 per cent on y-o-y basis in December 2008 alone. Thus, metal prices have fallen by 40-60 per cent over the past few months. And, with prices of raw materials (like coal and iron ore for steel players) remaining high, profits were seen falling.
Simultaneously, the global liquidity crunch coupled with high interest rates compounded the problems as many companies had borrowed funds for working capital and long-term growth plans (including acquisitions). During Q3 FY09, most of the ferrous metal producers (Tata Steel, SAIL, JSW Steel, JSPL) reported a decline of about 30 per cent in revenues and over 50 per cent in net profits.
Going forward, analysts expect the pain may last for a year with risk of further drop in margins and earnings. On the other hand, companies are re-negotiating prices with suppliers and cutting production to cope up with the situation. The significant correction in raw material prices and falling interest rates are also good news.
Overall, existing investors will need to take a one year view as near-term concerns remain. Positively, metal prices are trading near their respective cost of production (indicating marginal scope for further price correction) and stock valuations are low (PE of 2-3 times one-year forward earnings), indicating limited downside.
JSW STEEL: Lower demand and realisations (in India and US) took toll on JSW’s performance in Q3 FY09, wherein despite a 15 per cent rise in sales, the company reported a net loss of Rs 190 crore. For now, JSW has cut its production by 20 per cent and lowered capex plans. Analysts also expect realisations to fall by about 15 per cent. Falling coking coal and iron ore prices could however, ease some pressure, as JSW procures a majority of its requirements from the market. Overall, unless demand revives (especially in industrial sectors like pipes and plates), JSW’s prospects are unlikely to improve. Till then, potential or existing investors will have to wait before any decent returns from this stock can be made.
TATA STEEL: Like others, concerns over volume growth and operating margins exist; margins declined by a fourth to 30.8 per cent y-o-y in Q3 FY09. However, Tata Steel continues to be one of the most profitable steel companies globally, thanks to captive iron ore (100 per cent) and coking coal (60 per cent) resources. Factoring in lower volume and realisations, analysts have cut earnings estimates by 40-60 per cent for the next two years.
Concerns also persist on account of its UK-based subsidiary, Corus, due to the demand slowdown in Europe; Corus has already cut production by 30 per cent. Thus, its prospects depend on revival in global and domestic demand, which is not in sight. Investors with a 1-2 years perspective could buy on major declines.
| STRUGGLING FOR GROWTH | ||||||||||||
| in Rs crore | Net sales * | Chg ^ (%) | Net profit * | Chg ^ (%) | EPS for TTM ended | EPS (Rs) | PE (x) | Price (Rs) | ||||
| 7-Dec | 8-Dec | FY10 E | 8-Jan-08 | Latest | 8-Jan-08 | Latest | % fall | |||||
| ABB | 6,548 | 18.5 | 535 | 20.0 | 21.04 | 25.25 | 33.0 | 71.11 | 17.32 | 1,496 | 437 | -70.8 |
| BHEL | 23,023 | 20.0 | 2,902 | 0.1 | 59.22 | 59.27 | 95.0 | 42.12 | 22.76 | 2,494 | 1,349 | -45.9 |
| JSW Steel | 14,997 | 43.5 | 870 | -50.9 | 94.69 | 46.53 | 65.0 | 13.34 | 4.22 | 1,263 | 196 | -84.5 |
| Reliance Ind | 155,215 | 25.6 | 15,645 | 7.9 | 92.17 | 99.41 | 116.0 | |||||