Sharekhan Investor's Eye dated October 06, 2006

[Sunil]

 

Investor's Eye [October 06, 2006] Please see the attachment for details Share khan www.sharekhan.com

Summary of Contents MARKET OUTLOOK Earnings upgrades required Key points In our last Market Outlook report dated August 02, 2006, we had said that going ahead there would be two key positive triggers for the Indian equity market, viz a pause in the rate hikes by the US Federal Reserve (Fed) and better-than-expected earnings for Q1FY2007. The two triggers have played out as per our expectations and at the current level of 12,404 the Sensex has swiftly discounted both these positives, leaving very marginal upside. The Fed futures are indicating that any rate cut by the Fed can come in the first quarter of CY2007 at the earliest. This leaves us exposed to global economic risks in the interim six months. Corporate earnings haven't seen any significant upgrades over the last few months. Any upside from hereon would depend on the upgrades in the index' earnings driven by the better-than-expected Q2FY2007 earnings, especially in the banking and oil sectors. However, upgrades in the Sensex' earnings will have to be significant—in the range of 10%—to bring the market's valuations back to attractive levels. The Sensex is currently trading at 16.1x its one-year forward earnings, which is towards the higher end of the band in which it has usually traded, ie 12-16x. We continue to prefer domestic demand-driven stories like automobiles, banking, capital goods and cement. SHAREKHAN SPECIAL Q2FY2007 earnings preview Key points The domestic demand-driven story is likely to continue, as is evident from the growth in the Sensex' earnings led by automobile, cement, capital goods and fast moving consumer goods (FMCG) companies.

• We also expect the information technology (IT) companies to report a strong earnings growth on the back of a robust volume growth and the depreciation of the rupee vis-à-vis the dollar.
• We expect the earnings of the Sensex companies to grow by a strong 22.6% year on year (yoy) led by a strong growth in the above-mentioned sectors.
• The implied growth for H2FY2007 works out 21% yoy. Further upmove in the Sensex could come only from further upgrades in the Sensex' earnings.

 

Auto earnings preview
Q2FY2007 has been a good quarter for the automobile sector despite being a lean season due to the monsoons and the Shradh Paksha. Though the floods and heavy rains in some parts of the country affected automobile sales, the two-wheeler segment (except the market leader Hero Honda) has grown well; the commercial vehicle segment has also grown albeit at a lower rate as compared to Q1FY2007 and ditto for the passenger car segment. Bajaj Auto's sales grew by 27%, while Hero Honda reported a marginal rise of 1.3% in its motorcycle sales. Maruti's car sales grew by 12%, M&M's tractor sales were up by 29.7% and Tata Motors' commercial vehicle sales (including exports) grew by 39%.

 

Banking earnings preview

Key points

• We expect Indian public sector banks (PSBs) excluding State Bank of India (SBI), to report a healthy year-on-year (y-o-y) growth of 20% in their net interest income (NII) and a strong growth of 32.5% in their earnings for Q2FY2007. SBI, an exception, is likely to report a decline in its earnings due to high loan recoveries in the same quarter last year.
• The private sector banks are likely to continue their strong performance, as their earnings are likely to grow at 27.4% year on year (yoy) for the same period.
• We expect the loan book of the PSBs to grow at a healthy rate of 18-20% and that of the private sector banks at 40-50%. 
• The net interest margins (NIMs) are expected to remain stable as most of the banks have raised their prime lending rates over the last two quarters. The same should help them to mitigate the loss of income on account off non-payment of interest on cash reserve ratio (CRR) balances with the Reserve Bank of India.
• The strong performance at the operating level is likely to be aided by the declining 10-year government bond yield, which should help the PSBs to reduce their mark-to-market losses to nil or a negligible level.

 

Cement earnings preview

Key points

• The cement sector is expected to pick up from where its impressive Q1FY2007 performance ended. We expect the cement sector as a whole to report an impressive performance during Q2FY2007 due to a 9-10% growth in the cement volumes and a huge 29-30% rise in the cement realisations. Hence this sets a benchmark of 38-40% growth in the top line. 
• The cement consumption in the southern region has maintained a very healthy 20% growth. Further the sales tax rate in Tamil Nadu has been reduced from an average rate of 23.5% to 14.5% and the cement players have not passed on this benefit to the consumer, which was clearly visible in Q1FY2007. Hence we expect south-based cement manufacturers to deliver a superlative performance.
• Amongst the companies in our coverage we expect Madras Cement and Shree Cement to top the charts in terms of the top line growth. 
• On the earnings front we rate UltraTech Cement and India Cements as our top picks. On account of their huge leverage to the prices of cement, both these players are expected to report a multifold jump in their earnings. 
• We also like JK Cement and Orient Paper and expect them to report a 190% and a 672% growth respectively in their earnings.

Regards, The Sharekhan Research Team myac...@sharekhan.com

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