Ahead of the street

After last month’s severe pounding, investors were thrilled to see stocks bounce back from what appeared to be a knockout blow that could have kept the markets low for a while. Although the recovery is marginal, about 8 per cent from the Sensex’s February 11, 2008 lows of 16,457, it has been strong enough to drag it well above the crucial psychological 17,000 level to 17,766.63. By now much of the global tumoil that roiled the world markets and the temporary liquidity blip in the domestic market has passed.

The focus is back on the fundamentals of the corporate sector. Amid the growing concerns of a slowdown in the pace of earnings, India Inc.’s performance has, in fact, shown a resilient trend, perking up in the latest December 2007 earnings season. Much of the corporate sector’s results are out, and many companies have reported better-thanaverage growth rates. The 400 companies of the broader index, the BSE 500, that have announced their quarterly numbers saw year-on-year sales growth increase from 11 per cent in the second quarter (October 2007) to 15.8 per cent in the third-quarter, showing a remarkable uptick in growth rates (see Steady, Not Slow). Analysts were expecting the results to be muted following lower industrial production.

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But among the key concerns was whether corporate profit growth will be maintained on the back of rising input costs and an escalation in wages. On that front, India Inc. has not disappointed. It reported a healthy double-digit operating profit growth of 23.40 per cent, which is reasonable. However, this was marginally lower than last quarter’s 23.78 per cent. Still, it shows that companies were able to absorb the rising production costs, or pass them on to customers.

For the December quarter, net profit grew by a sturdy 23.75 per cent over the corresponding quarter last year. India Inc. has largely managed to do reasonably well, and the profit growth forecast for the coming years, despite global economic concerns, continues to remain in the mid-20 per cent range.

Some of the sectors that did well during the last quarter were engineering, and companies that supply vital capital goods for the oil and gas, drilling, mining and construction sectors. Brokerages and other financial services companies such as banks were also among the star performers. Others in the oil and gas space, such as drilling and offshore services, where demand is rising, have also turned in stellar performances. But a majority of the companies with an aboveaverage performance are in the core sectors. Despite lower tariffs, the telecom sector’s profit growth has been a positive surprise. Automobiles, too, figured in the list, while banks reported a strong set of numbers. Market observers point out that companies within these sectors that can keep their costs low and execute large projects will do well in the coming quarters.

Much of the growth over the next couple of quarters is expected to come from domestically strong sectors such as real estate, engineering & construction, telecom, capital goods, power and power components, and companies that have a backlog of orders. This should see the financial year 2007-08 end on a positive note.

Investments by the oil, resources, and power sector will ensure that the capital goods sector performs robustly. The financial services sector, with its increased penetration of financial products, robust credit demand from corporates, backed by healthy balance sheets, should continue to deliver better results in the coming years.

Among the worries is that the higher base of the last year could see profit growth slow down in the coming years. But investments in new capacities could counter this trend.

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With the third quarter results season almost over, all eyes will now turn to the end of the financial year. But 2008-09 is not expected to lag too far behind in profit growth. Motilal Oswal Securities estimates that the Sensex could report earnings of Rs 1,056 from Rs 873 expected in 2007-08, which is up a decent 20.96 per cent for the full year. But the Sensex comprises largely bigger companies, while the BSE 500 companies are expected to report better earnings growth compared to their larger counterparts.

The recent stock market’s correction has brought about a drop in the valuation of companies. Currently, the Sensex is trading at a P/E of 16.82 times of the financial year 2008-09. This has come down by more than 20 per cent over the last couple of weeks, even as many other growth stocks corrected by a bigger margin.

Currently, the market looks reasonably valued and given the growth rates, some stocks have come down to cheap valuations. Among other worries is a slowdown in the US, which could affect the India Inc.’s performance. While some companies will be affected, many others will be able to sustain their past performance. And since much of the corporate sector’s performance is domestically-driven, the US fears are exaggerated.

In short, investors should be looking for companies that have good execution capabilities of the growth plans going ahead. Some sectors will perform better than others, which investors must keep an eye out for. If all goes well, shareholder returns will mirror the good corporate performance in the long run. But when it comes to future corporate performance, the Indian growth story will not cease to surprise on the upside.