Q1 earnings seen weak; bearish IT, NBFCs, cement: Macquarie

The market may have little to look forward from the first quarter corporate earnings, feels Rakesh Arora, head of research, Macquarie Capital Securities. He sees aggregate earnings to be the lowest in many quarters, and for the year as a whole, expects it to be around 9 percent. But the June quarter numbers may not be a trigger for earnings downgrades, Arora feels.

In an interview with CNBC-TV18, Arora says he is underweight on the IT as the sector has little going for it other than a weak rupee. Indian IT companies are likely to feel the pinch of the US Immigration Bill on their operating margins. He is bearish on NBFC stocks, most of which are expensive at these levels, and cement companies, which are likely to report weak earnings for the June quarter. On the likelihood of a merger between ACC and Ambuja, Arora says the process would take at least a year to get approval. Among private banks, ICICI Bank and Yes Bank are Macquarie’s top picks. He is not too positive about state-owned companies, but sees NMDC as the better of the lot. The stock has little downside because of attractive valuations and a good dividend yield. Broadly, Arora is hopeful about the prospects for the second half of this fiscal, driven partly by a surge in government spending. Also read: Economy may touch 8% average growth: Maira Below is the verbatim transcript of his interview on CNBC-TV18 Q: This is really the start of what most feel is going to be one of the worst earnings season. Your report says that you expect only a 5 percent revenue growth. What is your overall expectation as we head into the season? A: It will be one of the weakest first quarters that we are going to see in the long time, largely because demand has been extremely low; both government spending has been missing, plus monsoon has come a little bit early this time. So all this things are impacting the revenues, which is translating into EBITDA growth and bottom-line. Apart from the revenue growth, currency movement too is going to impact net profits, because most companies will take forex mark-to-market hit. So, things are looking little bit gloomy on the first quarter's side. Having said that I do not think expectations are too high; for the full year consensus is expecting 8-9 percent revenue growth. So the scope for things to pick up in the second half and probably earnings downgrade may not be substantial from hereon.
Q: Do you think the weak Q1 earnings; has the potential to be a big trigger to lead the downside in this market going ahead? A: Expectations are extremely low. So, I don’t think Q1 results which are going to be weak are materially going to be driver of downgrades, which can move the stocks further down. Weak results are not going to be a trigger for market to move up, so it will look forward to other catalysts to trade in the next few months. Q: Infosys will kick-start the earnings season. Two weeks back there was a bit of chat around the street in terms of whether Infosys will cut its guidance. What is your own house view as we head into the earnings season and what is your call on the IT space? A: We have been maintaining an underweight stance and a little bit negative view on IT space, though rupee has been moving in the positive direction for them and that is helping them. However, we are worried about two things; one is the Immigration Bill, which can have a huge negative impact and shave off almost 20 percent plus of earnings, so that is one. Two, is that until and unless you are in the right segment, probably growth and demand may not be as high. We have recently seen some companies like Accenture, Cognizant cut guidance. So demand scenario is not looking that great despite US picking up. Therefore, apart from rupee, everything is moving in the negative territory for IT companies and stocks have been more or less stagnant. I think there is no real hurry to buy these names now. Q: What is your expectation from private sector banks this time around? Do you think they will continue to be insulated from the downside and hence continue to see an outperformance? A: Private sector banks and non-bank financial companies (NBFCs) have been doing extremely well because while the retail demand has been slowing down little bit but they have been probably capturing market share from the PSU banks. So private sector banks and NBFCs have seen upgrades come through. I think there is an opportunity in the private sector banks as yet. NBFCs have seen the highest upgrades but we think that the stocks look costly. Most of them are trading at 2.5 times price to book. Our favourites would be stocks like ICICI Bank, Yes Bank. Private sector bank is where we have a little bit of positive bias. _PAGEBREAK_ Q: You track cement quite closely. What did you make of that bit of buzz on Ambuja-ACC merger and what is your call on these two stocks as we head into the earnings season? A: We are negative on the cement space, because demand is surprising on the downside and oversupply issue is far from resolved. It will take another two years before oversupply is absorbed. In this scenario we are see that prices are very soft and for the first time in the last few years that we have been tracking cement, Q1 we are seeing a decline in prices as compared to Q4. I think results are going to be weak and could be the weakest Q1 that you have seen for sometime. Amuja and ACC have ticked up little bit on this news of merger but we think it will take long time for this merger to eventually happen though it is a logical step for these two companies. However, they need to take approval from Competition Commission of India (CCI) and being a horizontal merger it can take more than one year to get that kind of approval. The big benefit actually comes in form of logistic costs, which normally should happen with co-branding. So, basically you merge ACC and Ambuja brand into one and what Holcim would try to do probably is bring in Holcim brand at some point in time. But Holcim brand comes with cost, which is a loyalty on revenue which they are charging across the region. So, probably you will see 2-3 percent of revenue being charged as trademark fee and that alone can takeaway all the benefit which we expect from synergies on logistic side. There are two things with which we are not really comfortable. One, is the timing that is it will take one to two years for the merger. Two, we think that benefit can be taken out by Holcim via trademark fee, so local shareholders might not really gain too much out of this. Given the outlook for cement I think one should take advantage of the recent rally and book profits. Q: What is your outlook on the markets itself? Do you believe that this is range bound trade will continue within which we might see some volatility or do you think that there is any trigger which will lead this market to breakout either way? A: First, we are hoping that second half would be much better one because monsoon is slated to be normal this time around. So that should revive rural demand. Second, we are expecting the government spending to pick up materially in the second half. We are forecasting around 30 percent increase in government spending year-on-year (YoY) in the second half. One should also remember that we are into a pre-election period, so government has all the incentive to really kick start spending now. This should benefit infra space plus the consumer spending. So, there is a scope for markets to really recover in the second half. Also the concerns on quantitative easing phasing out would have muted by the time. We would about the kind of trajectory, etc. Our house view is that quantitative easing is going to continue at least till end of calendar year 2014 and probably end in first quarter 2015. It is not going to be a sharp phase out, it will be more of a gradual one and probably you will see some inflows come back to India in the interim. Therefore, there is a chance that market actually picks up in the second half and probably peaks out by January-February, before the elections in April-May. Q: How would this rupee depreciation story on the positive side? Would you play it via pharma stocks? Would you play it via upstream oil companies which also stand to gain? PSU oil companies may still have to share some of that due to subsidy burden, but overall how would you play this rupee depreciation story then? A: Clearly, the straight answer would be IT and pharma but both sectors are going through lot of issues. IT as we spoke about has the Immigration Bill casting a shadow on it. Therefore, it is not a clear story. On pharma side, recently we have been seeing spate of action by Food and Drugs Administration (FDA). Wockhardt has halved in last two months or so because of FDA action. Yesterday there was news on Strides Arcolab, before that on Aurobindo Pharma. So these stocks are trading at very high valuation and the risks are to downside. Therefore, people will have to find stock specific stories because I do not think there are across sector buys to play this rupee depreciation. People will have to be very selective to play this whole thing. Q: How would you approach a stock like Oil and Natural Gas Corporation (ONGC) now? It has been an anticlimax of sorts. One was expecting ONGC to seek good moves post the gas price hike, but it has reversed so much of its gains. Do you foresee more downside because of issues like subsidy etc.? A: It is not just ONGC, but the whole PSU pack has actually underperformed dramatically and despite the expectation that dividends are going to be much higher, government is doing a lot on reforms which can benefit these companies. So, PSU as a pack has been very disappointing. However, I feel that come September-October you will see spate of dividends and some special dividends, which should revive interest back into these names. They are extremely cheap on valuations, so I think downside is limited but upside would depend on how fast and how much government pushes these companies to rollout dividends in the next 2-3 months. Q: I read from your report that you are quite bullish on NMDC and have almost a 100 percent upside potential. What makes you that bullish on the stcok? A: NMDC is selling its iron ore at a much discounted price as compared to global markets, so we don’t really see much downside from the current levels. Secondly, we are expecting around 10 percent dividend yield this year which is a big number in terms of dividend yield for any of the Indian companies. Thirdly, valuations are extremely cheap at 2.5 times EV/ Earnings Before Interest, Taxes, Depreciation and Amortization (Enterprise value/EBITDA). So even though sentiments are not really great at the moment, this company is well poised, extremely cheap. We think once market starts to recognise that this stability is indeed sustainable, the stock should re-rate sharply.