Key sectoral trends from 3QFY21 earnings
* Technology: 3QFY21 marks the second sequential quarter of mid-single-digit QoQ revenue growth (+4.9% QoQ USD cumulatively) for our large-cap IT Services Coverage Universe – despite adverse seasonality (furloughs and fewer working days) and a high base (6.1% QoQ USD growth in 2Q). This has been the strongest 3Q performance in terms of growth for large-cap IT players in five years and stands significantly ahead of our estimates. Most companies have reported strong deal wins, with improved visibility on growth going forward. Management commentaries have also highlighted a strong tech spending environment, with a high focus on cloud migration. Moreover, the cumulative EBIT margin for the Top 5 IT services companies has increased 90bps QoQ – despite wage hikes and employee additions weighing on the margin – aided by all-time high utilization rates and the shift to offshore deliveries. Total headcount additions for 3Q stood at 39k, against net decline of 3k employees in the past nine months. This provides further assurance on sustained growth momentum in our IT Services Universe. We still believe this is the early phase of the technology spend cycle and remain confident that the sector would report growth in the mid-teens in FY22.
* Banks: The business momentum has improved across business segments, with disbursements in many business segments – such as Tractor, 2W, Housing, and Gold Loans – exceeding pre-COVID levels. Also, demand for LCV and Corporate Loans is showing signs of revival, while SME lending is supported by the ECLGS scheme. Growth in deposits remains strong, with the CASA mix showing a positive bias. Asset quality has been much better than earlier expected, led by improved collection efficiency, controlled slippages (proforma), and low restructuring (v/s earlier indicated). Large banks are better placed with high proforma provision coverage and lower restructuring, while mid-sized banks – such as RBL, DCB, and Bandhan – appear to be marginally more stressed and expect higher provisions in the near term. Overall, we expect a strong earnings rebound in large banks, led by moderation in credit cost and improved operating performances (as business trends gradually revive). We increase our earnings estimate for AXSB by 21%/10% for FY22/FY23. IIB earnings have also been upgraded by 35%/14% for FY22/FY23E; the earnings estimate for ICICIBC has been increased by 20%/3% for FY21/FY22.
* NBFCs: Recovery in Auto demand in 3QFY21 is not only encouraging but also meaningfully ahead of our expectations. Business volumes are near pre-COVID levels for most of the vehicle financiers. While MSME lending is yet to return to normal levels, the bulk of the momentum has been supported by ECGLS lending. Housing financiers have witnessed a strong quarter on all fronts – they are seeing MoM improvement and have surpassed YoY levels. NBFCs have diversified into newer borrowing sources such as retail NCDs and ECBs. Across financiers, liquidity on the books is gradually reducing. This, coupled with declining cost of funds, is likely to have a positive impact on margins in the ensuing quarters. Asset quality has shown resilience across companies, driven by robust collection efficiency and minor restructuring. We believe the provisioning cover across our Coverage Universe is adequate and a spike in credit costs is unlikely. For the coming year, we build in a strong earnings revival, driven by better operating performances and controlled credit costs.
* Consumer: Results of companies in both the Staples and Discretionary categories have thus far been highly impressive. In Staples, Dabur is once again the standout (similar to 2QY21) with 18% volume growth in 3QFY21. MRCO and HMN have also reported early to mid-teen volume growth, while HUVR’s performance has been in line with expectations. In Discretionary, strong demand revival, good festive demand, and pent-up demand have resulted in robust outperformance by APNT and PIDI on all fronts – with the demand momentum expected to be strong going forward as well. UBBL’s results have also been better than our expectations. While UNSP has reported continued healthy sequential improvement, it has been the only company thus far in our Coverage Universe to perform below expectations – in what has been a stellar quarter for consumer companies thus far. Strong rural growth continues to lead overall volume growth. However, urban demand, which had declined YoY in the preceding three quarters, has also started contributing positively to both volumes and the mix. An increase in ad spends YoY – after spends remained muted in 1HFY21 – also suggests a growing confidence among companies on incremental growth prospects. Sustained cost-saving efforts – even after growth revival and significant rationalization of channel inventory (v/s the pre-COVID period) – have also been a point of encouragement. A combination of higher material costs and urban recovery would result in improved price factor and a better mix, further aiding topline growth prospects – even as the volume growth outlook remains buoyant.
* Auto: 3QFY21 results have been a mixed bag, influenced by the timing difference in RM cost inflation reflecting in the P&L. While MSIL and ESC have seen a commodity cost impact of 2–3pp QoQ, BJAUT & TVSL have not reported any major impact in 3Q; expect a similar impact of ~3pp in 4Q. TTMT has been the standout thus far, with an all-round beat and strong performance across business verticals. Overall, volume recovery has led to operating leverage and sustained low other costs have supported profitability. The demand outlook remains positive for PV and Tractor. 2W demand is expected to remain subdued in the domestic market in the near term, although exports would sustain the momentum. Cost inflation is likely to sustain due to commodity cost inflation, an increase in variable marketing costs in some segments (such as 2W and CV), and the return of some other costs.
* Pharma: Nine companies have reported their earnings to date. The aggregate performance has been very strong, with 12%/34%/70% YoY growth reported in sales/EBITDA/PAT. a) A superior product mix, b) favorable currency benefits, and c) extended operational cost savings have led to better operating margins. This has been further supported by a lower tax rate for the quarter. Segmentwise, Domestic Formulation sales are starting to pick up, with 14% YoY growth (12% adj. for the Wockhardt portfolio addition in the case of DRRD) seen in the quarter on an aggregate basis. Operational costs are increasing, albeit at a slower pace than sales growth, owing to which superior profitability is maintained. US sales have grown 4.4% YoY on an aggregate basis, marking the second consecutive quarter of growth. This is largely attributable to niche launches and minimal price erosion in the base business. Management commentaries have been encouraging over the medium term, driven by better execution in focus geographies.
* Cement: 3QFY21 results have been impressive thus far, with companies that have reported their results showing robust growth of 40% YoY in EBITDA. This has been driven by a) 12% YoY volume growth, b) ~2% YoY realization growth, and c) ~3% YoY decline in total cost per ton (supported by reduced fixed overheads and operating leverage benefit) – resulting in 28% YoY growth in EBITDA/t. UltraTech (UTCEM)’s result was particularly impressive, with net debt falling 22% QoQ to INR94.4b (the lowest in three years), coupled with 47% YoY growth in EBITDA. Working capital has remained in check, led by both lower inventory and receivables. Management commentary on demand has also been positive as demand in Infrastructure and Urban Real Estate has seen an uptick. However, variable cost is expected to rise in the near term due to higher prices of petcoke and imported coal, which would fully reflect in the P&L in 1QFY22.
* Metals : 3 out of 4 steel companies (JSP, JSTL, and SAIL) have reported their results thus far, posting the highest ever quarterly EBITDA in 3QFY21. Aggregate EBITDA for these companies has risen 211% YoY to INR156b. PAT stands at INR76.4b (v/s loss of INR6.3b in 3QFY20). Robust performances in the steel companies have been led by the highest ever margins, backed by strong pricing and lower coking coal costs. This also helped companies reduce their debt significantly. SAIL and JSP have each reduced their debt by 12% QoQ to INR443b and INR256b, respectively. JSTL, however, has reported a marginal 2% QoQ debt reduction to INR518b on account of higher capex and the acquisition of Asian Color Coated for INR15.5b. JSTL’s volumes have declined 4% YoY to 3.9mt, whereas JSP/SAIL has posted volume growth of 11%/1% YoY to 1.8mt/4.1mt (on higher capacity utilization). With spot pricing higher by ~INR9,000/t over 3QFY21, the average earnings outlook for 4QFY21 is much stronger, which should result in accelerated deleveraging.
Operating performance beats expectations; recovery on track
* Aggregate performance for MOFSL Universe: Sales/EBITDA/PBT/PAT growth at -1%/24%/36%/32% (v/s est. -2%/16%/19%/13% YoY)
* Top companies that beat estimates: Bajaj Auto, Tata Motors, L&T, UltraTech Cement, Asian Paints, HDFC Bank, ICICI Bank, IndusInd Bank, HDFC, Cipla, Sun Pharma, JSW Steel, IOC, Reliance, HCL Tech, Tech Mahindra, and Wipro
* Top companies that missed estimates: Axis Bank, HDFC Life Insurance, SBI Life Insurance, Bajaj Finance, and Dr Reddy’s Labs
* Top FY22E upgrades: Tata Motors (36.5%), IndusInd (35.5%), Axis Bank (21.4%), Wipro (14.9%), Asian Paints (8.1%), Cipla (8.1%), Sun Pharma (7.4%), Tech Mahindra (6.9%), and Bajaj Auto (5.1%)
* Top FY22E downgrades: HDFC Life Insurance (-6%), SBI Life (-5.7%), and Dr Reddy’s Labs (-5.3%)
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