IT, pharmaceuticals could slide further

There is an obvious disconnect now between corporate results, which were poor in many sectors and stock market moves which seem to be headed into outer space. The BS Research Bureau recently looked at the results of 2,264 companies (including financials and energy). The combined net profit for these firms was up 20.3 per cent year-on-year (yoy). At first glance, this is excellent. However, there was a major base effect. The same sample showed 20.3 per cent y-o-y drop in profits during Q4, FY16 (January-March 2016) compared to Q4 FY15. The sample was also skewed by the fact that January-March 2016 was terrible for public sector banks, which reported huge losses due to the Reserve Bank of India enforcing an asset quality review in Q4, 2016. The same PSU banks reported profits in the March 2017 quarter.

Apart from PSU banks, a single company made a big difference. In January-March 2016, Vedanta reported a huge Rs 11,800 crore in non-cash impairments to reflect losses in the value of its Cairn India holdings. In contrast, Vedanta reported profits in January-March 2017.

If sectors like financials and energy and the one-off Vedanta are excluded, the combined net profit of the remaining 1,860 companies is down 6.7 per cent y-o-y during January-March 2017. Sales were up 5.9 per cent y-o-y for this smaller sample.

Domestic players did worse than outfits driven by global trends. If information technology (IT), metals and pharmaceuticals are also removed from the sample, the combined net profits of all other sectors declined 19.2 per cent and the sales growth was only 3.3 per cent.

Kotak Institutional Equities said, "Strong performances in overseas operations of Tata Motors; large adventitious gains in Bharat Petroleum and Indian Oil, and high other income in Oil and Natural Gas Corporation. Underlying drivers for most sectors continue to be weak, which has led to further earnings downgrades". Credit Suisse pinpointed metals as an outperformer, "Metal companies contributed to 40 per cent of the BSE100 revenue growth. A third of the companies in the BSE100 saw earnings before interest and taxes fall."

Going forward, the metals performance will continue to depend largely on global trends. It may be sustainable, if the global commodity cycle remains on an upswing. Private sector banks and housing finance companies should also do well if household consumption does see recovery as projected. The two-wheeler giants, Bajaj Auto and Hero MotorCorp were hurt by demonetisation. If rural consumption recovers as expected, given a good 2017 monsoon, there could be a sharp rebound in two-wheelers across second half of FY18.

But, IT and pharma, both often considered among the safest bets, are now going through their worst ever year. Both industries could slide further. The Indian IT sector faces a raft-load of problems ranging from visa issues to being wrong-footed by the move to artificial intelligence and cloud computing. Pharma has not seen this sort of deep slump since the industry became an export engine. The pharma industry will eventually recover but it could take a hammering for a while. It has very high institutional holdings and it also has very high valuations. If institutions do start selling, in order to shift to more attractive growth sectors, there will be no way for the volumes to be absorbed except at very deep discounts to the current prices. Telecom will remain under the hammer because of the new player's tactics and clout. FMCG could face a problem during the next two quarters at least due to GST. The migration will mean destocking for a while.

One industry that could swing either way is construction. It took a beating in Q4, FY17. But if activity does accelerate in infrastructure projects, construction may see a V-shaped recovery. If not, it could go further into the doldrums.

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