>INDIA EARNINGS PREVIEW (MACQUARIE RESEARCH)

Decreasing earnings stress

Event
■ We preview 1Q FY3/10E earnings for our coverage universe. Although earnings growth remains negative, we expect profits for the firms in our coverage, ex the oil and gas companies, to contract by 8% YoY vs -20% YoY in 4Q FY3/09; we see some signs of improvement in individual sectors.

Impact
■ Domestic cyclicals: not great, but looking better. The domestic cyclicals’ earnings, while not great, are starting to look better. Auto sales volumes have increased sequentially, with better financing from state-owned banks and higher rural sales the key drivers. Infrastructure should also see continued moderate growth due to the robust order backlog, with stable margins.

■ Banks to show robust growth. We expect banks to be the standout performers this quarter, with aggregate earnings forecast to increase by 34% YoY, after 24% growth in 4Q09. This is partly due to the lower base in 1Q FY09, with earnings in that quarter hit by large one-off bond provisions.
However, even on a pre-provision level, growth is expected to be a healthy 25% YoY.

■ Operating margins to improve sequentially. We expect aggregate operating margins to improve sequentially by more than 150bp as the lower costs kick in. The key sectors here would be auto – based on lower input costs – and cement and metals – due to a combination of lower costs and higher prices.

■ Commodities still under pressure. Commodities remain under pressure, primarily from the high base effect. We expect this to continue in the next quarter as well. Metal earnings are expected to contract. However, the sector should benefit from higher prices and aggressive cost cutting by the companies. The oil and gas sector’s earnings continue to fluctuate subject to the government’s subsidy policy, and we have therefore excluded them from our analysis.

Outlook
■ We believe that the recovery in the economy is still in its early stages and that it may be too early for a significant pass through to corporate earnings. However, the foundation for the recovery has been set, both by the policy measures carried out in late-2008 and by the further reforms expected to be carried out by the new government.

■ We continue to be positive on the Indian market and advise investors to stick with quality growth names and/or stocks with strong prospects for earnings upgrades, particularly in commodities and properties. We are replacing JSW Steel as one of our top picks with Tata Steel, in line with the views of our sector analyst Rakesh Arora. Our remaining top picks are Axis Bank, BHEL, Reliance and Unitech. Our key Underperforms are GMR Infra, Zee Entertainment and Idea Cellular.

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