1QFY07: A rear mirror gaze…

Source: EM

10 trading days and a point-to-point gain of 781 points!! To put it more simply, an average gain of 78 points per day. This is how the BSE Sensex, the benchmark Indian index, has moved over the past two weeks, and all the talk of how Indian markets have entered into ‘no man’s land’ and that valuations have become steep seems to have come to a grinding halt. With companies coming out with a stellar set of numbers for 1QFY07 and projecting similar outcomes for 2QFY07, it looks like the steam has not yet run out for them and India Inc is likely to continue with its robust performance.

The fact that the markets witnessed a meltdown during the month of May and valuations have come back to reasonable levels also helped. Little wonder then, that investors have come back and given the market an 800-point salute – well, almost. Amidst this euphoria, let us have a look at which sectors were the stars during 1QFY07 and which ones lagged. The companies used here are the ones from the Equitymaster universe.

The leaders – Commodities lead the pack: Sitting pretty atop the leaders’ pack is the cement sector, where revenues have grown by a strong 36% YoY and net profits courtesy the operating leverage have grown by a staggering 186% YoY. With demand growth outpacing capacity addition, cement companies are having a really good time, as rising prices are directly adding to the companies’ bottomlines and enabling them to register strong profit numbers. Going forward, while the demand is expected to remain strong, given the infrastructure boom in the country, new capacities coming on stream might cool down prices, thus leading to a drop in profitability. On the valuations front, we believe that current prices already reflect the medium term prospects but there are still some quality stocks in the sector that could give good long-term returns.

There isn’t much to choose from the other top-performing sectors, as all of them – steel, software, telecom and engineering – have logged in a net profit growth in the region of 46% to 50% on a YoY basis. Software stocks, however, have clocked the highest revenue growth of 46% YoY. With operating leverage amongst the lowest of all the sectors, growth in topline more or less gets reflected in the bottomline, excluding the other income component, and hence these companies will have to put up a strong performance on the topline front if net profits have to grow at a fair clip. That said, with most of the companies having strong order books, software stocks are likely to remain on the investor’s radar for quite some time to come.

The laggards – input prices mar profit growth: If one has a look at the last ranked sectors in terms of profit growth during 1QFY07, then a trend clearly emerges. Most of these sectors are the ones where raw material prices account for a chunk of total input costs. Indeed, with prices of commodities like metals and crude oil remaining at high levels or even breaching the previous highs, sectors like auto and energy have experienced a margin squeeze and have seen their bottomline rise marginally or even decline vis-à-vis 1QFY06. The worst-hit has been the energy sector, where government interference has led to bleeding of most of the public sector companies, as they have not been able to pass on the input price hike to the end-consumers.

Having touched upon the performance of the best performing and the worst performing sectors during 1QFY07, one must be curious to know where we go from here. While we admit that it is rather difficult to predict what course the future is going to take, zeroing in on companies that have strong track records is not that difficult a task. Focus on companies that have put in consistent performances year after year and then check if the valuation levels are within reasonable limits. Hold on to these principles tight and revenue growth or no revenue growth, margin pressure or no margin pressure, chances are you will be rewarded with adequate returns on your investment.

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