Q2 Earnings: Capital Goods Cos Hit By Lower Order Inflow

Transcription

1 November 16, 2011 Q2 Earnings: Capital Goods Cos Hit By Lower Order Inflow Also Inside This Issue: Sugar Cos Margins To Be Hit Top Line Of Steel Cos Driven by Better Realisation Auto Cos Hit Slow Patch With Muted Sales In Oct Telecom Industry On The Brink Of Losses...And Much More.

2 Q2 Earnings: Capital Goods Sector Hit By Lower Order Inflow c apital goods sector continues to face headwinds in terms of lower order inflows and hardening interest rates. The sector, a key component of the Index of Industrial Production, reported average growth rate of 5.83% in April-September, sharply lower from 17.93% growth in the first half of the previous year. In July-September, the sector shrank 5.50% against 17.53% growth a year ago. Most capital goods majors registered a slowdown in order inflows during July-September. ABB India Ltd was an exception with 21% growth in order inflow from a year ago. However, top line and bottom line of key companies don t reflect the fall in output in the sector during the quarter. The reasons for the strong earnings are as follows: Net sales of most companies were boosted by better project execution during the quarter. Larsen and Turbo Ltd posted better results due to strong performance of the engineering and construction division. Companies also benefited from onetime gains from other income that boosted their bottom line. Bharat Heavy Electricals Ltd, India s largest engineering and manufacturing enterprise, posted 23.62% rise in net profit from a year ago mainly due to accounting policy changes that resulted in lower employee cost. ABB India Ltd s net sales growth of 29.4% from year ago was aided by consolidation with ABB Global Services and Industries Ltd that was acquired from the parent company. Among the capital goods and engineering majors that have announced July-September results, ABB India Ltd posted the highest growth in sales and net profit from a year ago. Financial results of other companies that were reviewed includes Bharat Heavy Electricals Ltd, Larsen and Turbo, Crompton Greaves Ltd and Thermax Ltd. Bharat Heavy Electricals BHEL s net sales in July-September rose 23.7% from a year ago to `10,298 crore on better execution of projects in the industrial segment. The industrial segment registered a top line growth of 78% to `2,960. However, it accounts for only 27.5% of total revenue of the company (refer Table 1). Quarterly revenue from the power segment stood at `7,790 crore, up 10.5% from a year ago. However, its share in total revenues declined to 72.5% from 80.9% in the previous year. The company got no orders in the first two months of the quarter. In September, it won two orders from Andhra Pradesh and Madhya Pradesh for coal-based boiler-turbine-generators. The total size of these orders was `14,300 crore, taking the company s order inflow during the quarter up 6% from a year ago. Table 1: Financial Results For July-September ( ` Crore) BHEL L&T ABB India Q2FY12 Q2FY11 YoY (%) Q2FY12 Q2FY11 YoY (%) Q2FY12 Q2FY11 YoY(%) Net Sales 10,298 8, Raw Material Cost Operating Profit PBT PAT

3 The operating profit in the second quarter rose 16.47% to `1,174 crore mainly due to the higher interest income earned by the company and reduced employee expenses. Accounting policy changes for leave encashment was changed to base of 30 days month compared to 26 days month earlier. Reduction of the liability resulted in employee cost being lower by `166 crore. Net profit grew by 23.62% to `1,412 crore for July-September period. With the total order backlog standing at `161,000 crore, we expect it to translate into a healthy revenue stream in the future, backed by operational efficiency. Larsen & Turbo Net sales of engineering major Larsen & Turbo Ltd in July-September stood at `11,245 crore, up 19.3% from a year ago, led by strong performance of the engineering and construction, and electrical and electronics divisions. The engineering and construction and electrical and electronics divisions grew 19.9% and 26.2%, respectively, from a year ago. Machinery and industrial products segment witnessed minor slowdown in revenue growth of 3.1% to `678 crore compared to a year ago due to fall in mining activity. Order inflows stood at `16,100 crore, down 21.4% from a year ago due to continuous deferral of order decisions and project delays. Pressure on margins mostly came in from higher employee and raw material costs. Raw materials costs in July-September rose to 47.4% as a percentage of sales from 41.7% a year ago. Employee costs rose 9.8% in July-September mainly because of higher headcount besides compensation restructuring. Increased competition, order deferrals and subdued macro environment are putting pressure on the performance of the company. Given concerns such as lower infrastructure spending, rising interest rates, land and coal availability issues over the past few quarters, L&T has witnessed a slowdown in its order inflow. Competition by new participants and limited boiler-turbine-generator order pipeline are likely to impact order inflows in coming months that could impact the company s top-line growth. ABB India In July-September, ABB India Ltd reported revenue growth of 29.4% from a year ago to `1,730 crore, driven by better execution of projects across segments, especially in the power segment. Net sales in power systems, process automation and low voltage product segments grew 39%, 28% and 34%, respectively, compared with a year ago. Growth was also partly aided by consolidation of ABB Global Services and Industries Ltd with the Indian arm. The company witnessed consecutive quarters of healthy order inflows. Order inflow grew by 21% compared with a year ago to `2,460 crore due to two large order of `330 crore and `820 crore from Steel Authority of India Ltd s Bhilai steel plant and a substation order from Isolux, respectively. The order book stood at `9,150 crore at the end of September. Going forward, the company s margins are expected to improve due to its planned exit from non-core business, mainly rural electrification. ABB India has been striving to improve indigenisation of its high-voltage products over the past year. It has taken initiatives to improve the supply chain and designs, the benefits of which would accrue over the next year. Competition from Chinese and South Korean manufacturers would continue to affect pricing over the medium term. Crompton Greaves Crompton Greaves Ltd s consolidated top-line in July-September grew 13% from a year ago to `2,710 crore led by growth in power systems and industrial systems that grew by 12% and 29%, respectively (refer Table 2). The two new acquisitions (QEI and Emotron) in April-June proved to be beneficial for the company, with each contributing 12 million

4 euro and $4 million to total sales, respectively. These two subsidiaries contributed over 45% to total sales in July-September. Soaring raw material and interest costs took a toll on the company s margins. Net profit fell 45% from a year ago to `118 crores because of raw material cost as a percentage of net sales rising to 67.3% from 61% a year ago. Consolidated order inflow in July- September stood at `2,260 crore. On a standalone basis, quarterly net sales was flat at `1,450 crore. Net sales in power systems segment fell 7% from a year ago to `598 crore. Industrial systems and consumer products segments recorded a moderate sales growth of 9% and 4%, respectively. In the industrial systems segment, Crompton Greaves is witnessing a slowdown mainly because of delay in capital expenditure by companies. Earnings before interest, depreciation and tax or operating profit declined 30% to `160 crore from a year ago. Profit after tax declined by 29% because of higher raw material costs. Going forward, power systems segment will continue to witness intense competition, pricing pressures and slowdown in majority of its markets, which will adversely impacted the company s profitability. However, recent softening of prices of key raw materials (steel, aluminum and copper) will benefit the company up to some extent. Thermax Thermax Ltd s revenue grew of 19.4% from a year ago to `1,303 crore in July-September, driven by strong execution of orders in the energy and environment segments that posted growth rates of 16.1% and 19.1%, respectively. The company s quarterly order inflow fell 8.8% from a year ago to `1,284 crore amid the tough business environment. It won orders worth `934 crore in the energy segment and `351 crore in environment segment in July-September. Consolidated order book at the end of September stood at `6,531crore. Led by strong top line, the company s EBITDA and net profit registered growth of 9.3% and 13.6%, respectively. The company s future growth is directly linked to the industry s capital expenditure. which is showing no visible signs of improvement. Perceived shortage in coal supply casts a grim outlook on the power sector. While ultra mega power projects are likely to receive priority in supplies over smaller ones, independent power producers below the 300-mw category are likely to be hit. Thermax has a strong presence in utility boilers (up to the 300-mw category) and may face a slowdown in order inflows in such a scenario. Table 2: Financial Result( `Crore) Crompton Greaves Thermax Ltd Q2FY12 Q2FY11 YoY Q2FY12 Q2FY11 YoY(%) (%) Net Sales 2,705 2, Raw Material 1,820 1, Cost Operating Profit PBT PAT PRU View Among all the five companies, ABB India s raw material cost as percentage of net sales stands at the highest in July-September (Table 3). However, the company registered highest growth in net profit on a low base. Net profit margin stands at 1.28%, the lowest in the capital goods and engineering space (refer Chart 1).

5 Order inflows fell sharply across the board in July-September and we expect it to remain muted for rest of the financial year (refer Table 4). There is limited scope for new power projects being awarded in the near-term due to absence of fuel supply agreement with Coal India Ltd. The annual power capacity addition is not expected to increase significantly in the 12 th Five-Year Plan. On the other hand, most of the new entrants have gone ahead with their plans of putting up a manufacturing facility in power equipment. Hence, going forward we expect competition to intensity in the boiler-turbine-generator segment. Part of the working capital requirements for most equipment companies are funded through advances received for a project. With muted order flows, advances too could decline in future leading to increase in working capital days. Table 3: Raw Material Cost As % Net Sales Q2FY12 Q2FY11 BHEL L&T Crompton Greaves ABB India Thermax Table 4: Order Inflow ( ` Crore) Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 BHEL 13,506 12,592 23,554 2,471 14,300 L&T 20,470 13,370 30,410 16,190 16,100 Crompton Greaves ABB India Thermax Ltd

6 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 November 16, 2011 Sugar Pricing: Bittersweet Pill ugar harvest in India seen missing forecast as yields drop: Sugar output in India, the world s second-biggest producer, may S drop short of government and industry estimates as wet conditions curbed cane yields amid the country s heaviest June monsoon rainfall in three years. (Bloomberg, November 14) PRU Analysis Sugar production in India is expected to rise for the third consecutive year. Government s latest estimates show sugar output will rise to 25 million tonnes in the sugar year October 2011-September 2012 from 24.3 million tonnes in the year before. Output is expected to be higher because of a rise in area under sugarcane cultivation and utilisation of more cane for making sugar. Sugarcane acreage has increased in the past two years because of higher remunerative prices offered by government. The central government has raised fair and remunerative price (FRP) of sugarcane by 4.2% to `145 per 100 kg for the sugar year October September Key sugarcane-producing states have upped state advisory prices (SAP) way above the increase in FRP. Uttar Pradesh, the biggest cane producer, increased state advised price by a whopping 19% to `250 per 100 kg for the best quality cane. Punjab government hiked prices 15% to `230. Maharashtra has advised a new price range of ` Price hikes by Uttar Pradesh and Punjab appear to have been driven by political compulsions ahead of elections in these states in A fall in prices of jaggery and khandsari will lead to reduced compensation offered to sugarcane growers. This will result in higher diversion of sugarcane for production of sugar. Nearly 68% of sugarcane was used to make sugar in the last season. Cane Yields To Drop While sugarcane acreage has increased, triggered primarily by the higher procurement prices, yields are expected to drop in the current sugar season that ends September The average recovery rate (sucrose extracted from sugarcane) between and has been 10.26%. Early and heavy monsoon in some states and drier conditions in others (particularly in July) have led to lower yield projections. This is expected to result in lower-than-projected output. Price Trend Domestic sugar prices are likely to remain under check because output is likely to be higher in the current year compared with last year. Government has also increased sugar releases to the domestic market to rein in prices. Given the high supplies of sugar in the domestic market, there seems a need to allow exports to enable sugar mills to reap the benefit of relatively higher prices ruling in the international market. India exported 2.6 million tonnes of sugar in the last sugar year. High opening stocks of sugar in the country together with healthy domestic production estimates necessitates the need to export more in the current year. A panel of central ministers may meet this week to consider the demand for exports of up to 4 million tonnes this year, said Food Minister K.V. Thomas. Impact On Profitability million tonnes Chart 2: Domestic Sugar Scenario Sugar Releases (Levy + Free) Price (RHS) `/kg While state governments have announced high prices for sugarcane, wholesale prices of sugar also need to rise accordingly. This seems

7 unlikely as the International Sugar Organisation expects a sugar surplus of 4.2 million tonnes globally in the sugar year ending September Thus, sugar prices in the international market are expected to cool off, after rising 14-17% last year. Sharp rise in sugarcane prices together with softening sugar prices will erode a large portion of profits of domestic sugar mills. It will also result in higher working capital requirements for mills that are mainly financed by cooperative banks. These banks typically lend in accordance with ruling prices that are currently stagnant. Sugar Stocks Nosedive Reports that sugar output in India may fall short of government and industry estimates led to a slide in sugar shares. Shares of Bajaj Hindustan Ltd, Balrampur Chini Mills Ltd, Dhampur Sugar Mills Ltd, Empee Sugars and Chemicals Ltd, Triveni Engineering & Industries Ltd hit their 52-week low in the current week. Name of Share High on Nov 14 Low on Nov 14 Closing Price on Nov Week High 52-Week Low Bajaj Hindustan Balrampur Chini Mills Empee Sugars and Chemicals Oudh Sugar Mills Dhampur Sugar Mills Triveni Engineering & Industries PRU View With state governments announcing higher prices for sugarcane produce, profits of sugar mills are expected to be adversely impacted. This is because current fundamentals of the industry do not support such high input prices. However, political motives seem to have taken precedence over fundamentals. If Uttar Pradesh sugarcane, which has a recovery rate of around 9.5%, commands a price of `250 per 100 kg, then produce from Maharashtra with a higher recovery rate of 11.3% should get at least `280 per 100 kg, according to Ashok Gulati, chairman, Commission for Agricultural Costs and Prices. Profits of sugar mills in Uttar Pradesh are expected to be the worst affected by the sharp rise in SAP announced by the state government. Auto Cos Hit Slow Patch With Muted Sales In Oct ew vehicle launches and festivals failed to lift domestic automobile sales in October as high fuel costs, rising loan rates and uncertainty about the future kept buyers away from showrooms. Last month, domestic automobile sales fell 1.1% from a year ago N to 1.44 lakh units, latest data released by the Society of Indian Automobile Manufacturers show. Overall sales remained stagnant helped by 14.5% growth in exports. Domestic automobile sales across all vehicle categories registered a decline of 1.1% to 1.44 lakh units in October compared with the year-ago month. Nearly 85% of the total automobiles are sold domestically. However, a 14.5% growth in exports from India prevented a decline in total sales, according to figures released by the Society of Indian Automobile Manufacturers. Total sales that constitutes domestic sales and exports rose 0.8% in October compared with the year-ago level.

8 In October, domestic passenger vehicle sales fell 20.3% from a year ago to 1.83 lakh units. This fall was despite new launches. Strike at Maruti Udyog Ltd s Manesar plant contributed to fall in sales. Maruti sales fell by 50,562 cars in the local market in October compared with a year ago. Overall fall in car sales was 43,183 units. Toyota Kirloskar Motor Pvt Ltd managed to up sales by 5,577 units, thereby improving its market share. Domestic two-wheeler sales grew merely 2% to lakh units in October from a year-ago level. Motorcycles, the largest segment in the two-wheeler industry, registered a marginal 1% growth in domestic sales to 8.8 lakh units. Scooter/moped sales rose 12% from a year ago in the country. Hero Motorcorp, the largest player in the two-wheeler market, continued to record healthy sales growth during the month. Table 5: Domestic Automobile Sales Growth (% YoY) Passenger Vehicles Passenger Cars Utility Vehicles 0.4 Vans Commercial Vehicles (CVs) 18.5 M&HCVs 22.9 Domestic sales of commercial vehicles grew by a robust 18.5% to 61,800 units last month. It was the only category to have recorded a double-digit growth in sales. Fall in domestic sales in October forced most automakers to hold back price rises. Sales usually peaks in October because of demand led by festivals, but that did not happen this year because of the rise in fuel prices, high interest rates and uncertainty about the future. Most automakers have retained price levels despite higher prices of steel and other raw materials (on a year-on-year basis), including tyres and spare parts. Due to sluggishness in demand for automobiles, the industry also fears it may get stuck with large inventories. Price rise is also unlikely in November and December because typically there is a let-up in sales during the year-end as vehicles registered in the new calendar year garner a better price in the second-hand market and automakers offer heavy discounts in the last two months of the calendar year to clear inventories. Passenger Carriers Goods Carriers 32.1 LCVs 15.3 Passenger Carriers 5.2 Goods Carriers 16.7 Three Wheelers -2.1 Passenger Carrier -5.1 Goods Carrier 12.3 Two wheelers 2 Scooter/Scooterettee 12.1 Motor cycles/step- Throughs 0.7 Mopeds -9.6 Grand Total of All Categories -1.1 The two passenger vehicle companies that raised prices in the past few months are Mahindra & Mahindra Ltd and Toyota Kirloskar. Both these companies registered healthy demand growth that enabled them to raise prices. Mahindra & Mahindra, India's No. 1 utility vehicles company by sales, raised prices in August -- its third price hike in eight months. The rise was in the range of 1.5-2% across all product categories. Barring new models Etios and Etios Liva, Toyota Kirloskar raised prices of other models like Innova, Corolla and Fortuner in the range of 1.5-2% in October. Capex Slowdown in the economy and fall in automobile sales have led companies to adopt a wait-and-watch stance towards new expansion plans. For example, a sharp contraction in demand for passenger cars in the domestic market has led Hyundai Motor India to shelve its plan to set up a diesel engine manufacturing plant. The plant was envisaged at an investment of `400 crore to produce 1-litre, 1.4-litre and 1.6-litre capacity engines and to cater to fresh

9 demand in the domestic market. The company imports diesel engines from South Korea for its current models such as i20 and Verna and plans to continue to do so. Honda Motorcycle and Scooter India Pvt. Ltd plans to set up at least two more plants in the country in 10 years, the company said. The company garnered 13.4% market share in the current financial year up to October. It is the third largest player after Hero MotoCorp Ltd (45% share) and Bajaj Auto Ltd (20% share). PRU View Contracting automobile sales and inability of companies to pass on the rise in raw material costs are expected to hurt profit margins of the industry. This, together with the labour problem at Maruti, is expected to shave off profits of the industry. Automobile parts supply from Japan and Thailand has contracted substantially, thereby affecting Indian manufacturers. Exports that account for nearly 15% of the total sales also recorded slower growth of 14.5% last month compared with over 30% growth a year ago. Slowdown in domestic sales comes amid economic uncertainties in the Euro-zone and the US. Top Line Of Steel Cos Driven by Better Realisation teel majors Tata Steel Ltd, Steel Authority of India Ltd, JSW Steel Ltd, and, Jindal Steel and Power Ltd have reported dismal results in July-September mainly because of fall in S sales. Note: In case of Jindal Steel and Power Ltd, which also has power generation, we have taken only the steel segment into consideration. The companies managed to register top-line growth during the quarter mainly due to better realisation as steel prices in the domestic market have been rising since February. Only JSW Steel posted a rise in sales in July-September. Tata Steel and SAIL registered marginal fall in sales. Profitability during the quarter was mainly impacted by higher costs of coking coal imports because of rupee depreciation. Tata Steel Ltd registered an 89.3% year-on-year fall in consolidated net profit due to increased raw material costs, higher tax outgo and lower other income during the quarter. Tata Steel Tata Steel s consolidated net sales rose 14.5% from a year ago to `32,798 crore, led by higher average realisation per tonne in its Indian operations (refer Table 6). Average realisation of Indian operations rose by 18.6% from a year ago to `46,402 per tonne. However, average realisation per tonne of the company s European operations fell 1% to $1,148 because of subdued demand in Europe. Consolidated sales volume in July-September was flat at 6.2 million tonnes compared with a year ago. Operating profits declined 25.1% to `2,750 crore compared to a year ago due to higher raw material cost. Consolidated net profit of the company declined by a whopping 89.3% to `212 crore. Standalone net sales for the quarter grew 15.7% to `8,142 crore compared with a year ago driven by 16.4% year-on-year improvement in realization. Despite better realization and stable volume, operating profits was impacted due to higher raw material and energy costs. The company reported a 27.6% fall in net profit to `1,495 crore due to absence of other income and higher tax outgo during the quarter. Going forward, Corus, the company s European unit, would continue to suffer because of subdued demand. Tata Steel is in the process of developing a coking coal mine in Mozambique and an iron ore mine in Canada to enhance integration levels of Corus. The projects are expected to be commissioned in phases, beginning from second half of Steel Authority Of India

10 In July-September, the company s net sales grew 2.2% from a year ago to `10,837 crore mainly due to increased realization per tonne, which was partially offset by lower sales volume. Realisation per tonne went up 8.7% to `38,023 compared with a year ago. Sales volume in the second quarter stood at 2.9 million tonne, down 5.9% from a year ago. Despite higher realisation, the company s earnings before interest, tax and depreciation fell 13.9% to `1,327 crore from a year ago. The decline in EBITDA or operating profit was mainly due to higher power and fuel and staff costs. Power and fuel cost rose 28.2% from a year ago to `1,124 crore (up 36.3% per tonne basis) and staff cost went up 16.5% to `1,981 Crore (up 23.8% per tonne basis). The company reported an exceptional item related to foreign exchange loss of `509 crore on the back of depreciation of rupee that resulted in higher price of imported coal (SAIL imports 75% of its coking coal requirement). Hence, net profit fell 54.6% to `495 crore from a year ago. However, excluding exceptional items, adjusted net profit grew 7% to `1,003 crore in the second quarter. Going forward, we expect these cost pressures like higher power, fuel and staff costs to result in margin contraction. Nevertheless, declining coking coal prices (but, partially offset by rupee depreciation against the dollar) should benefit its margins slightly. JSW Steel JSW Steel Ltd reported robust numbers in July-September, given the disruption in iron ore availability. Quarterly net sales rose 33.5% from a year ago to `7,625 crore because of increased sales volume and higher realisation per tonne (refer Table 7). Sales volume went up 18.9% from a year ago to 1.9 million tonnes and realisations witnessed growth of 14.6% to `42,831 per tonne. Iron ore costs increased because of mining ban in Karnataka and subsequent procurement through e-auctions and purchase from other states (which resulted in higher freight costs). Overall, the company s cost of production rose 11.4% to `33,666 per tonne. Table 6: Financial Result (` Crore) SAIL Tata Steel(Consolidated) Q2FY12 Q2FY11 YoY (%) Q2FY12 Q1FY11 YoY (%) Net sales 10,836 10, ,798 28, Raw Material cost 5,608 4, ,220 12, Operating Profit 675 1, ,750 3, PBT 714 1, ,046 2, PAT 495 1, , Hence, EBITDA per tonne grew only 9.9% to `6,887 compared with a year ago due to rise in raw material costs. The company reported exceptional items related to foreign exchange loss of `513 crore during the second quarter due to depreciation of rupee against the dollar, which resulted in higher imported cost of coking coal. Consequently, net profit fell by a whopping 71.5% to `127 crore. However, adjusted net profit, excluding exceptional items, increased 43.7% to `640 crore. JSW Steel s Vijaynagar plant operated at low utilisation levels in July-September because of higher e-auction price of iron ore. Going forward, we expect utilisation levels to improve as the company receives higher supplies from NMDC Ltd, which is ramping up its

11 iron ore production in Karnataka. Further, lower coking coal prices (partially offset by rupee depreciation) should benefit JSW Steel s margins in remaining quarters of this financial year. Jindal Steel And Power Quarterly net sales of the company rose 44.5% from a year ago to `3,317 crore, largely due to higher sales volume of pellets. Revenue from steel segment accounted for about 77% of total revenue in July-September. Cost pressures as well as foreign exchange loss of `105 crore pared top line growth. Raw material cost increased 65.4% to `1,025 crore compared with a year ago. Net profit during the quarter fell 17.23% to `875 crore due to higher interest, depreciation cost and one-time expenses of `74 crore due to write-off of Congo Mining investments. Table 7: Financial Result(` crore) JSW Steel JSPL (standalone) Q2FY12 Q2FY11 YoY(%) Q2FY12 Q2FY11 YoY(%) Net Sales 7,625 5, ,317 2, Raw Material Cost 5,083 3, , Operating Profit PBT PAT Going forward, we believe depreciation and interest are going to remain high in the coming quarter as the company is speeding up its capital expenditure. PRU View Profit margins of all the major companies were hit during the quarter mainly due to depreciation of rupee that resulted in higher imported coking coal prices (refer Chart 3). Iron ore prices continued to rule high in the domestic market following the continued ban on iron ore 30 Chart 3: Net Profit Margin Movement(%) Q2FY12 Q1FY12 Q4FY11 Q3FY11 Q2FY11 Q1FY11 SAIL Tata Steel JSW Steel JSPL

12 mining in three districts of Karnataka. As shown in Chart 4, JSW Steel had the highest raw material cost as percentage of net sales compared with its competitors. The company has only 30% integration of iron ore and absolutely no integration of coking coal. Although coking coal price declined to $285 per tonne in July-September, it was still 35% up compared with last year. As shown in Chart 3, Tata Steel reported the lowest consolidated profit margins. Net profit of the company has been boosted in the past backed by higher other income and operation efficiency, which was absent this quarter. We believe there is still room for upward price movement as there is a gap between domestic prices and landed price of imported steel. But softening international steel prices will restrict upward movement. Hence, during October-December, top line of steel companies is likely to be driven by higher realisation as we expect sales volume to remain flat. Most of the inventory destocking is likely to happen during that period. Telecom Industry On The Brink Of Losses The telecom industry in India is going through turbulent times and witnessing erosion in profits. Data compiled by DhanBank PRU (refer Table 9) reflects weakened operational performance. After widening their subscriber base, the focus of telecom companies was value and not on volumes to boost growth. Earlier, spectrum was allotted to telecom companies based on subscriber numbers. And so companies boosted numbers to gain spectrum. However, given the limited spectrum space, the operators concentrate on high-revenue customers. A key indicator of operational income is average revenue per user (ARPU) by companies. ARPUs of telecom companies continued to record a decline in September quarter (refer Table 9). But contraction in ARPU was slower compared with the previous quarters. This was despite an increase in tariffs by several telecom operators including Bharti Airtel, Vodafone India, Tata Teleservices, Idea Cellular and Reliance Communications during July-August. Minutes of usage, another indicator of operation performance, also registered a fall. This may be because consumers in India are highly price-sensitive and an increase in tariff may have restrained usage by subscribers. Table 8 : Company-Wise Performance Indicators Sep-10 Jun-11 Sep-11 Blended ARPU (Average Revenue Per User in Rs.) Bharti Airtel Idea Reliance Vodafone India Blended MOU (Monthly minutes of usage) Bharti Airtel Idea Reliance ARPM (Average Revenue Per Minute in Rs/Minute) Bharti Airtel Idea Reliance Source: Companies, DhanBank PRU Financial Performance of Indian Telecom Companies (% YoY growth) Sep-10 Sep-11 Net sales Network cost Access charges Regulatory charges like license fees & spectrum charges Interest expenses Depreciation Net profit PAT / Total income (%) Note: Financials of Bharti Airtel, Idea Cellular, MTNL, Tata Communications, Tata Teleservices and Reliance Communications are included

13 Hike in tariff is well-reflected in the average revenue per minute (ARPM) figures released by companies. ARPM for companies including Idea and Reliance rose by 2-3 paise. Telecom Regulatory Authority of India releases data on Indian telecom services performance for each quarter with a huge lag. Its latest data release for April-June (refer Table 9) show that average ARPU for GSM (global system for mobile communications) providers slid to `98 in April-June from `100 in the preceding quarter. For CDMA (code-division multiple access) also, the ARPU fell by `2 to `64. This is substantially lower from the year-ago quarter. Table 9: Revenue & Usage Parameters June 2010 June 2011 Average Revenue Per User - GSM `122 `98 Average Revenue Per User - CDMA `74 `64 Minutes of Usage - GSM Minutes of Usage - CDMA Source: TRAI Similarly, minutes of usage declined at a slower pace to 344 minutes for GSM in April-June compared with 349 in March. The fall was sharper in case of CDMA where minutes of usage fell to 238 from 263 in March. Depressed Financial Performance Falling ARPU, lower minutes of usage and slowing subscriber additions, together with rising 3G-related expenses, higher interconnection costs and surge in interest outgo led to a sharp fall in profits of telecom majors in India. Companies including Bharti Airtel and Reliance Communications registered high mark-to-market losses during the quarter as the Indian rupee depreciated against the dollar. According to data from Vodafone s Web site, Vodafone s India services revenues for the quarter ended September rose 18.4% to 1,056 million pound sterling. According to the company, this growth was because of higher contribution from data and messaging services. Following the launch of commercial 3G services in February, 3G was available to Vodafone customers in 534 towns and cities across 20 circles as on September 30. Increase in revenue was partially offset by higher customer acquisition costs and increased interconnection costs. This resulted in an EBITDA growth of 14.8%. PRU View Despite hike in tariffs and rollout of 3G services, ARPUs of telecom companies are likely to record a slide, albeit at a slower pace. Income from data services is likely to play a bigger role in boosting revenues of industry. For now, heavy investments made in acquiring 3G spectrum and high interest rate scenario are likely to keep interest costs high and erode profits. Cotton Prices Likely To Fall Further On Fresh Arrivals Cotton Price Falls Despite Hoarding: Halt in purchase by Cotton Corporation of India Ltd tests the nerves of farmers waiting to sell at better prices. Cotton farmers and traders have been holding back stock in the hope of selling at a better price. This has been reflected in lower arrivals from the onset of the new season, in October. (Business Standard, November 10) PRU Analysis Cotton farmers and traders have been holding back their stock waiting to sell at higher prices. This is reflected in lower cotton arrivals in October that marks the beginning of the new season. Although production likely to hit an all-time high of 35.5 million bales this season, cotton arrivals in October stood at 1.48 million bales (a bale is 170 kg), down 42% from a year ago. Cotton prices also have been falling. Spot price of cotton is currently hovering around `105 a kilogram, down 5% from the beginning of this month (refer chart 5).

14 Cotton Corporation of India, a government agency that procures cotton from farmers to prevent price fall below mining support price, has stopped procuring cotton from the market, as it expects prices to fall further on higher arrivals. Arrivals are expected to increase in the spot market in coming weeks. Cotton spinners have been affected by high inventory costs, as many of them piled up cotton procured at high prices earlier (February), after which prices have fallen sharply. Manmade fibre prices have also fallen as it follows the pricing trend of cotton and cotton yarn. Most spinning units are facing difficulty in debt repayment as working capital requirements have gone up due to high-cost inventory. This is reflected in July-September results of top three spinning companies in the cotton and blended yarn industry. The two large companies that declared their results reported higher sales compared with a year ago. However, both were unable to translate the same into a healthy growth in profits. (refer Table 10) The spinning mills are likely to witness better performance in October-December as they are in the process of getting rid of their inventory of cotton yarn. The two large companies that declared their results reported higher sales compared with a year ago. However, both were unable to translate the same into a healthy growth in profits. Table 10: Financial Results (` crore) Alok Industries Bombay Rayon Fashion Q2FY12 Q2FY11 Y-o-Y % Q2FY12 Q2FY11 Y-o-Y% Net sales Raw Material cost Operating Profit PBT PAT Alok Industries witnessed a robust growth of 47.2% in its sales during the quarter compared with a year ago. Volume growth in the fabric (made of cotton yarn) division was moderate for this quarter with customers delaying purchases on expectation of reduction in fabric price, post sharp correction of cotton prices. Cotton spinning segment witnessed a sharp decline of 46.7% and 62.4% in volume and value terms respectively. Operating profit margins declined sequentially from 35% to 28% due to high cost inventory. At the net level, profit increased by only 2.39% to `81 crore due to sharp rise in non-operating expenses, mainly interest expenses. Net sales of Bombay Rayon Fashions Ltd for the July-September quarter grew by 21% compared to a year ago. However, the net profit plunged by 12.49% due to higher cotton prices. The spinning mills are likely to witness better performance in October-December as they are in the process of getting rid of their inventory of cotton yarn.

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