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'Markets likely to be range-bound'
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July 28, 2006

Jyotivardhan Jaipuria of DSP Merrill Lynch believes that Q1 earnings have been ahead of expectations. He feels that while some companies gained from re-depreciation, some are facing margin pressures.

Among autos, Jaipuria feels that two-wheelers are under margin pressure. However, results from four-wheeler companies have been better than expected, he says. He believes that results from banks have been mixed depending on their immunity from bond portfolio.

Jaipuria further states that FY08 earnings growth is likely to be less than 15 per cent. He also adds that earnings growth might slip by 300 bps every quarter.

According to him, companies will struggle to maintain and enhance margins. He sees markets ranged between 9,000 levels and current highs.

Excerpts from CNBC - TV18's exclusive interview with Jyotivardhan Jaipuria:

From a large cap perspective, what have been the key hits for you? What stood out to deliver a positive surprise?

Overall the earnings were good. We were expecting a strong quarter. Margins have been ahead of analyst expectation, so that is a good thing. There can be varying reasons and some of it may not be exactly, operationally business reasons.

Software did well because they were benefited from the rupee depreciation. That was probably the biggest reason why we saw earnings supply really come through there.

There are some companies, which are talking of margin pressures coming through. So overall, we had very good results but I guess there are signs that we need to be more cautious in the future.

What are your observations on banks and autos?

The auto results were a mixed bag. The two-wheeler sector showed margin pressure and that is what we have been saying for some time, that there is competitive pressure, which will start building up.

So even though the volumes came in line with expectation, we saw some operating profit and net profit being slightly lower than expectation.

The four-wheelers margins were better than what we thought. Some of the companies still have to report their numbers. Overall I would say that two- wheelers numbers are not so good but four wheelers were good.

Bank results were also a mixed bag. There were banks, which were hit by the bond portfolio, and there were some, which were immune from those issues. So I would say the private sector banks will continue to do well and public sector banks, especially banks that are more vulnerable to the bond portfolio struggled in their earnings.

Was there any dark horse in the earnings that surprised you pleasantly with its numbers?

I would say software was a surprise for everybody in terms of net profit and they gave a very strong outlook. Part of it was led by the rupee depreciation. I would also say that the telecom sector did well in terms of numbers. There have been some concerns in the market that competitive pressures will start hitting that sector.

We were expecting cement to do very well. We said that analysts would upgrade that sector after the results and cement sector delivered results, which were above analysts' expectation. Hence that is one sector, where we thought that the numbers would get beaten and they did.

How do you map out earnings now for the next few quarters in terms of the pressure that you just pointed out? On a valuation basis, where does this market stand for you then?

Earnings will progressively slow, as we get into the later part of this year, especially more moving into next year. If you see the consensus forecast for this year, people are looking at 25 per cent growth, which they typically do.

But for next year, people are looking at earnings below 15 per cent. The consensus on earnings today is at 13 per cent. That is what you have to keep in mind. May be on an aggregate basis, we have probably seen the best of the earnings season now. Going into next year, we will see a slow down coming through.

I guess there are a couple of reasons why there will be a slow down. First, interest rates are rising so it will start hitting demand growth in some sectors.

Second, global commodity prices are falling so probably this year in the later part and next year, we will see some of these global commodities stocks perform badly in earnings.

Thirdly, cost pressures have begun to mount. In India, we increased oil prices only now. So far, companies were safe from all the increase in global oil prices but that has got increased now. So in the next few quarters, it will start to hit margins to some extent.

What are your observations on operating margins. Do you say that the companies have done a reasonable job of holding margins in this quarter or are you already beginning to see the first signs of margins beginning to slip?

Overall margins are still good. But there are signs in some pockets; we are starting to see a competitive pressure building up. For a lot of companies, even for software, the overall numbers were very good. But if we look at operating margins, there were signs of slippage.

Two-wheelers clearly announced that they were starting to see margin pressure coming through. I guess there are trends; there are early signs that people will struggle now to maintain operating margins or to expand operating margins over the next 6-8 quarters.

This quarter has been good as you said, in terms of earnings, but if the view is that they will slow down, which quarter would you expect to see the first crack showing up, in terms of a visible slow down?

I think it will be a gradual process. Probably, every quarter will see earnings slip may be to 300 basis points, in terms of growth rate. But probably the worry for investors will start coming in from Q4 of this fiscal year. I think, around Q4, we will see earnings growth getting closer to 15 per cent.

At DSP ML, have you gone overweight or underweight on any sector because of earnings now?

No, we have not made any change to our strategy in the last 15-20 days. But ahead of the earnings season, we had said that we think software cement and telecom will do well. So those are the sectors that we had been overweight on and they have been broadly in line with those expectations.

In your strategy report, what is the Sensex band that you have indicated?

Basically on the lower side, we are looking at 9,000 and below and on the upper side, I guess it should be somewhere around the current levels. We think it will be more of a range bound market over the next 6 months.

I think the global cues are more important than the domestic factors for the market. We are probably hoping that Fed will pause in the early part of August. That's what is really taking global markets up at the moment.

But if we see history, after every Fed pause, markets have initially had a rally but since then, they have gone into a very sluggish phase.

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