The results saga, as is the general practice, has begun with TCS on 8th July. The June quarter was always going to be challenging for the IT sector and the signals of stress are already visible. In the June 2022 quarter (Q1FY23), TCS reported 5% growth in net profits on a yoy basis. However, the real concern was the spike in the attrition rate at TCS to 19.7%. That only means that the attrition would be much steeper for most of the other IT companies. TCS does not provide forward guidance, but the review is good enough. Let us now turn to the overall Q1 results picture at a macro level and later at a sectoral level.
The big picture and how it looks ahead of Q1FY23 results?
The macro picture almost looks similar to what it looked like when the March 2022 quarter results had started trickling in. The 4 major challenges still remain. Firstly, there is the risk of commodity inflation. It has tapered in the current quarter, but still elevated. Secondly, the Russia war and the China COVID restrictions pose the two biggest risks to the supply chain of global companies. Thirdly, companies have to prepare for an era of higher yields and higher cost of funds and that is already manifesting in the June 2022 quarter. Lastly, there is the added risk that too much of hawkishness by the central banks may eventually translate into a recession. That will result in a lot of demand destruction across sectors.
However, on an optimistic note, many of the constraints above are not as bad as they were at the start of the June 2022 quarter. For example, the inflation in food grain, crude oil and industrial metals are all sharply down in the last couple of months. Secondly, if the inflation pressures taper sharply, it is very likely that most central banks may do a rethink about being too bullish. There is one more point to remember. In the last 3 quarters, India companies managed the headwinds through cost cuts, lowering inventory lock-ins, better creditor and receivables management etc. These benefits are largely saturated and the scope for further improvement is limited from here on. Here is a quick sectoral view.
1. Oil companies could see a return to reality
Oil extraction companies are likely to gain from higher average oil price per barrel. However, the recent imposed windfall gains may be a problem for the coming quarters. The same applies to refining companies as the higher GRMs will be offset by higher duties on export of oil. Downstream oil companies could still be under pressure as the price hikes have not been in tandem with the spike in crude prices. The upstream oil companies like ONGC and Oil India are likely to be the best performers in Q1FY23.
2. FMCG could see back-ended benefits of lower input costs
The benefits of widening operating profits in this quarter could be visible after a long time. The major FMCG companies have all raised their market prices but now the input costs of most agricultural inputs and even crude have fallen sharply. Lower inflation with elastic pricing is likely to translate into better than expected performance by FMCG companies in this quarter. Most of the FMCG companies are likely to see higher operating costs but that is likely to be largely offset by higher spreads on most of its products. The larger FMCG players stand to gain more than the mid-sized FMCG players.
3. Autos could be the surprise pack of Q1FY23
Make no mistake, the auto sector has already been a surprise package in terms of price performance. At a time when the index was down about 8% in the June 2022 quarter, the BSE auto index is actually up by 16%, providing a tremendous outperformance. There are several things that have worked for the auto companies in Q1FY23. For instance, the price of steel, aluminium and copper have gone down and that is having a salutary impact on auto companies. Auto numbers have been robust on the back of greater vehicle affordability and an improvement in rural demand. While the second quarter could see more traction, the first quarter Q1FY23 will also see some benefits of growth and profitability spilling over from the previous quarters.
4. Steel and aluminium may face a double whammy
Let us remember that the demand for steel would still remain robust. There may be some delay in construction and infrastructure projects but the broad demand from auto, electrical goods and FMCG products are likely to remain robust. The problem for steel is on the price front with the steel prices having already corrected over 20% from the recent peaks. In addition, the export duties levied on steel is already hitting the export demand for steel, especially from the EU region. On the positive side, the cuts in duties on ore and coking coal will be a positive but this is likely to be a pressure quarter for the metals sector.
5. Banks could be the quiet performers in Q1FY23
What exactly could be positive for the Indian banks and financials? According to the ground reports, credit growth has been picking up momentum while the higher bond yields is likely to expand the NIMs of the banks. The private sector banks are expected to have done better than the PSU banks and are likely to report stronger profit growth in the June 2022 quarter. At the same moderate credit costs will come to the rescue of the banks and help them widen the spreads. However, analysts have warned that most banks could face subdued treasury income with higher operating costs hitting profits. However, private banks are expected to have done better than the PSU banks in Q1FY23.
6. It is likely to be a mixed bag for the IT sector
The IT sector in Q1FY23 is likely to see robust growth in the top line. However, the bottom line is likely to suffer on account of higher manpower, offshoring and travel costs and higher attrition related expenses. The first company to announce quarterly results for Q1FY23, TCS, has also shown a spike in attrition rates to 19.7%. Most IT companies see an improvement in deal execution in Q1 and that is likely to hold the top line growth in good stead, combined with a greater focus on new age technologies. However, higher manpower costs, higher travel costs and spill over effects of attrition are likely to keep IT margins under pressure in Q1FY23.
One broad trend we could get to see in Q1FY23 is the weight of performance shifting from the pure commodity plays to the user industries. That should be a positive shift.