NEVER before in recent times has an earnings season been so disappointing. Not only have the numbers for the three months to December, 2014, come in way below expectations, commentary from India Inc has been more cautious than ever, leaving analysts will little choice but to downgrade estimates.
The weakness has been fairly widespread: for a clutch of 3008 companies (excluding banks and financial services) the growth in the top line has been flat—up just 0.4% year-on-year (y-o-y) —partly because of softer prices of commodities. Net profits have crashed 26% y-o-y despite a sharp fall in the cost of raw materials–which should ideally have cushioned the weak top lines–and a smaller tax outflow.
Aggregate net profits for the Sensex companies, have declined for the first time since Q1FY14, a 5.5% fall y-o-y, with the top line contracting 1.2%y-o-y.
Clearly, companies are neither able to push through volumes nor earn better realisations save in some sectors such as cement; moreover, the sharp drop in the prices of commodities has taken the sheen off the top lines of players in this space. Credit Suisse points out that the Nifty’s top line performance was the worst in last five years with both sales and operations lacklustre; at 15.9%, the EBIT margin was just 50 basis points away from the crisis lows of March 2009.
Household spends remain muted – a reflection of the low level of confidence; the drop in domestic volumes of 17% y-o-y at Bajaj Auto is a sign that consumers are still holding back. Volumes at Hindustan Unilever grew a sluggish 3% y-o-y versus estimates of 5-6%. Most worrying, the capex cycle is far from turning; Larsen and Toubro not only lowered the guidance for the growth in its order book for FY15 to 15-20% from 20% earlier, but also believes the recovery in its domestic business could be up to a year away.
Not surprisingly, analysts have been compelled to trim their earnings projections– for FY15 these have dropped from R1,585 to R1,534, implying a growth of just 8% while for FY16 EPS, these have been cut from R1,882 to R1811.
If India Inc is to better these forecasts, much needs to happen by way of policy reform; on the wish list are a clear timeline for the Goods and Services Tax (GST), easier land acquisition rules, a friendly direct tax regime, a robust dispute resolution mechanism in the infra space and freeing up of limits for foreign direct investment in sectors such as defence and insurance.
With the Sensex trading at a one year forward earnings multiple of 16.5 times and near its record highs, expectations from the Union Budget are running high. The Street doesn’t mind paying a little more by way of taxes—a 0.05% cess for Swachh Bharat—but is hoping for more plan expenditure that will boost demand and create jobs. Moreover, rejigging the personal income tax slabs so that the maximum rate kicks in a little higher than the current R10 lakh will leave more money in the hands of consumers —good for consumer goods manufacturers—while higher income tax deduction limits under section 80C from the current R1,50,000 to R2,00,000 will boost savings—good for capital goods makers.
Relief by way of lower excise duties, now at 12% for most products, is unlikely—in fact, there’s talk of higher service tax rate of 14% so India Inc needs to brace for more taxes. And the government will most likely raise duties on petroleum products, which if passed on by oil refiners, will mean higher transport costs, adding to companies’ expenses.
Steelmakers, however, are hoping for higher duties on steel to counter the threat of dumping from China and Russia which could benefit them by $10-15 per tonne.
One area where the government could look to spend is affordable housing; that would help revive demand in a whole host of sectors including real estate and construction, consumer goods and cement. Tax breaks for REITs—Real Estate Investment Trusts—would prompt companies to monetise rent yielding assets, helping them pare debt and repay banks. Tax breaks, in the form of a lower MAT and DDT, for manufacturing, especially in SEZs, for instance, should prompt companies to take up new projects. Indeed, a demand boost from an increase in government spends on infrastructure and welfare schemes is what India Inc is hoping for most. In this context, the Street would prefer that the government spends more next fiscal and even offer industry some sops, even if it means some fiscal indiscipline since that would help kick-start growth; if ever these were needed, it’s now.