If the stock market ran up a sharp 35% between February and September this year, much of the rally has resulted from the confidence of investors in the NDA government, A stable government, investors believed, would deliver reforms quickly.
However, the sharp run-up in prices was also accompanied by a belief that corporate earnings would be impressive, if not in FY15, given the economy is yet to turn conclusively, at least in FY16. The 29% gain in the market, since January, has seen the benchmark indices trade at par with their long-term average valuations, about 15-times the one-year forward earnings in case of the Sensex.
But the mediocre corporate performance in the first six months of FY15 has left strategists with little choice but to temper their expectations, not just for this year, but also for FY16.
The ground reality is that although the government has moved on several fronts, big reforms are yet to be ushered in and, moreover, interest rates are yet to fall meaningfully enough to help bring down interest costs.
The Street now estimates the earnings per share (EPS) for the Sensex in FY15, to come in at R1,552, an increase of 9% over FY14; in April-May, the consensus had been far more bullish with analysts pencilling in an increase of close to 15%. As for FY16, the outlook on earnings growth has moderated from R1,901 to R1,876 since early November.
The unimpressive performance of the oil & gas, utilities, and capital goods spaces in the September quarter with no sharp uptick in the performance of consumption- linked sectors has compelled the Street to revisit the numbers.
Neelkanth Mishra, MD and Head of India Equity Strategy, Credit Suisse, says downside revisions to FY16 earnings are likely to be led by the financial sector. “The consensus numbers are too high. The bigger part of the earnings cut, of 3%-4% will come from financials, materials and industrials,” Mishra told FE recently.
He pointed out that a 50 basis points fall in interest rates might not make much of a difference except a handful of companies given that the interest coverage ratio, of companies that account for as high as a third of loans, is less than 1.
“The risks associated with companies from say the metal space are not reflected in valuations of some of the banks as people expect credit costs to come down which I doubt will happen,” Mishra said.
That view is shared by others too; the Street believes loan growth could stay muted while highly leveraged sectors like metals, power and industrials would weigh on the profits of banks.
Indeed, while lower commodity prices will cushion earnings in the midst of the continuing slowdown as will lower interest rates starting March or April, given how several large companies are dependent on the European and other overseas markets, the delayed recovery could continue to pressure profits. After all, more than 50% of the earnings of the Sensex are made overseas.
KIE, which has dropped estimates for the Sensex’s FY15 EPS growth to 10.7% has held on to the FY16 growth outlook of 18.3% for now but points out there could be a revision coming from worse-than-expected performance by the cement, industrial, metal and power sectors. KIE says a fourth of the net profit of the Nifty 50, for FY16 ,comes from firms with significant overseas revenues while an equal proportion is brought in by Coal India, GAIL and ONGC that see “controlled” or regulated profits. Some of these companies, it feels, may not be in a position to grow their earnings beyond certain ‘normalised’ level.
By Devangi Gandhi