The report has warned about risks related to politics, global factors, and policy choices. One of the areas where earnings went between 2010 and 2018 was to firms abroad.
In the last eight years, corporate earnings have been disappointing the markets. Although the brokerages had expected new cycles, but earnings didn’t turn up in the past.
For instance, Morgan Stanley in 2016 predicted that corporate earnings would turn up in FY2017. However, owing to events such as extreme volatile oil prices, sharp surge in dollar and trade tension between China and the US emerged, things turned out differently. Also, shock of demonetisation and introduction of the GST caused a sharp slowdown in growth.
This delayed the bottoming out of capacity utilization rates and any turn in the capex cycle, putting a hold on margin and profit recovery. In summary, corporate India lost profits to global firms along with other issues such as poor investment decisions, risk aversion and some policy actions.
“We observe that most of these factors have reversed for FY20, setting the stage for a new earnings cycle. This cycle could last for four to five years with market earnings compounding at 20% per annum,” said Ridham Desai, managing director at Morgan Stanley India. “As a consequence, India’s new RoE cycle should also gain momentum,” shared Sheela Rathi, executive director at Morgan Stanley in a report.
The report has warned about risks related to politics, global factors, and policy choices.One of the areas where earnings went between 2010 and 2018 was to firms abroad. Since India has limited domestic production of oil, terms of trade are heavily dependent on the price of oil.
The current account surplus ex-oil started falling somewhere in the middle of the previous earnings cycle (2003-2010) and the fall accelerated as earnings peaked in 2010. “The fall in the return on capital, overvalued currency and the poor investment decisions that caused losses for banks and companies led to a sharp fall in risk appetite,” the report added.
The report said the outlook for profits is better because the rupee is no longer overvalued. In addition, the government counter-cyclically spent on investments directly over the past few quarters, which could lead to a start of new investment cycle post elections. With the depletion of capital stock, even a small acceleration in demand would result in higher pricing in several domestic sectors.
“We are already seeing this in banking, hotels, airlines, commercial real estate and cement – and this could spread to other sectors by 2020,” the report said. The brokerage has recommended to buy domestic cyclicals and financials. This includes consumer and industrials – its current favorites are autos, hotels, airlines and cement – as well as banks, select non-bank financials, and real estate. “MS has suggested to avoid sectors with global exposure which include technology, pharmaceuticals and global materials,” the report said.