Earnings at risk

Consensus earnings estimates for 2011-12 have witnessed a downward revision despite India Inc presenting a good December reportcard. Cost pressures are getting more pronounced and the hardening of the interest rates has prompted analysts to downgrade the earnings estimates.

Lower growth for 2012

Among the major sectors, IT services companies managed to beat expectations (with the exception of Wipro) with a decent volume growth and uptick in average realisations due to improving trend in the demand environment. However, a high attrition rate and wage cost pressures were visible during the quarter. More so in the mid-cap space, where some companies resorted to unscheduled wage hikes to curtail attrition.

Banks and financial services companies posted robust results but still witnessed earnings downgrades as the pressure on their net interest margin is likely to get more pronounced in the coming quarters. For them, the cost of funds is likely to rise further whereas the re-pricing of assets would happen only with a lag. Consumption-driven sectors such as fast moving consumer goods (FMCG) and automobiles are the other key segments that have witnessed downward readjustment in their earnings estimates. The spike in their input cost in an unfavourable demand environment may limit their ability to pass on the increase in costs to consumers.

Lastly, some of the other index heavyweights such as Larsen and Toubro (L&T) and Reliance Industries had company-specific issues that prompted moderation in their earnings estimates.

All in all, the consensus earnings growth estimate for the fiscal year 2011-12 is likely to slip to around 17-18 per cent from the 20 per cent-plus projected a couple of months back. But that's not the only reason for the recent correction in the markets amidst a strong rally in the equities globally.

Deteriorating macros

There is also the deterioration in the macro environment. Stubbornly high inflation, the growing twin deficits (current account and fiscal), hardening of interest rates and slowing industrial production are all posing obstacles to the India story. Not to forget the political instability and concern about the policy inaction.

Thus, the recent correction of 12-14 per cent in the stock indices from their peaks largely resulted from the compression of the price-earnings multiples rather than just the downgrade in the consensus earnings estimate for FY-2012. Even after taking into account a further downgrade in this estimate over the next few months, the one-year forward price-earnings multiple has declined from 16.5-17 times to a more comfortable 14.5-15 times now.

PE contraction

The compression in the price-earnings multiple is obviously driven by selling pressure from the foreign institutional investors. After record inflows of close to $30 billion in 2010, recent outflows indicate a tactical shift in favour of other competing emerging economies. The spiralling food and energy inflation makes an import-dependent country such as India quite vulnerable and relatively less attractive compared to some of the other emerging economies such as China, Taiwan and Brazil. Some semblance of political stability and proactive policy action would go a long way in boosting sentiment among the investors. The government's dilemma is to avoid overheating of the economy by kick-starting infrastructure spending, even while managing and curtailing the current account and fiscal deficits. In this context, the Budget could have strong influence on the direction of the market in the near-term.

(The author is Head of Research at Sharekhan Ltd.)

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