Earnings growth will drive the market

The worst of the earnings cycle is behind us

The month of July saw the Nifty 50 index scaling an all-time high, buoyed by an improving macro backdrop and a good start to the earnings season. A majority of Nifty companies have released their first quarter FY19 results so far, constituting more than two-thirds of estimated Nifty profits and 50 per cent of India’s market capitalisation.

The Q1 of FY19 has seen robust performance, with around 80 per cent of companies reporting earnings in line with or above consensus estimates. Excluding corporate banks that missed their earnings due to higher provisioning and will need time to stabilise, Nifty sales has grown by ~23 Y-o-Y; EBITDA by ~24 per cent Y-o-Y, and adjusted PAT has grown 15 per cent Y-o-Y. Even the broader market trend is positive with earnings for the BSE-200 (ex-financials) growing 12 per cent Y-o-Y. The growth figures may seem high due to the base effect, but even adjusting for that, growth has been strong.

Broad trends

Looking at the sectoral earnings growth, there are some broad trends. Fast-moving consumer goods companies have reported strong earnings, which reflect the uptrend in consumption and robust rural demand. Within financials, private banks have seen strong topline growth, while PSU and corporate banks saw reduction in fresh slippage of non-performing loans. NBFCs posted another quarter of healthy performance due to stronger topline growth, despite margin pressure. Cement companies have seen healthy volume growth, but their profitability has been impacted by cost pressures. In IT, the demand is showing gradual improvement. With crude below $80/bbl and strong refining margins, oil companies have seen robust earnings.

Sectors which disappointed were auto, which saw margin pressure due to higher raw material cost; telecom due to higher competitive intensity, and metals due to heightened uncertainty in the global environment in the face of a potential trade war. Pharma, building materials and textiles were a mixed bag.

Over the past four years, consensus Nifty 50 EPS estimate got downgraded up to 20 per cent by the beginning of the fiscal year. However, for FY19, consensus Nifty EPS was downgraded by only 6 per cent. In addition, for the first time in many quarters, there has been a healthy earnings upgrade-to-downgrade ratio on the back of Q1FY19 results. Sector-wise, consumer durables, banking, industrials and IT are seeing upgrades, while auto and cement have been downgraded.

Also, over the past three years, earnings growth was muted. However, earnings recovered last year with Q4FY18 seeing a pick-up. This has continued in Q1FY19 with improvement in the economy and the benefits of various government policies trickling in. The consensus is at 18 per cent EPS growth for Nifty 50 Index for FY19 (EPS positive companies) and 16 per cent for FY20. The earnings recovery is expected to continue and the probability of achieving these numbers is high, not only due to base effect but also due to economic growth coming back and reduced disruptions.

Positive indicators

The macro backdrop for India turned favourable in July as crude oil prices declined and the rupee stabilised, post the sharp sell-off in June.

Investment activity remains firm even as there has been an increase in interest rates. Capacity utilisation has risen to a two-year high of 75.2 per cent, mainly in the steel, cement, and auto sectors. In addition, global GDP also posted a strong 3.4 per cent annualised gain in H1FY18 and the underlying global macroeconomic cycle is expected to remain strong in H2FY18.

Domestically, there have been certain systemic as well as sector-specific issues in the past, which are now easing and will drive earnings growth. The reduction in GST rates, which consumer companies have passed on to consumers, augurs well for volume growth and will boost earnings. The progress of the monsoon and the increase in agricultural support prices for farmers should bolster their income and support the rural economy.

The banking sector is expected to get a boost from Project Sashakt for resolving bad loans and Project Samadhan for turning around stressed power assets. The NPA resolution process will bring in new owners with fresh capital, leading to repaired balance-sheets giving the propensity to spend on capex, improved working-capital cycles, and improvement in the overall vendor ecosystem, thereby stimulating demand. The worst in pharma may also be behind us. The regulatory onslaught in developed countries has slowed down significantly, intensity of price erosion has reduced, and companies have also rationalised their cost structures.

The worst of the earnings cycle is behind us. And, since earnings lag behind the economy, we are confident of seeing a broad based recovery across sectors.

Even on the macro front, although there is a lot of noise on the global front such as trade wars, the negatives have eased off and disruptions should be minimal. Until now, P/E re-rating was the dominant factor for the market but, going forward, it is earnings growth that will drive the market.

The writer is co-CIO, Aditya Birla Sun Life AMC

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