By Invitation. Earnings recovery is around the corner 

We have seen the curtains come down on the earnings season of the second quarter of the fiscal year. It continues to be a fourth quarter of weak earnings. For the Sensex companies, the topline is down 6 per cent year-on-year (yoy), operating profit is down 1 per cent yoy and net profit is down 2 per cent. There has been an operating profit margin expansion of over 120 basis points year on year.

The weak revenue for companies is because of weak volume growth and dis-inflationary pressure in the economy. The latter is not a surprise as the WPI (Wholesale Price Index) has been in the negative territory over the past year. The operating profit de-growth has been lower than that of the topline because of lower input prices, which led to margin expansion. Among the sectors, private sector banks, NBFCs, IT, media and pharma companies continue to post good numbers. This can be attributed to the pricing power these companies enjoy. Metals, capital goods, PSU banks and oil & gas posted disappointing numbers. Selectively, some of the mid-cap companies have done well.

We expect the worst is behind us for earnings and recovery is around the corner, starting in the second half of the fiscal year. The negative impact of cross currency movements and inventory losses due to lower commodity prices will not recur. The base effect from the next quarter will also be favourable. The domestic economic growth may also stir up earnings growth. However, we believe that the benefit of lower raw material prices, which was helping in margin expansion, may peak out.

 For the past four years, market players began the year with expectations of about 20 per cent earnings growth, only to taper it down to lower single digits by the end of the year. This year may be no different as markets are now expecting FY16 earnings per share (EPS) growth to be around 8 per cent. For the next financial year, the EPS growth estimate is around 20 per cent. We believe the reasonable level to be 16 per cent. It has to be noted here that this phenomenon of earnings revision downwards from the beginning of the year is not unique to India but is true in almost all global markets, including the US.

It is pertinent to reason out why earnings in the next fiscal could be better. The government has taken some measures that could bear fruit in the coming quarters. For instance, as private capital expenditure may take a while to return, the government has taken the onus of increasing capital expenditure. Thus, in the roads sector, in the first half of the current fiscal, the government has already spent 50 per cent more than that in the last fiscal. The expenditure in Railways will pick up pace in the second half. Public sector banks (PSB) have been laggards in credit growth due to the non-performing loan issue. The government is tackling this issue through recapitalisation of PSBs as part of the Indradhanush programme and transferring the debt burden of State Electricity Boards (SEBs) to States through the Uday programme, steps in the right direction.  Further, the norm in our country has been to freeze all expenditure in the last quarter of the fiscal year. This could change this year due to healthy tax collections and prudent fiscal discipline.

The recommendations of the Seventh Pay Commission were made recently, reasonable for the government to accept and significant enough for consumption growth. Also, note that State Governments will also take inputs from the Pay Commission to implement pay hikes for their employees and pensioners.

The transmission of lower interest rates from banks has not fully happened. Next year banks will have further room to reduce rates which will increase discretionary expenditure for existing borrowers and see higher capex borrowing. Finally, the law of averages should catch up with rainfall after two consecutive years of drought — only the fourth time in 144 years. Good rainfall next year will lead to better agricultural output. This would stem the pain of falling rural incomes and help push up growth. Are we there yet? Just a little further!

The author is Co-Chief Investment Officer, Birla Sun Life AMC

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