Light at the end of the tunnel

The second half of fiscal 2018 promises to be a period of positive surprises

It has been seven years that the market analysts (forecasters) started with a very high earnings growth estimate at the beginning of the year, only to eat humble pie as they downgraded the numbers during the course of the year. It is but natural for investors to stop believing the forecasters. While I agree with the investors’ reaction, I also empathise with the forecasters who have been dealt blind cards over and over again — both by the economy and the market, globally and domestically. However, the good news is that the intensity of blind cards being dealt with is reducing. H2 FY18 could be a period of positive surprises on corporate earnings not only due to base effect but also due to reducing disruptions and economic growth coming back.

The quarter gone by

Let us take a quick look at the earnings season gone by. For Nifty50 companies, sales, EBITDA and adjusted PAT grew by 11 per cent, 14.7 per cent and 13.4 per cent, respectively. This was lower than the expectations on all three counts. The miss was primarily due to 1) higher than expected provisioning of non-performing loans (NPLs) by certain banks and 2) lower than expected inventory gains for oil marketing companies.

On the other hand, what helped the earnings was 1) lower losses due to decreasing competitive intensity in telecom, 2) lower slippages in certain banks 3) restocking and accrual of Goods & Services Tax (GST) tax benefits for consumer companies.

The one metric that provides hope for future earnings recovery is the earnings upgrade to downgrade ratio. For the first time in many quarters, the ratio has improved significantly (with more downgrades still).

Earnings recovery

The consensus is at 11-13 per cent EPS growth for Nifty50 Index for FY18 and the same stands at over 20 per cent for FY19. The probability of achieving these numbers is high (even though, historically, the forecasts have been proved wrong). The recovery could be broadbased and sectors that have been under-performing could come back.

There have been certain sectors and companies that have been struggling due to specific issues, which are easing. One, the recapitalisation plan will accelerate the resolution of NPLs in the next two quarters for both public sector banks and corporate oriented banks (indirectly). With fresh capital in their arsenal, the focus will be on lending and regaining market share.

Two, the consumer companies have been unanimous in stating that normalisation of operations post GST implementation (restocking, managing supply chain, hand-holding vendors, etc.) will happen in the course of the next few weeks. They were confident of improved volume growth in rural areas.

Three, the competitive intensity in the telecom sector due to the new entrant (Reliance Jio) has been decreasing. Additionally, the pace of consolidation has increased, easing pricing pressure and capex needs.

Four, the worst in pharma may be behind us. Companies are adjusting their cost structures to the new reality of price erosion in the US and the regulatory onslaught has slowed down significantly.

Apart from easing of pressures faced by companies over the last few years, growth is coming back. GDP bottomed out in Q1 FY18 at 5.7 per cent (y-o-y) growth. The same was 6.3 per cent for Q2 FY18 and could breach 7.5 per cent in the next few quarters.

First, the recent reduction in GST rates augurs well for consumer companies due to volume growth. Additionally, the focus of the government on supporting the rural economy adds to the aggregate demand.

The huge surplus moving from State governments to farmers through loan waivers (to the tune of ₹1,20,000 crore so far) helps in consumption. Populist measures before state and Central elections will leave more money in the hands of the people (voters!) which will prop up consumption.

Hence, consumer oriented companies could see good growth. Second, deleveraging (Debt/Equity at 0.64 for BSE500 companies ex-financials in FY17 vs 0.73 in FY16) combined with increasing free cash flows and ability of banking system to lend could lead to pick up in private capital expenditure.

While this may play out over the next few quarters, the green shoots are visible.

Third, “housing for all by 2022” is picking up well which has cascading effect into other related sectors.

There is every reason to believe that there is light at the end of the (earnings) tunnel!

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

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