Markets at a peak, but weak earnings outlook a hurdle
PremiumA striking feature in Q1 has been the divergence in earnings, with the good show in some sectors offset by the weakness in others
Last week, Indian stocks witnessed a new milestone, with the benchmark Sensex topping the 56,000 mark for the first time during trading hours on Wednesday. This is at a time the June quarter results prompted meagre earnings upgrades for this financial year (FY22) and the next.
“Our FY2022E and FY2023E net profits of the Nifty-50 Index are higher by 0.4% and 0.8%, compared to the start of the 1QFY22 results season," said analysts from Kotak Institutional Equities.
True, the fiscal first quarter was challenging for Indian companies as the second covid wave’s restrictions made business conditions tough. Analysts pointed out that the pace of earnings upgrades has slowed down.
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“The FY22 earnings for 49% of the 117 companies (analysed) were upgraded while 42% saw downgrades. The pace of upgrades is the slowest in the past four quarters, but we note that as the earnings season progressed, analysts were more biased towards upgrades—likely as companies presented a bullish July/ September quarter commentary," said analysts from Jefferies India Pvt. Ltd in a report on 17 August.
A striking feature of the June quarter results has been the divergence in sectoral earnings, with the good show in some sectors offset by the weakness in others.
“Double-digit earnings upgrades were seen in commodities, hospitals and select capital goods/infra; while double-digit downgrades were there in autos, insurance and select NBFCs/small financials," Jefferies said.
Companies also faced margin pressures in the June quarter owing to higher input costs. The steep increase in metal prices has meant robust price realizations for the sector, particularly steel firms. However, debt reduction was lower than expected owing to working capital build-up, analysts said. Cement companies, too, performed well during the quarter. This was aided by robust volume growth as this year’s lockdown restrictions weren’t as severe as last year’s. Cost control measures and higher prices helped, too. Information technology (IT) firms saw strong execution and revenue growth last quarter. Within the oil and gas sector, the performance of oil marketing companies (OMCs) was decent, helped by better marketing margins.
On the flip side, it was a rough ride for auto firms, with the pandemic weighing on volumes sequentially. Margins were hurt owing to commodities inflation. Consumer staples firms, too, faced margin pressure from higher raw material costs.
Commenting on the overall quarterly performance, Edelweiss Securities Ltd said, “Earnings momentum sustained in Q1FY22, with our coverage universe posting 17% profit after tax on two-year CAGR basis (estimate: 22%), although the second wave hurt top-line growth (3% on two-year CAGR)." CAGR is compounded annual growth rate.
To be sure, it is not as if the earnings outlook is rosy hereon. There are some downside risks. “One of them being high commodity costs. In the March quarter, companies had the advantage of a low-cost inventory, which saved margins, but that benefit has now waned over the next two quarters. Another risk, especially for FMCG companies, is from the slower offtake in rural India, where demand has been hit by the aftermath of the pandemic and uneven kharif rains," said Deepak Jasani, head of retail research, HDFC Securities.
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Jasani added, “In short, for earnings to see meaningful upgrades, Nifty heavy-weights have to perform well."
Meanwhile, valuations have skyrocketed. The MSCI India index is trading at a one-year forward price-to-earnings (PE) multiple of around 21 times—a steep premium to the valuation multiple of MSCI Asia ex-Japan, trading at a PE of 13 times.
Analysts say although the valuation premiums of Indian equities have moderated, valuations remain more expensive than emerging market peers. In the backdrop of dearer valuations and limited triggers from the domestic market, Indian investors are taking cues from global events.
Here, the covid-19 delta variant is a big worry. As such, the pace of vaccinations remains a key monitorable. While management commentary has been encouraging, one has to watch how cost inflation moves.
Investors need to watch the extent to which price increases would save margins, especially for the consumer sector.
Note that the Sensex peak achieved last week was short-lived, with investors choosing to book profits.
Kotak expects very strong growth in the net profits of the Nifty-50 Index in FY2022 (31%) and FY2023 (14%); and a stable-to-modest increase in bond yields over the next few months on the back of robust economic recovery.
“Thus, we would rule out meaningful earnings upgrades or lower bond yields. However, rich market valuations (Nifty-50 Index) at 23.1X FY2022E ‘EPS’ and 20.2X FY2023E ‘EPS’ are largely factoring in the above-mentioned positives," said Kotak’s analysts in a report on 16 August. EPS is earnings per share.
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