Earnings downgrades accelerate after poor Q1

215 stocks downgraded against 105 upgrades; FY16 could be washout year

The earnings outlook of India's top companies has weakened further after a lacklustre June quarter. Weak demand conditions persisted depressed sales, even though falling commodity prices helped bump up operating margins of Sensex companies. During the quarter, aggregate sales of Sensex companies declined five per cent while net profit growth remained flat year-on-year.

The disappointment was across the board and not restricted to select sectors. While the metals companies bore the brunt of declining prices and weak demand, the banking sector continued to see a build-up of stressed assets. Consumer companies also struggled to grow sales, as demand continued to be subdued. Explains Dhana-njay Sinha of Emkay Global, “Weak demand condition has persisted on the back of contraction in exports, deceleration in services exports and still weak government spending. Also as expected rural demand has been moderating.”

Following weak numbers in the June quarter, the Street has started downgrading earnings estimates of companies for the rest of the financial year. The number of downgrades has outpaced the upgrades, implying that a large number of companies are expected to do worse than expected at the start of the year. ICICI Securities sees consensus earnings downgrades in 215 stocks and upgrades in 105 stocks in FY16. Within the 215 downgrades, 143 are mid-caps (167 in fourth quarter of FY15) and 72 are large caps (79 in fourth quarter of FY15).

In Nifty, the brokerage has seen 13 upgrades and 37 downgrades. While the total number of downgrades has come down compared to the March quarter, the upgrade cycle remains weak. Also, the market's overall earnings outlook remains weak. Motilal Oswal expects earnings of Sensex companies to grow 12 per cent year-on-year in FY16. The brokerage has cut Sensex earnings estimates by three per cent after the first quarter to Rs 1,515 a share.

Despite earnings weakness, several companies have reported an increase in operating margins as raw material prices remained low. The operating margins of Nifty companies increased by 78 basis points year-on-year, says ICICI Securities. However, with demand remaining weak, Emkay’s Dhananjay Sinha believes the advantage might fade as companies pass on the benefit of lower commodity prices to gain volume growth.