BofA-ML warns of more earnings downgrades

Banks, energy companies account for 50% of 2013-14 estimated EPS growth

Investors may need to brace for another round of earnings downgrades by companies in FY14, according to Bank of America Merrill Lynch (BofA-ML).

Earnings per share (EPS) growth estimates of top 30 Indian companies, constituting the Sensex, could be downgraded to 10 per cent in 2013-14 to below Rs 1,300, compared with the current expectations of 17 per cent, said the investment bank.

A delay in economic recovery in FY14, coupled with the influence of banks and energy companies on the Sensex, could drive the earnings downgrade in the year, said BofA-ML. Banks and energy companies account for 50 per cent of FY14-estimated EPS growth.

These estimates are a contrast to the broader expectations on Dalal Street that earnings downgrades could trough out in the first half of 2013-14. Earnings downgrades put pressure on stock prices, whose valuations are calculated on the basis of their EPS.

“Analysts are, as in FY13, being too optimistic about a recovery in the economy on the back of a sustained fall in interest rates,” said BofA-ML analysts Jyotivardhan Jaipuria and Anand Kumar in a client note. “So far, rate cuts have been slow and we think sales growth in FY14 will continue to be weak. Hence, the expected recovery in margins may disappoint.”

The investment bank said five stocks: Oil and Natural Gas Corporation, ICICI Bank, HDFC Bank, State Bank of India and Tata Steel account for nearly half of the profit growth of the Sensex. “For FY14, analysts are building an increase in sales growth as well as margins in energy, metals and some of the auto companies. We think these sectors are likely vulnerable to downgrades,” said Jaipuria and Kumar.

However, the EPS growth in FY14 at eight-nine per cent will be higher than five per cent in the previous year, said BofA-ML. “The other good news is that, for long-term investors, we are probably close to the bottom of the earnings cycle, though FY14 is unlikely to be the year of recovery,” said the analysts.
GLOOMY OUTLOOK

• Sales and Ebitda growth in 2012-13 is likely to be the third-slowest in 20 years
• 2012-13 EPS growth will be the sixth-slowest in the past 20 years
• Weakest EPS growth spell over five-year period was between 96-97 and 2000-01, when EPS grew 5%
• Over the next seven years, EPS growth averaged 22%
• The five-year period to FY13 has averaged 8.8% EPS growth

Source: BofA-ML