Earnings growth: Markets waking up to the reality

In FY15 , brokerages did not cut forecasts to bring it in sync with ground realities, this time they seem to be proactive

Over the past few quarters, markets have severely punished stocks of companies that have reported sub-par earnings. Given the global growth concerns that have rattled global equity markets over the last few weeks, brokerages have started to caution investors and are downgrading earnings estimates for India Inc.

This is in contrast to the previous financial year when a majority of brokerages were upbeat regarding earnings growth pick-up. However, it was only in the last quarter of 2014-15 that they realised that earnings would not grow in the high teens that markets were expecting.

In a recent note, foreign brokerage UBS has not only lowered the December 2015 – end target for the 50-share index to 8,200 versus 8,600 earlier but has also cut the top-down earnings growth forecast for the Nifty at eight per cent for FY16 and 15 per cent for FY17 versus 10 per cent and 18 per cent earlier, respectively.

Gautam Chhaochharia, head of India Research at UBS, believes that though markets appear to be trading at average multiples (15.8x one-year forward) on Street estimates, they are trading at 16.5x on UBS’s top-down estimates. He cautions that the growth recovery will be slow and is likely to disappoint Street expectations.

“This (growth recovery) is especially on hopes of public spending driven capex cycle and in context of some recent green shoots in macro growth data points. Hopes from a significant government wage Bill stimulus may also likely underwhelm. UBS remains positive medium-term given our long-held aggressive view on interest rates, policy/reforms and India's sustained relative attractiveness. Our new Nifty target (incorporating lower growth, still based on 17x one-year (FY17) forward PE) for end-December 2015 implies reasonable upside post recent market correction,” Chhaochharia said in a note.

Recently, Barclays in an India equity strategy report titled ‘When will earnings recover?’ suggested Indian earnings have now remained stuck in a single-digit growth territory for the past three years and this year is following a similar pattern with downgrades to FY16 estimates persisting (consensus earnings now projecting 16 per cent EPS (earnings per share) growth for FY16 compared to 19-20 per cent at the beginning of the year).

“Weak revenues are ostensibly to blame, though a closer look indicates top-down issues led by high real interest rates and a negative WPI (wholesale price index) culminating in lacklustre IP (industrial production) growth are the real culprits. However, postponement in earnings recovery leads us to reduce our 12-month forward NIFTY index target to 9,642 from 10,219,” it says.

Morgan Stanley, too, believes that slowing global growth has increased risks to corporate earnings and has cut its earnings forecast in this backdrop.

“Slowing global growth has increased risks to earnings and, to that extent, we cut our forecasts. Our new estimate is for 17.3 per cent and 14 per cent compounded annual growth rate (CAGR) in Sensex and broad market earnings growth to FY2017 versus 20.8 per cent and 17.5 per cent earlier. Back home, the risk is that real rates get too high because the RBI delays rate cuts. While the reforms agenda appears shaken with the delay in the GST Bill, the government has made good progress on the cyclical front (capex and inflation) while showing intent on structural reforms,” points out Ridham Desai, managing director, strategist and head of India equity research at Morgan Stanley in a recent report.

“Growth factors could gain performance over quality which has been the market's favourite since 2008. We prefer rate sensitive and cyclical stocks but continue to avoid high beta. We are overweight financials, industrials, consumer discretionary, technology; underweight consumer staples, healthcare, materials, telecom and utilities. We are neutral on energy. Our Sensex target for August 2016 is 31,000,” he adds.

Given the pain facing the banking sector, especially public sector banks, which are facing asset quality stress as well as credit slowdown, commodity producers (lower crude oil and metal prices) it is difficult to visualise that earnings will grow at a fast pace. Even the safe havens like IT and pharma are facing demand issues in the US and other global markets besides challenges on the currency front. FMCG, too, is facing weak demand in the country.