Earnings pressure to persist even in September quarter, says Gautam Duggad

IT looks very interesting to us as it is one of the more sensibly-priced sectors, says Duggad

The June quarter performance of India Inc was subdued with majority of the companies seeing their earnings getting downgraded, said Gautam Duggad, head of research, institutional equities, Motilal Oswal Financial Services. Given the macro economic backdrop, corporate earnings will remain under pressure in the September quarter as well, Duggad tells Sundar Sethuraman. Edited excerpts:

Corporate earnings were disappointing in the June quarter. What are your expectations for the next quarter?

Earnings were subdued in the June quarter with Nifty earnings growth coming in at 5 per cent compared to our expectations of 12 per cent growth. Instances of earnings downgrade increased with 90 companies seeing more than 3 per cent earnings cut for 2019-20 (FY20) and only 30 firms seeing their earnings being upgraded. As a result, we have revised our Nifty FY20 earnings growth estimates downwards by 4 per cent to Rs 560. Expectations for the September quarter are also modest, given the weak underlying trends in the economy and consumption slowdown. Even the high frequency data is pointing towards near-term challenges.

How much will the economic slowdown weigh on earnings, going ahead? 

Consumption slowdown is just two quarters old. Also, private capex trend remains modest. This, along with the commodity price correction, means that earnings headwinds can continue. Rupee depreciation could provide some offset to export-oriented sectors. We are currently expecting 13 per cent profit growth for Nifty companies in FY20. But excluding ICICI Bank, Axis Bank and State Bank of India (SBI), the Nifty FY20 profit growth is expected to be just 3 per cent. In fact, half of incremental Nifty profit growth for FY20, as per our estimates, will come from SBI. So, to that extent, the earnings are disproportionately linked to banking asset quality recovery and write backs from NCLT cases which have seen inordinately delay.

Are we seeing any green shoots? What is your view on the overall macro-economic scenario?

There are two clear green shoots. These include reduction in cost of capital following the rate cuts by the Reserve Bank of India (RBI) and sharp recovery in the monsoon. From more than 20 per cent deficit two months ago, we are at 2 per cent surplus now. Overall macro scenario for India remains mixed. Some other positives include global softening of interest rates and continued low crude oil prices. However, from India’s perspective, the single biggest concern is growth. Until growth revives, challenges could persist despite benign crude oil and low interest rates. Multi-year low print of nominal GDP growth for the June quarter is a concern. It can put the government’s fiscal estimates at risk and also delay the long-awaited corporate earnings recovery.

How does this impact your Sensex and Nifty targets?

As far as our targets are concerned, given the current valuations and earnings expectations, we expect the Nifty to stay range bound.  

Is there a possibility that Nifty valuations could revert to long-term averages?

Nifty trades at 19 times its estimated earnings for FY20. The valuations are at a premium to the long-period average. However, looking at index valuation from a lens of long period average is bit erroneous. This is because index composition has shifted decisively in the last decade in favour of sectors that trade at high multiples. Therefore, plain vanilla comparison of valuations may not be the right way to look at it. Within the Nifty, there are 10-15 stocks which are trading at substantial premium to their own long period averages. They are mainly consumer shares, that of private banks, and some IT stocks. The remaining 35-40 stocks are trading at a significant discount to their long-term averages, particularly stocks in oil & gas, utilities and pharma sector.

How is your sector positioning? 

Private banks’ financials still look well poised as long-term value migration from state-owned banks opportunity remains huge. Asset quality recovery, though uneven, should benefit them. IT looks very interesting to us as it is one of the more sensibly-priced sectors. 

Defensive sector with high quality managements, strong balance sheets and significant cash returns look good. 

We also like consumption from medium- to long-term perspective. Interest rate softening coupled with high dividend yields and low valuations make utilities an interesting bet in this environment.