Q4 earnings likely to be weakest in many quarters

Days away from results season announcements, analysts continue to downgrade 2014-15 estimates across sectors

The March quarter (Q4) of 2014-15 is expected to be brutal for investors. Thanks to a sharp fall in commodity prices and currency turmoil, sales growth of Sensex 30 companies as well as India Inc is expected to contract sharply. While Crisil Research expects India Inc’s revenue growth to slip to a seven-quarter low of 2.5 per cent, other research houses expect Sensex revenue growth to be flat to minus seven per cent. On the other hand, Sensex earnings growth is estimated in the range of -7.6 per cent to 5.6 per cent for the March quarter. In the December quarter, Sensex earnings had contracted five per cent.

Worse, a dramatic moderation in profit growth of defensive sectors, which had propped the broader market in recent years. Over the past few weeks, analysts have downgraded earnings estimates of Sensex companies on more than one occasion. The result is a lack of consensus among equity strategists. Not many were expecting earnings’ downgrades of so many sectors in a short span. This has made forecast of earnings growth a lot more difficult, leading to a divergence in estimates (see table). In fact, there is scope for further downgrades.

Currently, even the most optimistic estimate suggests Sensex earnings growth by no more than six to nine per cent in FY15. Edelweiss says: “Given the poor earnings expectations, another two-three per cent downgrade in EPS (earnings per share) is likely.”

Kotak Institutional Equities writes: “Very few stocks offer any value on reasonable earnings assumptions. Some are terribly expensive and some face earnings downgrades from tenuous earnings assumptions.”

Ambit Capital’s Nitin Bhasin writes, “Following a disappointing third quarter and with signs of moderation across sectors, our analysts have downgraded their estimates for Q4 from three months ago for the majority of sectors. The more notable downgrades are in the automobile, consumer, cement, financials and E&C (engineering & construction) sectors.”

The sharp drop in earnings of commodity-oriented sectors, oil & gas and metals & mining, are expected to dent the performance of cyclicals. While defensives matter from an earnings perspective, cyclicals account for 58 per cent of the benchmark’s revenues. The big worry is the defensives (information technology or IT, pharmaceutical & consumer goods). Their revenue growth is expected to almost halve to 10.7 per cent year-on-year (y-o-y), against the 20.2 per cent y-o-y rise in Q4 of FY14, says ICICI Securities.

The sharp pullback in government spending over the past two quarters, impact of deficient and unseasonal rain on rural India, and the dollar’s strength against all other currencies have come together to hurt the earnings trajectory of corporate India.

For IT companies, Q4 is historically weak. This one is expected to be worse, due to cross-currency headwinds. The dollar’s strengthened by four to 10 per cent against most other major currencies, which would hurt the earnings of companies with a strong presence outside America. Sequential dollar revenue growth might remain flat or fall up to three per cent for many. Earnings growth, too, for most large IT companies is likely to be muted.

Among other key sectors, metals might be the worst hit. While domestic steel demand is weak, a 60 per cent surge in Chinese imports is hurting business. Led by global cues, domestic prices are down eight to 10 per cent, impacting profit. Edelweiss estimates Tata Steel’s net profit to fall by 95 per cent, while Kotak estimates a net loss of Rs 130 crore versus a consolidated profit of Rs 1,060 crore in Q4 of FY14. Profits of Jindal and JSW Steel are also seen falling sharply. Base metal companies Hindalco and Sesa Sterlite are expected to see a sharp decline in profit. The decline here of Tata Steel, Sesa Sterlite and Hindalco means their contribution to the Sensex profit after tax (PAT) will shrink from over five per cent last year to about one per cent in Q4.

Engineering and capital goods companies will also see pressure on profits, particularly Bharat Heavy Electricals expected to be a drag for this sector. Positively, banking, financial services and insurance is expected to deliver healthy earnings growth. A big contributor to the Sensex PAT (13.5 per cent in the year-ago quarter), it has a strong influence on overall numbers. Earnings will be led by private sector banks Axis and HDFC, seen posting an 18-22 per cent rise in profit. Edelweiss analysts, led by Nilesh Parikh, say: “Industry credit growth, running at multi-year lows, will exert pressure on top-line growth of banks, especially public sector players facing capital and asset quality challenges, while private banks will continue to outpace industry growth.”

Oil & gas will also be a mixed bag but broadly positive. Oil marketing companies should deliver good operating performance, led by strong gross refining margins (GRMs). However, there is no clarity on net realisations. Among Sensex companies, strong GRMs mean Reliance Industries will deliver good performance. Estimates peg its profit at Rs 5,900-6,300 crore. Though oil prices are down (so, lower contribution on account of its stake in Cairn’s oilfields), Oil & Natural Gas Corporation should benefit on account of a lower subsidy burden.

So, too, with automobiles. Two-wheelers have seen pressure on volumes, while passenger cars and commercial vehicles have fared better. The sector is expected to grow headline revenues in low single digits but net profit growth is expected to be about 10 per cent, led by better margins (lower input costs and currency gains).