Rupee decline starts to cut into Sensex earnings in dollar terms

The recent depreciation in the rupee has begun to adversely affect the Sensex earnings per share (EPS) in constant currency terms. The index’s underlying EPS when converted into US dollar is down 2.2 per cent during the month, even as it continues to rise in rupee terms. This is the first significant decline in Sensex EPS in dollar terms in the post-pandemic period and could partly explain the fresh round of selling by foreign portfolio  investors (FPIs).

FPIs have turned net-sellers in September after turning net-buyers in August. According to the data from the National Securities Depository, FPIs sold $391 million worth of equity in September so far, compared to their net purchases worth $538 million in August.

The Indian benchmark ended on Thursday with trailing EPS of $31.6 per unit of the Sensex — down 2.2 per cent from record high EPS of $32.3 at the end of August.

The rupee closed at Rs 81.85 to a dollar — down nearly 2.8 per cent during the month so far.

The index underlying EPS, however, continues to expand in rupee terms. Its EPS grew to Rs 2,584 on Wednesday, up from Rs 2,565 at the end of August. 

The recent decline in the US equity market has revealed a significant valuation gap between the Indian and the US equity markets.

The Sensex is currently trading at a trailing price-to-earnings (P/E) multiple of around 22x — nearly 35 per cent premium to the Dow Jones’ current trailing P/E of 16.4x. Historically, the Sensex valuation premium over Dow has been 24 per cent average since 2002.

The decline in the Sensex’s underlying earnings in dollar terms mirrors a similar decline in the underlying earnings of the Dow Jones Industrial Average. The Dow’s trailing EPS is down 3.4 per cent in the past seven months, from a record high of $1,878 at the end of February this year to $1,814.4 on Wednesday.

Analysts see further decline in the index’s underlying EPS in dollar terms in the second half (H2) of 2022-23 (FY23) from the combined impact of rupee depreciation, lower commodity prices, and higher credit cost.

This, coupled with a relatively higher stock valuation, could be the trigger for the recent sell-off by FPIs.

“There is a significant impact of the dollar and global commodity and energy prices on India’s corporate earnings. A decline in the dollar index and ensuing rally in commodity and energy prices greatly augmented corporate revenue and profits in the post-pandemic period. The process is now reversing and will hit corporate earnings in H2FY23,” says Dhananjay Sinha, director and head-research, strategy & economics, Systematix Institutional Equities.

Corporate earnings, observes Sinha, will also face headwinds from a rise in credit costs and bank deposit rates after the recent rise in bond yields and the benchmark interest rate — both in India and abroad. Mining and metal companies and oil and gas producers had reported the fastest rise in their earnings in the post-pandemic period, accounting for a bulk in the rise of corporate earnings in the non-financial space.

Bank and non-bank lenders had gained from a sharp decline in credit cost after the pandemic. Both these earnings drivers are now receding, clouding the earnings outlook for H2FY23.

Others, however, see little or no impact on corporate earnings from rupee depreciation and higher bond yields.

“In fact, we expect corporate margins to improve in H2FY23 due to gains from the recent decline in commodity and energy prices,” says Shailendra Kumar, chief investment officer, Narnolia Securities.