First-quarter earnings preview

Initial signs suggest margins will be stable, interest costs will put pressure on earnings.

In a week’s time, corporate India’s report card for the first quarter will be out. While the numbers will reflect slowing sales and higher costs (interest to be precise), analysts believe earnings will be hit even harder as rising interest costs will start hurting companies. The destruction of demand is already visible in auto and home sales for the same reason. Given the macro-economic situation, what can one expect from Sensex stocks?

Analysts believe that despite the headwinds, corporate India will be able to retain sales and operating profits. While the slowdown is a given, the good news is that margins are largely expected to stay flat quarter-on-quarter. Annually, margins may record a fall, but all initial signs suggest they could be stabilising on a quarterly basis. According to Citi, this mix of stable operating profitability but moderating demand contrasts with the earnings drivers of FY11: strong demand but falling margins. “In our opinion, the overt top-down caution in the market is the view that both growth and profitability will face pressure: this quarter could challenge this expectation.”

However, the consensus earnings forecast of 18-22 per cent for 30 Sensex companies could be at risk, if both sales and margins decelerate. Based on its view on market expectations, Citi believes upside surprises would lie with the cement sector, SBI, Tata Steel, Jindal Steel & Power, while Cipla, Bharti, Hindustan Unilever and Maruti could fall short of expectations and surprise on the downside.

Despite the downside risk in earnings, foreign investors seem to be changing their view on India, as valuations have never looked more attractive since 2003. UBS is the latest to turn overweight on India. Interestingly, apart from India, China is the only other market the brokerage is overweight on. In its Asia Equity Strategy Report, UBS Investment Research says: “There is an earnings risk in both, but unlike a quarter ago, this is now beginning to be reflected in estimates in India, which we take overweight.” Global cyclical proxies like Korea and Taiwan remain underweight and Singapore has been cut to neutral from overweight.

So, which sectors are likely to emerge as winners and which ones will lose? The sectors where margin downgrades have happened include autos, basic resources, construction and utilities. For most sectors, except basic resources, revenue forecasts have moderated. While analysts have not downgraded margins of industrial goods and household and personal products, the valuations look rather stretched at this point and may not be justified in times to come.