Q2 shows only the fittest survive

Companies with strong earnings visibility and a natural hedge against the rupee will continue to command a premium.

Another forgettable quarter has come to a close. Nifty 50 or Sensex 30, earnings have disappointed. While most companies have managed to grow sales, staying profitable is proving to be a challenge. With management commentary turning cautious, the writing is on the wall. Mahindra and Mahindra, for instance, has highlighted risks “emanating from rising interest rates, deteriorating global macroeconomic scenario and continued policy and regulatory uncertainty”. This is despite the company doing exceptionally well this year.

As macro headwinds gain momentum, many companies will start looking at protecting cash, believe analysts. Since the investment cycle has come to a grinding halt, indefinite deferment in capex plans is not good news. At the end of the second quarter, the earnings per share (EPS) of the 30 Sensex companies stood at Rs 250, as against Rs 285 in the first quarter. Pankaj Pandey, head (research), ICICI Direct, expects the same rate in third and fourth quarters. This means the benchmark index will close the year with an EPS of Rs 1,100-1,120 and ample downside risks.

Going forward, the pain is only going to increase, as the investment-oriented sectors are yet to see revival. According to Edelweiss Financial Services, sector-wise indicators point to growing pain within rate cyclicals, with capital goods, PSU banks and real estate showing worsening metrics. Interest expenses now account for 1.9 per cent of the Nifty top line, the highest since Q4FY09.

Anyone looking for proof of the pain’s magnitude only needs to look at infrastructure bellwether Larsen & Toubro. In the wake of poor order inflows in the capital goods sector, the company slashed its FY12 order intake growth guidance to five per cent from 15 per cent. Construction, industrials and metals have seen a particularly bad quarter in terms of margins. Another sector contributing to the pain is banking, where slippages of PSU banks have shown a steady rise. According to Kotak Institutional Equities, banking, energy (higher share of underrecoveries assumed for upstream companies), metals & mining and telecom sectors account for the bulk of earnings downgrades.

So, what should investors do? Equity strategists believe it’s best to stick to the large-caps, as they have earnings visibility. Even if these stocks are pricey, the premium is worth it. Kotak recommends stocks with natural hedge against rupee depreciation, such as those of energy and technology companies.