Revenue growth to slow in Q3

Downgrades may extend into FY13; 14,500-16,700 a reasonable range for Sensex.

Contrary to expectations, earnings downgrades are not yet over. Corporate India’s second quarter numbers show the worst is not over. While sales have held up in Q2, profits have remained stagnant or have contracted for most companies. Equity strategists believe falling profits are a precursor to slower sales in the third quarter. Anish Damania, head of institutional equities at Emkay Global, explains: “I expect the earnings downgrade cycle to extend into the next two quarters. The earnings per share estimate for the Sensex in FY12 has declined 9.3 per cent to Rs 1,170. And I expect further correction to around Rs 1,120 by the fourth quarter.”

There’s reason behind such a gloomy forecast. The post-tax earnings of the Nifty 50 have fallen by 2.7 per cent year-on-year in the second quarter, while the Sensex companies have clocked a meagre 2.1 per cent growth in profit. The mid-cap companies have been worst hit, as net profit of Nifty Midcap 50 has fallen by 20.1 per cent annually in Q2. The profit after tax of BSE 500 (ex-Nifty), representing nearly 93 per cent of India’s listed universe, has contracted 3.6 per cent.

Most analysts were expecting margins to stabilise in this quarter, but they continued to fall. As if a sharp rise in raw material prices and interest rates was not bad enough, a depreciating currency has taken the wind out of India Inc. As a result, margin compression worsened in Q2, with sales growth outpacing Ebitda growth. Analysts believe that index forecasts are at risk, as profits have fallen for the first time in this cycle. According to Credit Suisse, several sectors saw a profit decline year-on-year (ex-financial services/PSU oil), which is a ‘first’ in this cycle. Except IT, most sectors have put up a disappointing show. Sales growth has been revised down across sectors (except IT), and margins have been cut further, Credit Suisse adds.

Earnings downgrades are likely to spill over to FY13 as well. Citi’s equity research team believes that for FY12 most of the earnings downgrades are over but it’s not so for FY13. Damania says: “Average Sensex EPS for FY12 & FY13 (currently at Rs 1,257) on a further five per cent cut will be Rs 1,194, implying a 14.5x multiple at the current levels. With one standard deviation below long-term mean of 14x, a reasonable range for Sensex is 14,500-16,700 with a higher probability towards the lower end of the band than upper end.”