Earnings likely to disappoint investors amid expensive market valuations

By Chiranjivi Chakraborty

Investors in Indian equities expecting a robust earnings season to justify expensive valuations are likely to be disappointed.

Strategists predict lackluster profit growth for companies in the NSE Nifty 50 Index in the three months ended June. Citigroup Inc. sees their aggregate net income rising just 2 per cent from last year, while Motilal Oswal Securities Ltd. pegs the number at 4 per cent. In the prior quarter, the expansion was more than 11 per cent, outpacing forecasts.

That’s not enough for analysts struggling to justify an 11 per cent recovery in the Nifty from the June 4 selloff, which was triggered after India’s ruling party lost a majority in parliament and shocked investors. The earnings slowdown is caused in part by a severe heat wave, drawn-out election activity, and central bank curbs on unsecured loans, all of which have dampened consumption.

“The initial expectation for the earnings season is subdued,” said Vinod Nair, head of research at Geojit Financial Services Ltd. He sees profitability of Indian companies coming under pressure as flagging demand forces firms to take steps to boost volumes, which will likely hurt their bottomline and stock valuations. “The period of margin expansion appears to be concluding,” Nair said.

Energy, banks and commodity companies are expected to have a rough quarter, and drag down the Nifty’s aggregate performance. HDFC Bank Ltd. and Bank of Baroda Ltd. posted a sequential drop in credit growth, suggesting that lenders — who have the highest weighting in the index — are struggling to keep up the rapid expansion seen in recent years.

Local stocks need consistent earnings growth to justify the high valuations. At over 20 times one-year forward earnings, the Nifty trades at a 27 per cent premium to its historical mean, data compiled by Bloomberg show. 

To be sure, technology companies — making up 13 per cent of the Nifty 50 — may help offset the slowdown in banks. Nomura Holdings Inc. last week said that the slowdown in the sector likely bottomed in the quarter through June and is unlikely to worsen further. Motilal Oswal has upgraded software exporters to overweight from underweight.

Tata Consultancy Services Ltd. will announce its results Thursday, kicking off this reporting season in earnest. HCL Technologies Ltd. is due to report Friday. 

Indian stocks remain on course to outperform their Asian peers for the fourth successive year, data compiled by Bloomberg showed. Robust economic growth, strong local mutual fund buying and steady earnings so far have made the nation one of the preferred bets for outperformance for the rest of 2024, according to a recent Bloomberg survey.

The main equity indexes have scaled fresh highs as Modi’s return as prime minister reassured investors of continued focus on pro-growth policies. Supporting those gains are expectations that his administration would use the $25 billion dividend windfall from the central bank to boost consumption and infrastructure spending in the upcoming budget. 

“There will be a sustained focus on infrastructure, capex, and manufacturing, which will occupy center stage,” Gautam Duggad, head of research at Motilal Oswal, wrote this week.

Still, a slow start to the results season for the new fiscal year ending March 2025 could set the stage for local equities to consolidate in the near term, according to Citigroup.    

“I will not be surprised if earnings growth for this year comes down to just mid-single digit if the June quarter reflects weak demand and margin compression for companies,” Dhananjay Sinha, co-head equities at Systematix Group, said by phone. “It will become a struggle to get strong returns from the market that investors have been accustomed to.”