Preview: Earnings to rebound in Q1FY19, but momentum may taper off

The momentum in consumption demand is likely to sustain in Q1FY19, with strong numbers coming in from Consumer Staples, Durables and Auto sectors. The banking sector credit growth rising to 13 per cent also underscores gradual improvement on the back of increasing retail lending and rising sales growth of companies.

The cyclical upturn is largely attributed to higher revenue spending by the government, especially in the rural areas, its multiplier effect on aggregate demand, moderate improvement in global trade, depreciation in INR/USD and rising commodity prices.

Also, there is a significant beneficial effect of last year’s low base due to GST transition and regulatory change for the Auto sector. Indian companies had seen a decline in sales growth and contraction in earnings at a broader level. For the Emkay universe (ex-financials and oil & gas), sales growth decelerated to 6 per cent yoy in Q1FY18 while profit contracted by 10 per cent yoy.

Hence, the robust earnings growth expected in Q1FY19 on the back of a cyclical uptick cannot be extrapolated to predict strong full year FY19 earnings. Importantly, the impact of demonetisation and GST related dislocations has led to significant volatility in the earnings performance of companies in the recent years. It will take some more time before stability is attained in overall earnings.

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Sales growth for our coverage universe (ex-financials and oil & gas) is expected at 15.5 per cent yoy, with overall earnings growth of 27 per cent yoy, even as the operating profit margin (OPM) is expected to expand by over 110bps yoy. This rebound will likely be led by our Large Cap universe, whereas the Mid Cap universe is expected to deliver 9.6 per cent yoy growth in net profit.

Spiraling raw material costs have had a mixed impact, with consumer-oriented companies sustaining better margins, while others have failed to demonstrate strong pricing power.

Our estimates capture strong traction in sectors such as auto & auto ancillaries, consumer-centric segments and metals. All these sectors are expected to see margin expansion. Hence, they are expected to deliver strong earnings growth.

Within the banking sector, the performance on asset quality will be key to watch out for after a turbulent Q4FY18 that saw corporate banks suffering significant slippages and credit costs as a result of RBI’s circular in Feb’18 on revised framework for stressed assets. With a few large resolutions already underway under IBC, corporate banks are relatively on a better footing at present.

RBI data indicates that systemic loan growth accelerated to 12.7 per cent yoy compared to 5.7 per cent a year back. This rebound is led by retail lending. Also, while corporate lending remains subdued, increase in working capital requirement, rising commodity prices and substitution of non-bank borrowings in the face of spiraling money market rates are supporting overall lending. Having said that, constraints on growth capital will make public sector banks (PSB) lag behind private banks.

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We also remain cautious on the treasury loss of PSBs on account of the recent RBI guidelines on pricing of SDLs (State Development Loans) and hardening of G-Sec yields over the last one year; the 10-year benchmark yield has hardened to over 8 per cent from a low of 6.4 per cent nearly a year back.

Notwithstanding the strong headline earnings growth at the aggregate level in Q1FY19, there are tell-tale signs of stress in sectors such as agri inputs, building materials, cement, infrastructure capital goods, oil & gas and PSBs.

Agro chemical companies have been affected by delay in sowing in the ongoing kharif season. Cement companies are getting adversely impacted by rising RM costs, leading to a 20 per cent decline in operating profit/tonne. Construction and infra sector is facing execution and tendering issues despite healthy order books.

Overall, the Q1FY19 results are expected to be a mixed bag, with strong momentum expected in consumer-facing companies and those that are impacted positively by the improvement in global trade. We add one caveat that the rising RM costs and hardening of interest rates can start piercing the momentum with some lag. Moreover, the beneficial base of last year for the quarter will fade away in the coming quarters.