Vijay Kumar Gaba: Corporate Earnings

Friday, November 22, 2019

My take on popular market narratives

I find the following four narratives are presently dominating the financial market research in India:

(1) Slowing economic growth

India's economic growth hit a six-year low of 5% in 1QFY20. The consensus estimates indicate that the growth may further slip even to below 5% in 2QFY20. Some estimates are forecasting that the 2QFY20 GDP growth, to be announced next week, may be closer to 4% rather than 5%. The full year growth number, after accounting for base effect and recovery in 2HFY20, are also expected to remain closer to 5% rather than 6%.

The slowdown in economic growth is widespread, encompassing all the segments and sectors of the economy. Agriculture, industry and services have all slowed down. Investment and consumption demand is multiyear low; and so are savings, investments and credit growth.

The financial research is adequately capturing the slowdown since August when 1QFY20 GDP growth numbers were announced. However there are still differences about the future outlook. A significant section of the market appears convinced that the slowdown shall bottom out in 2HFY20 and a sustained recovery may be seen from FY21. On the other hand, many economists still have doubts about the FY21 recovery. This section appears convinced that road to recovery is bumpy and to regain a 7% growth trajectory, India would require many structural reforms over next 2-3yrs.

In my view, based on my interactions with various stakeholders, any meaningful recovery in the economy may not begin before 2QFY21, and FY21 growth will be closer to 6% rather than 7%. Unless of course the government changes the denominator by making FY18 as the base years.

(2) Divergence in economic growth and equity prices

While the economic growth is sliding to multiyear low, the benchmark equity indices are trading close to all time high levels. This divergence of economy and equity prices is a popular topic of discussion amongst various market participants.

I have no view on this issue. Nonetheless I would like to highlight the following two small points:

(i) The total market capitalization of stocks listed at NSE was Rs15.2trn in January 2018. Almost two years later, it was at the same level yesterday.

(ii) The nominal GDP of India grew 24% during two year period FY17-FY19. The market capitalization of NSE grew by the same percentage from April 2017 to March 2019.

So the argument that equity prices are outpacing GDP growth may not be entirely true. It is the skew in the market cap that is perhaps the cause of intrigue for research analysts.

(3) Fiscal challenges

The consistent decline in household savings and rise in household debt; poor GST collections; and rise in social sector spending and urgent need for the fiscal stimulus has made the task of fiscal balancing very challenging. It is therefore a subject of intense debate how the government will be able to manage to increase the public spending to stimulate the economic growth. Large scale disinvestment, release of RBI reserves and perhaps new avenues of taxation (estate duty etc.) are some of the ideas being discussed.

In my view, higher effective of taxation seems inevitable, even if the government is able to execute its ambitious disinvestment program. However, I am not overly worried about fiscal deficit number, so long the government is transparent about the accounts (deferred subsidies, withheld refunds and suppliers' payments, direct borrowing by NHAI and Railways etc. and revenue earned through book entries, e.g., through PSU buyback, inter se sale of PSU stakes etc.)

(4) Earnings revival

The 2QFY20 corporate earnings have been mostly in line with already moderated estimates. The tax cut announced in August did help to some extent. However, the corporate commentary has remained downbeat and does not inspire much confidence for earnings revival in the coming quarters. The common theme therefore is that we may likely see further moderation in the earnings estimates for FY21 and even FY22.

There are few analysts who believe that earnings revival is imminent, but majority does not appear to be concurring with that. Earnings growth is therefore mostly a contrarian idea.

In my view, the earning revival will be very stock specific. Active investment may therefore be a better idea in FY20.

Tuesday, October 15, 2019

2QFY20 - Muted expectations

The latest results season has started on a somber note. Both the IT bell weather TCS and Infosys have highlighted the challenges persisting in the operating environment. Though the 2QFY20 saw divergent performance for both the leading companies, the guidance for near future underlined the growth challenges.

The quarterly performance has to be evaluated with the backdrop of already muted expectations and earnings downgrades post 1QFY20 results.

Some key points of 2QFY20 results forecast by brokerages could be summarized as follows:

Expect profit before tax (PBT) for the KIE coverage universe to decline by 4.6% yoy in 2QFY20, led by a yoy decline in PBT in the following sectors: (1) automobiles (lower sales volumes and margin compression due to increase in discounts), (2) metals & mining (sluggish demand, weak realizations and volumes on a yoy basis), (3) oil, gas & consumable fuels (dragged by decline in volume growth for Coal India and lower net crude realizations for ONGC) and (4) telecommunication services (seasonal weakness).
Expect strong yoy growth in PBT for several sectors: (1) banks (led by Axis Bank, ICICI Bank and SBI) (2) construction materials (yoy improvement in profitability but deterioration on a sequential basis), (3) diversified financials (steady operating performance aided by a decline in the marginal cost of funds for large players) and (4) pharmaceuticals (strong quarter for the domestic formulation segment).
Expect PBT of the BSE 30 Index to decline by 1.4% yoy and that of Nifty-50 Index to decline by 4.4% yoy.

Note that 2QFY20 net profit/earnings numbers are not comparable with 1QFY20 and 2QFY19 numbers given (1) lower corporate tax rate for several companies for 2QFY20/FY2020 (announced on September 20, 2019) and (2) resultant tax reversals pertaining to higher taxes paid in 1QFY20 in 2QFY20 tax numbers, which will ‘inflate’ 2QFY20 net profits/earnings. (Kotak Institutional Equities' Research)

"The second-quarter earnings-report season will be more of the same – tepid and uneventful. Underlying demand slowdown in the domestic economy and weak global commodities prices are expected to take a toll on earnings with very few bright spots, if any. However, it is important to look at this quarter’s numbers from a PBT perspective, as the reduction in the corporate tax rate cuts will result in several adjustments in this quarter’s tax numbers."

Our FY20 Nifty EPS estimate has been cut by 3.8% to INR539 (prior: INR560). We now build in EPS growth of 12% for FY20. Ex-corporate banks, we expect 3% profit growth for the Nifty in FY20.

The reduction in the corporate tax rate has brought some cheer to earnings, but for FY20, it has been more than offset by sharp cuts in Autos and significant adjustments of deferred taxes for large corporate banks. The silver lining to this somber backdrop is that the festive season demand has begun on a positive note. (Motilal Oswal Securities).

In 2QFY20, the first quarter after the cut to corporate tax rates, for the 164 companies under our coverage we expect a profit growth of c.5.4% YoY, revenue growth of (-0.6%) YoY and EBITDA growth of 0.9% YoY. Excl. financials, we expect an PAT growth of (-3.5%) YoY while excl. corporate banks (SBI, PNB, BoB, Axis, ICICI and Yes) the growth is expected to be c.1.0% YoY. Excl. financials, profitability is expected to decline with overall EBITDA margin contraction of c.26bps YoY driven by metals and auto and auto ancs companies. For the Nifty50, EPS is likely to grow by c.3.7% YoY aided by strong growth in financials even as telecom and consumer discretionary remain a drag (exhibit B). Financials, healthcare and consumer staples are likely to be the main driver of earnings growth thereby offseting the weakness in other sectors.
From the consideration set, financials, cement and chemicals are expected to be the major sectors with highest profit growth YoY in 2QFY20 while auto & auto ancs and metals are likely to witness the highest decline in PAT.
In terms of profitability, cement, pvt. Banks and NBFCs could witness the highest expansion in operating margin YoY while that of metals, utilities and auto & auto ancs are expected to have the highest decline. (JM Financial)
Top-line deceleration to continue: Across Emkay coverage universe, our team expects growth trends to weaken further from Q1 levels, with the decline led by Auto, Telecom Power, IT services and Pharma sectors. On a positive note, Cement (positive pricing trends yoy), Engineering/Cap goods and Media/Entertainment (subscription and multiplex footfalls growth) could see an acceleration in top-line growth trends.

Softer commodity prices should help margins of input-cost dependent sectors: Cement, FMCG, Durables, etc. Strong GRMs/marketing mix should lift margins for refiners/OMCs. However, margins should decline for Auto (low volumes) and Pharma (step up in R&D investments).

Many companies for which the path to move to the new tax regime is clear cut should be making the move in Q2 itself. In fact, some companies may report some write-backs of excess taxes paid in Q1, leading to a lower than 25% ETR. Overall PAT growth for Emkay universe should be flat ~-1% (up from -4% for Q1FY20). PAT growth should be led by Cement, BFSI and FMCG, while sharp PAT declines are likely for Auto and Mining sectors.

H1FY20 Nifty PAT growth should come in at -5% yoy vs. 15% yoy growth expected for the Nifty for FY20 – implying room for cuts in the Nifty earnings estimates.

Watch out for early signs of greenshoots. However, we also highlight some greenshoots that could be seen across sectors during Q2, setting up stage for longer-term positive trends: Auto sales decline could be nearing the bottom and commodity pricing trends are expected to support margins across sectors. (Emkay Global Research)