Vijay Kumar Gaba

The latest earnings season has started on a very buoyant note, led by some IT companies. In line with the high speed macro indicators, most brokerages have upgraded their earnings estimates in past one month. The present estimates are building in a very strong earnings recovery over FY22-FY23. The estimates for the current year FY21 have also been upgraded sharply from a contraction of 5% to 12% to a growth of 5% to 12%. Currently, the market is estimating an earnings growth of 24% to 38% in FY22 and another 18% to 22% growth in FY23.

It is important to note that these estimates assume GDP growth of -7% to -7.5% in FY21; 9% to10% in FY22 and 4 to 5.5% in FY23; interest rate bottoming in FY21 and elevated inflation of 5 to 6% over FY22 and FY23.

This implies less than 3% CAGR of GDP over three year period of FY20-FY23. Whereas, the present estimates imply ~19% CAGR in Nifty EPS over FY20-FY23. Apparently, there is disconnect between the macro forecast and earnings forecast. In past two decades at least, there is no precedence of such strong earnings growth with a dismal economic growth.

Furthermore, the estimates assume a strong recovery in earnings of financials and materials, from a very low base. Just to give a sense, Kotak Institutional Research estimates 473% (yoy) growth in Banks PAT and 860% rise in Metal’s PAT in Q3FY21. Construction Material (86%) is the third fastest growth forecasted. These three sectors probably have the strongest correlation with the macroeconomic growth and stability. Next 9months may be a case of low base effect, but with 3% economic growth, higher interest and inflation, it is tough to fathom these sector continue clocking sustainable high growth.

So in all likelihood the earnings estimates for FY22 and FY23 will fall in due course, as has been the case historically. Credit Suisse highlighted in one of their December report that EPS estimates fall 10 to35% from the level that is first estimated.

In my view, therefore, it would not be advisable to consider aggregate earnings as a key factor for investment decision. Better would be focus on the companies where sustainable earning growth visibility is very high. Of course these stocks will also fall in case of a broader market correction, but the chances of their bounce back would be much higher.

I shall therefore remain agnostic to sectors and size of companies. I would rather focus on individual companies for investment. Sustainability of growth would be my key consideration in selecting the company.

The precipitous fall in 1QFY21 GDP has attracted attention of most people. The economic managers of the government have sought to pass 23.9% yoy contraction in real GDP as an exceptional event which is direct outcome of the global lockdown due to outbreak of COVID-19 pandemic.

Indubitably, the contraction is a non recurring event and may not be a trend beyond FY21. Nonetheless, adjusted for lockdown also, the current slowdown does not appear be entirely cyclical. It certainly has some element of structural weakness in the economy.

I have highlighted this issue earlier also. In my view, the fall in nominal GDP is more worrisome than the real GDP. This fall has been more consistent and sharp in past 7 years. The nominal GDP growth rate has almost halved during FYFY13 and FY20.

For common man nominal GDP is more important because lot of variables like effective taxation, budgetary allocations for development and social welfare, subsidies, salaries of public servants, etc are calculated as a factor of the nominal GDP. Lower nominal GDp essentially means, lower income for people and lower tax revenue for the government.

For example, the sharper fall in nominal GDP has resulted in sharper rise in effective rate of indirect taxes; which impacts the common people more, resulting in increase in income inequality and social injustice.

Moreover, the public expenditure which has been supporting the GDP for past few years, will be constrained due to lower nominal GDP and therefore lower tax revenue. For key parameters of fiscal health, e.g., government borrowing, fiscal deficit etc., also nominal GDP is the denominator. A lower denominator would make fiscal health look weak even if deficit and borrowings remain the same in absolute terms.

Some other pointers to the non cyclicality of the GDP slowdown could be listed as follows:

• Sales of commercial vehicle recorded negative growth in most of the previous 6 quarters. It continues to remain negative.

• Cargo and passengers handled at Airports recorded negative growth even in the 1QFY20.

• Manufactured product inflation has been below 2% for most of previous 6 quarters. This highlights lack of pricing power with the manufacturers. When juxtaposed with persistently low capacity utilization, it indicates that the pricing power may not return anytime soon and nominal GDP growth rate may continue to slide.

• Even after 22years of NELP, we have not been able to significantly ramp up the local production of crude oil and natural gas. Even the coal imports have not seen any meaningful reduction.