Will an earnings recovery elude us in fiscal 2019 too?
The recently concluded June quarter earnings were rather dismal, considering that the expectations bar was set so low. After the last quarter, we had said that a slew of factors including the transition to the goods and services tax (GST) and the after-effects of demonetisation would make fiscal year 2018 (FY18) a forgettable year for earnings revival.
Are broking houses confident about FY19 earnings though? Will we finally see the earnings revival, or are further downgrades in store?
As it turns out, after the discouraging first quarter performance, faith on this front is on shaky ground. Kotak Institutional Equities sums it up: “We have limited confidence in our FY2019E estimates given (1) little evidence of a strong turnaround in the economy, which can drive volume growth and (2) high margin and profitability assumptions in several sectors, which may be at risk.” Note that Kotak projects a very strong recovery in earnings in FY19 after flat net profits in FY18 for the Nifty 50 index.
Confidence in a FY19 recovery remains low, given the current underlying operating metrics of various sectors, wrote analysts from Motilal Oswal Securities Ltd in their results review on 18 August.
Cast your eyes on the chart above. Average Bloomberg estimates for the Nifty earnings per share for FY19 have declined by 4% so far this fiscal year. Individually, ICICI Securities Ltd, Edelweiss Research Ltd and IDFC Securities Ltd among others have trimmed their FY19 earnings estimates.
One reason why FY19 numbers look lower is because of the earnings cut for FY18, but that is not the only reason. Ongoing slowdown in industrial activity and subdued credit offtake dampen hopes of a revival. In the quarters ahead, earnings growth may bounce back aided by the low-base effect of demonetization and restocking after GST transition, but the question is whether that will sustain.
Suhas Harinarayanan, managing director (Institutional Equity Research) at JM Financial Institutional Securities Ltd, shares similar concerns. “The second half of this financial year will be critical given that most companies have guided that they should be back to normal (pre-GST levels) by September/ October. However, if the second half doesn’t pan out as expected, there will be another round of earnings cut towards the end of the financial year 2018,” he said over the phone.
The onus of faster earnings recovery is also on the pace of overall economic growth, which slid to 5.7% in the June quarter, the slowest in three years, largely hit by GST-led disruption and demonetization. If the economy fails to recover quickly from the temporary disruption arising from the aforementioned factors, Kotak Institutional Equities does not rule out further earnings downgrades.
“Government expenditure can support GDP growth up to a point. We do not rule out an extended slowdown in consumption, hiring and investment in the informal economy if it is unable to cope with the changes arising from GST and resultant formalization of the economy,” the broking firm said in a report on 15 August.
India’s report card on earnings downgrades is nothing to write home about. India stands out as the country with highest one-year forward earnings downgrade at ~8% so far in FY18 among global peers, informs ICICI Securities. Here’s what it said: “Ironically, India has been one of the best performing emerging market (8% FYTD) during the same period which further validates our thesis that investor focus has shifted from near-term worries to longer term optimism while continued institutional flows support equity markets.”
Clearly, the dichotomy between valuations and earnings growth is likely to remain for some time—the former driven by liquidity, the latter by reality.