Has the downward trend in corporate earnings revisions reversed?
Barring a few companies, corporate earnings in the December quarter either exceeded analysts’ expectations or were in line with them. But the jump in earnings was largely a function of a favourable base, because demonetisation had impacted businesses in the same quarter in the year-ago quarter.
The key question is: has the trend of downward revisions in corporate earnings been reversed?
Unfortunately, a look at the recent one-year forward consensus earnings per share (EPS) estimates for the Nifty shows a mixed picture.
The accompanying chart shows that earnings estimates for the Nifty were steadily revised upwards as the December quarter corporate results trickled in, but they started to fall right at the end of the results season.
Disappointment with the Union budget may well have been a factor. Even so, the Nifty EPS estimate is still higher than where it was before the quarterly earnings were announced, a welcome change from the trend of downward earnings revisions.
Unfortunately, recent events suggest that earnings may well be hit once again. Banks, especially state-owned ones, would be at the centre of this fading optimism following the recent developments in the sector.
In the December quarter, improved performance of other PSU banks was overshadowed by large losses in State Bank of India (SBI); similarly, a 30% decline in net profit at ICICI Bank Ltd offsets increases among private banks and non-banking financial companies (NBFCs). The Reserve Bank of India’s revised framework on bad loans would mean a prolonged non-performing asset cycle, higher provisioning burden and slower private sector capital expenditure cycle. And what further dents Street confidence about the sector is the scam at Punjab National Bank. It is also entirely possible that these developments in the banking sector may affect credit flow to other parts of the economy as well, in particular to the gems and jewellery sector, as bankers turn extra-cautious.
The Q3 earnings review report by brokerage Motilal Oswal says: “We have cut our FY18E Nifty EPS by 3.2% to INR471, and FY19E EPS by 0.6% to INR595. Almost 1.7% cut in Nifty EPS comes from SBI.” It adds that uncertainty pertaining to credit losses for PSU and private corporate banks continues to pose risks to their estimates.
On the other hand, fast-moving consumer goods (FMCG) firm Hindustan Unilever Ltd’s earnings suggesting a gradual recovery in consumer sentiment was encouraging; but weak realizations in the cement sector—a proxy for capex growth—signals that investment demand may remain muted. Also, demand in consumer discretionary sector like paints is yet to bounce back to pre-GST levels. GST stands for Goods and Services Tax (GST).
So what does all this mean for valuations?
For long, the Street has been ignoring dismal earnings growth and continues to trade at rich valuations. For the valuations to be justified, overall earnings have to turn around.
What’s more, the kind of earnings growth is also important. “Notwithstanding the usual issues regarding the quantum of earnings growth, the quality of earnings growth is also quite poor with 60% of the incremental profits of the Nifty-50 Index for FY19 coming from sectors such as PSU banks, metals and mining, oil and gas and utilities, which should logically trade at low multiples,” Kotak Institutional Equities said in a report dated 15 February.
The broking house further added that market valuations could be under pressure if GST revenues were to fail to pick up over the next few months and if oil prices were to move up to around $70/barrel, adding to the nervousness of the bond market. Note that, although Nifty earnings estimates are now higher than they were at the beginning of the year, so are bond yields.