The June quarter results are not matching up to investors’ expectations. That’s the message from a recent report by Citigroup Inc. Among the companies covered by Citigroup, around 50 firms (excluding energy sector companies) have already reported results. Only 14 of these have surprised on the upside, while as many as 24 have disappointed, says the report. Results in nine out of the 14 sectors covered fell short of expectations, with only the banking industry meaningfully outperforming.
Excluding Reliance Industries Ltd, oil companies and banks, profit of the companies covered by Citigroup has increased by just 6% year-on-year, against an expectation of 14%. Note that this is compared to a relatively low base in the previous year, when the pick-up in the Indian economy was still gathering steam. As Citigroup notes rather ominously, “Is this just an earnings miss, or is something more fundamental amiss, particularly given a significant low base effect?”
Also See Muted Results (Graphic)
Analysts have already started revising their earnings estimates downward. The Citigroup report points out that their estimate of earnings growth for 2010-11 is now 20.8%, down from 27.36% a month ago.
Though that hasn’t yet been reflected in a sell-off, investors should be concerned. After all, expectations from the current earnings season were running rather high, supporting the high valuation of the Indian market. As on 30 June, the MSCI India index had outperformed the MSCI emerging markets index by 9.7% in terms of year-till-date returns. This was on the back of an outperformance of 15% in 2009. With valuations at a premium compared with emerging market peers, the only factor that could drive stocks was better-than-expected earnings growth.
Already, the disappointment in earnings is taking a toll on the relative valuation of the Indian market. In July, the MSCI India index has underperformed the MSCI emerging market by as much as 7%. True, both the MSCI India index and the Nifty have risen by around 1% in July. But the MSCI emerging market index and the MSCI emerging market Asia indices have risen by much more—8% and 5%, respectively. If the trend of disappointing results continues, the Indian markets could take a further beating. After all, on a year-to-date basis, they continue to outperform their emerging market peers in terms of returns, albeit a much lower rate of 2%.
Why the earnings disappointment? Citigroup notes that sales growth has been robust at 21%, but that margins have been vulnerable. The easing of commodity prices could mitigate margin pressure for Indian companies. But the flip side is that this would impact the profit growth of companies that rely on commodity prices. These companies drove profit growth in the June quarter and an impact on their profitability would largely offset the raw material cost savings of other firms. The Citigroup report poses the unsettling question: “Earnings growth expectations are on a slide….will the market follow?”
Graphic by Yogesh Kumar/Mint
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