Long-awaited earnings recovery just got pushed back further
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Just as corporate India started to look beyond demonetisation, the introduction of the goods and services tax (GST) has once again dashed the hopes of a long-awaited earnings recovery.
Ambiguity on rules and the urgency to comply with the new tax law triggered a supply-chain disruption during the June quarter.
Sectors focused on domestic consumption, such as fast-moving consumer goods, autos and consumer discretionary, were key casualties.
While transiting to the new tax regime, manufacturers limited production to clear existing inventory with hefty discounts. In that process, they also doled out incentives to those involved in the trade channel to compensate for GST transition losses. That is why corporate earnings growth for the first quarter of FY18 is likely to be largely about subdued revenue growth, eroding margins and muted guidance, analysts said.
“Nifty companies are estimated to report top line, Ebitda and profit after tax growth of 10%, -5% and -2% year-on-year (y-o-y), respectively. Margins of Nifty firms are estimated to decline 280 basis points (bps) y-o-y,” an Edelweiss Securities Ltd report said. One basis point is one-hundredth of a percentage point. Ebitda, or earnings before interest, taxes, depreciation and amortization, is a measure of profitability.
But GST is not the only party pooper. There are other crosses, too, which the corporate sector had to bear in the June quarter.
For instance, exchange rate dynamics are expected to weigh on earnings of export-oriented sectors such as information technology (IT) and pharmaceuticals. “Rupee has appreciated 3.5% against USD and will impact Ebit margins by 50-to-90 bps after considering cross-currency tailwinds,” a Kotak Institutional Equities (KIE) report said. Visa costs and wage revisions would also impact margins of technology firms. EBIT stands for earnings before interest and tax. It should be noted that June is a seasonally strong quarter for IT firms.
Ahead of GST’s implementation, there were reports of destocking in the pharma sector, too, but analysts also see pressure on margins coming from increasing research and development (R&D) costs and lack of meaningful launches in the US.
For telecom firms, increased competition would hamper earnings growth. Oil marketing firms may see weaker profitability dented by lower refining margins and inventory losses due to falling crude prices. Also, muted private sector capex, coupled with low capacity utilization, would keep performance of the industrial sector subdued.
Not to forget, surging commodity prices have kept input costs across sectors elevated.
On the bright side, a handful of surprises is expected from the financial sector, especially private banks. “We see public banks reporting lower slippages q-o-q (quarter on quarter), but high provisions will continue, with likely support from treasury gains. NBFCs (non-banking financial companies) could report strong performance as the operating environment has improved from demonetisation-related stress,” the KIE report added.
The market, however, seems to be unfazed by weak earnings. Since financials have higher weightage in the Nifty, the benchmark index could further head northwards. But a rising index may not necessarily indicate all is hunky-dory. In fact, average Bloomberg estimates for the Nifty EPS (earnings per share) for FY18 and FY19 have been declining from the start of this fiscal (see chart). This means analysts are not confident about what lies ahead. They fear one quarter of dismal earnings would weigh on overall FY18 Nifty earnings. “The base effect for y-o-y earnings growth comparisons is likely to stay adverse for another quarter, which increases the risk to existing y-o-y consensus earnings forecasts of 22% for FY18,” Abhay Laijawala of Deutsche Bank said in a report.
So, don’t be surprised if brokerages start revising FY18 earnings estimates lower.
In a nutshell, given the ongoing confusion about GST’s impact on businesses and no clear signs of private capex revival, an earnings recovery in FY18 looks like a lost cause.