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Markets yet to factor in a protracted downturn

Markets yet to factor in a protracted downturn
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First Published: Tue, Jul 08 2008. 10 51 PM IST
Updated: Tue, Jul 08 2008. 10 51 PM IST
The corporate results season is around the corner.
Earnings growth has been braking very rapidly with that for Sensex components excluding oil firms slowing from a scorching 48.8% during the third quarter of fiscal 2007 to 11.8% during the fourth quarter of fiscal 2008.
Simply put, the rate of growth of earnings is now a quarter of what it used to be at its peak a year and a half ago.
The macro data also show a slowdown, albeit a far less dramatic one. For instance, while it is true manufacturing has not dropped off a cliff, growth was at 7.5% in April compared with 12.4% a year ago, a considerable deceleration. The Index of Industrial Production was up 7% in April, again considerably below the 11.3% growth it notched up a year ago. These macro numbers are more closely correlated to growth in corporate sales than in earnings.
As a matter of fact, sales growth has not dropped sharply the way earnings growth has: For the Sensex companies, ex-oil, sales growth fell from 33.6% in the third quarter of fiscal 2007 to a low of 15.5% in the second quarter of fiscal 2008 and 23.8% during the fourth quarter.
Unlike the continuous and sharp decline in earnings growth, sales growth has shown a less steep decline and has rebounded from its lows.
Margin pressures
The obvious reason for the disparity is pressure on margins. That squeeze is also brought out by the data on inflation. Most of the rise in inflation has occurred on account of substantially higher prices for primary products, minerals and, even within the manufactured products space, for basic metals and alloys. Final goods prices have not increased to the same extent. But, we’re unlikely to see any marked change in the first quarter numbers—a Citigroup Inc. research note forecasts earnings growth at 10.7% for ex-oil Sensex companies, not too far below the previous quarter’s 11.8% growth.
In any case, monetary policy acts with a lag, so the effect of the Reserve Bank of India’s tightening of monetary policy is likely to be felt 12-18 months down the line. The impact of the deterioration in the government’s finances will also be felt later, probably when a new government comes to power and is handed the keys to an empty treasury. And, at the micro level, many companies ride out the initial months of a downturn relatively well, thanks to funds raised earlier.
Long-term trouble
However, longer-term trends are not reassuring.
India, unlike most Asian countries, runs a current account deficit and its currency is dependent to a large extent on short-term capital inflows.
In an environment where the dollar is depreciating and oil priced in dollars becomes more expensive, a lower rupee adds to import costs and inflation. Also, the credit crunch has affected us through risk aversion, which has sparked a wave of selling by foreign investors.
India, paradoxically, is getting hit by the aftermath of both the credit crunch as well as by the steps taken by the US Federal Reserve to protect the credit markets by lowering interest rates, which has cheapened the dollar and sent the price of oil skyrocketing.
Temporary problem?
The snag, as a fund manager points out, is that while nobody expects first quarter earnings to be great, most people in the market continue to believe that the problems we’re seeing are temporary and that earnings growth will go back up within the next few quarters.
With consensus earnings per share (EPS) estimates of Sensex components, according to Bloomberg, at Rs986 for fiscal 2009 and Rs1,182 for fiscal 2010, growth is expected to be around 17% this fiscal year and 20% in the next. But, as Religare’s Amitabh Chakraborty points out, according to his estimates, Sensex earnings will grow by around 10.7% in the first quarter of fiscal 2008, which means earnings will have to grow at 16.5% or so in the subsequent quarters to arrive at a 15% growth rate this fiscal year. That, he says, is unlikely and he’s revising his target for Sensex companies’ combined EPS down to between Rs940 and Rs950.
Downward revisions
These cuts in estimates are likely to continue. For instance, a Citigroup analysis points out that consensus earnings growth estimate for the Indian market for fiscal 2009 has corrected from 21.1% in January to 16% by June. Nor is this trend confined to India—for Asia ex-Japan, earnings per share growth for this year, which was estimated at 11.5% in January, had been revised to 6.7% by June. The problem is that, according to Citigroup, “2008 forecasts are still running at 6.7%. Over the last 30 years, each global downturn has seen EPS growth declines of between 30% and 50%. To assume rising earnings seems totally unrealistic.”
As a fund manager put it, the situation is exactly the opposite of what happened during fiscal 2004, at the beginning of the upturn. At that time, analysts acknowledged that earnings growth was improving, but expected a quick return to a lower trend. Analysts are prone to extrapolating numbers from the recent past, rather than consider that there may have been a fundamental change in the cycle.
The markets are yet to factor in a protracted slowdown.
(Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at capitalaccount@livemint.com)
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First Published: Tue, Jul 08 2008. 10 51 PM IST