Sensex tumbles to 7-month low on earnings outlook

Sensex tumbles to 7-month low on earnings outlook

Mumbai: The benchmark Bombay Stock Exchange (BSE) Sensex tumbled to a seven-month low as worries over earnings downgrades in an unfavourable macroeconomic environment and lack of clarity on policy direction put the scare into foreign investors.

The Sensex slump comes as the S&P 500 closed at an 18-month high on Monday on expectations of improved economic growth and upward revisions in earnings estimates for US companies. The US index was up 0.2% at 1,321.12 as of 9pm IST on Tuesday. Most Asian indices fell but the decline in India was the sharpest in continuation of the decoupling trend, evident since the start of the year.

After pumping a record $28 billion (Rs 1.27 trillion today) into Indian equities in 2010, foreign institutional investors (FIIs) have pulled out roughly $1.5 billion this year, pulling the Sensex down 13.4% since the start of 2011 to close at 17,775.70 points on Tuesday.

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Even as valuations have started falling in line with historical averages, concern on earnings growth has grown. The Sensex currently trades at 14 times its forward earnings estimate of 1,250-1,260 per share, close to its average for the past five years. However, the expectation of a downgrade in estimates has forced analysts and fund managers to assume lower earnings growth, making valuations look more expensive.

Rising prices of commodities in global markets on the back of better global growth prospects and the tightening of monetary policy to curb rising inflation are expected to hurt profitability at Indian firms.

The consensus earnings per share (EPS) estimate for Sensex companies in fiscal 2012 could be revised downwards to 1,150-1,200, analysts say, indicating profit growth at 10-14%, sharply down from the earlier projection of 20%.

This coming amid talk of moderation in economic growth in the next fiscal is not good news for investors, despite gross domestic product numbers for fiscal 2011 being revised upwards to 8.6% on Monday.

“The consensus earnings estimate of 1,250 per share is likely to be corrected to 1,150-1,200," said Hong Kong-based Jason Todd, global head of equity strategy at Religare Capital Markets Ltd. Todd said potential downgrades to earnings growth have discouraged foreign investors at a time when developed markets are expected to see upgrades.

“To buy India, you either need valuation comfort, which is still not there, but could be there say at 13-14 times earnings, or you need positive triggers such as a fall in inflation numbers," Todd added.

Markets may already be factoring in downgrades as corporate earnings for the December quarter indicate that firms have not been able to pass on the entire burden of cost increases.

“Based on what we have seen in the December quarter earnings season so far, we maintain our view that the fiscal 2012 consensus earnings growth is too optimistic and downgrades have further to go," said Prabhat Awasthi and Nipun Prem, analysts at Nomura Financial Advisory and Securities (India) Pvt. Ltd in an 8 February note. “We stick to our cautious view on the market, despite the recent market declines."

The overarching takeaway from the earnings season has been the widespread margins pressure being witnessed across sectors, the note said.

This pessimism has been exacerbated by policy paralysis over the past few months that has delayed key projects, especially in the infrastructure sector, worrying investors as they can no longer take either growth or corporate profitability for granted.

“The market has not waited for analysts" to revise their earnings estimates, said Prasun Gajri, chief investment officer at HDFC Standard Life Insurance Co. Ltd, which has 24,790 crore of assets under management. Consensus estimates for Sensex companies’ EPS could drop to 1,200, Gajri said.

“Besides, delays in policy issues like clearances to key projects, especially in the infrastructure sector and issues surrounding land acquisition, could hurt growth," he added.

Stocks fell across sectors on Tuesday, but information technology (IT) shares, which have delivered positive surprises in their December earnings, were least affected. BSE’s IT index fell 0.1%.

Hero Honda Motors Ltd, the nation’s biggest motorcycle maker, declined to its lowest level in 15 months. Research costs will rise after a split with its Japanese partner, Bloomberg UTV reported on Tuesday, without saying where it got the information.

Analysts expect markets to remain volatile till there is more clarity on policy issues and inflation cools off.

“Markets have traded at a range between 12-21 times forward earnings in the past five years," said Sandeep Singal, co-head (institutional equities) at Emkay Global Financial Services Ltd.

“Even with a revised forward target of 1,200 and assuming 13 times forward earnings, 15,600 could be a likely bottom and it is a fairly attractive level for the Sensex," he said.

Graphic by Ahmed Raza Khan & Naveen Kumar Saini/Mint

Bloomberg and Ashwin Ramarathinam of Mint contributed to this story.