Green shoots, at long last
One swallow does not a summer make, but what about two? Aggregate earnings estimates of the Nifty index have risen for the second consecutive quarter, after several quarters of downgrades in earnings estimates. This supports the Street’s excitement about a recovery in earnings growth.
“December quarter results have provided further evidence of steady recovery in the Indian economy and increased confidence about FY19 earnings with no major downgrades during the quarter,” analysts led by Sanjeev Prasad, managing director and co-head of Kotak Institutional Equities, said in a note to clients.
Of course, while the recovery in earnings is well established, the fact also remains that valuations are rich. “The recent small correction in the market notwithstanding, valuations of the Indian market are still quite stiff; the Nifty-50 Index trades at 17.9 times estimated FY19 earnings on a free-float basis,” Prasad wrote in the 15 February note. Since then, the Nifty index has corrected marginally.
The concern about valuations aside, the December quarter results included a number of positives. For instance, volume growth was strong in a number of industries, although some of this was on account of the low base a year ago, thanks to demonetisation.
Credit growth picked up, and auto and cement volumes grew at a decent pace. What’s more, order inflows at capital goods firms picked up pace as well, although some of this appears to be owing to a backlog from previous quarters.
Overall credit growth rose 9%, aided by a sharp rise in retail loans; credit to industry rose by only 2%. Data collated by Kotak show credit growth at private sector banks under its coverage rose 22.3% year-on-year (y-o-y) in the December quarter, up from 17% in the September quarter. Credit growth at public sector banks under its coverage rose 3.8% last quarter, up from 1.2% in Q2.
Volume growth picked up sharply at nearly all consumer goods firms, although, as pointed earlier, this was aided by a low base effect. “Most of the consumer staple categories reported a double-digit growth in volumes. Discretionary categories and stocks in certain discretionary segments showed strong momentum in 3QFY18, too, following a strong y-o-y performance in 2QFY18,” Kotak’s analysts pointed out. What’s more, the growth in volumes led to an improvement in operating profit margins as well.
Cement volumes grew at a fast pace, too, helped by the government’s support for affordable housing and to the infrastructure sector. However, profit margins fell owing to the double whammy of lower realizations and rising costs. Automobile sales were strong across segments, with commercial vehicle volume growth of over 40% for both Tata Motors Ltd and Ashok Leyland Ltd.
Order inflows at six large industrial and construction firms nearly doubled on a y-o-y basis, although this should be taken with some doses of salt. “Order inflows played catch-up as backlog of previous quarters started to flow. As such, the strong order inflows in 3QFY18 have to be seen in the context of a weak 1HFY18 due to GST-led disruption and, hence, mark an exceptional quarter and may be difficult to extrapolate,” Kotak’s analysts wrote.
While things seem to be looking up overall, a moot question is what price is appropriate for the growth that Indian firms are experiencing. Kotak is estimating a 25.6% growth in Nifty earnings in the next fiscal. Considering that the price-to-earnings ratio is less than 18 times, valuations may seem alright. But Prasad warns that a large chunk (~60%) of this earnings growth is coming from sectors such as PSU banks, metals and mining, oil and gas and utilities, which should logically trade at low PE multiples. In addition, there may be bumps ahead for investors if GST collections fall short of expectations and if oil prices continue to rise, leading to higher costs for Indian firms.
So, while a pick-up in growth is a given, stocks seem to have already priced this to perfection.
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