Markets
Margins to make or break corporate earnings in FY25
Summary
- Stocks of Indian companies are trading at a premium to those of their Asian peers, and they will have to deliver earnings growth to justify their high valuations. That’s easier said than done, though, with waning margin tailwinds and persistent weakness in demand.
India Inc’s December-quarter (Q3FY24) earnings were a mixed bag. A key highlight was improved corporate profitability, driven by easing commodity prices, but demand momentum was muted. Going ahead, there are several moving parts to the earnings-growth picture, both local and global. Potential negative developments could lead to disappointments in FY25, triggering more downgrades.
First, margin improvements from softening input costs are abating as global oil prices stabilise. “The Ebitda margins of most sectors (excluding oil & gas) are likely close to decadal highs in FY24E. While the consensus is forecasting further margin expansion for most sectors, we think this could be difficult to achieve unless demand improves or there is a supply-side tailwind from oil prices," said Prateek Parekh, vice president, institutional equities, Nuvama Wealth Management.
The margin strength seen in the nine months to December suggests the implied asking rate to meet FY24’s earnings per share (EPS) estimates is low. The weak exit and fading margin tailwinds pose risks to the 15% consensus FY25 EPS growth estimate for Nifty50 companies, Parekh added.
Weak demand also persists. Uneven rainfall and elevated inflation have kept rural consumption subdued. While an election-led improvement in rural incomes and a potential increase in minimum support prices could boost demand, any such boost could be short-lived. Nonetheless, this should aid sales growth of consumer staples and discretionary companies in Q4FY24 and Q1FY25. After all, now that support from lower commodity prices is set to wane, earnings growth in FY25 needs to be volume-led to meet or beat the market’s expectations.
But it is better to keep hopes of earnings growth in check as challenges abound. “Earnings growth is expected to moderate across most sectors over the next two years versus FY24, owing to a high base," said a Nomura Financial Advisory and Securities (India) report dated 23 February.
The market expects the Nifty 100 index to record 28.4% earnings growth in FY24E, aided by strong profits in the oil and gas sector and financials. For FY25E and FY26E, earnings growth expectations are modest at 12.1% and 13.3% year-on-year, respectively, said the report. A slowdown in economic growth and higher commodity prices are key risks to the market's current earnings estimates, Nomura cautioned.
Further, the improvement in performance must be broad-based to avoid a situation in which a handful of sectors compensate for the weak growth of others. This was seen in Q3FY24. An analysis by Motilal Oswal Financial Services showed that Nifty 500 companies reported earnings growth of 25% year-on-year in Q3FY24, but this growth was largely fuelled by the banking, financial services and insurance (BFSI) and automobile sectors.
Meanwhile, it is widely expected that the outcome of 2024 general elections in May will be favourable for the market. For now, there seems to be a low probability of political discontinuity. But once the model code of conduct is implemented, jitters in the form of lower order inflows and subdued volume offtake could be felt at companies in the infrastructure sector, weighing on Q4FY24 and Q1FY25 earnings.
Apart from this, a pronounced slowdown in the US could prevent a revenue revival at Indian IT companies. Any further escalation in tensions in the Red Sea region and resulting disruptions in supply chains could stall earnings growth momentum as operating costs take a hit. Meanwhile, the MSCI India index is trading at a one-year forward price-to-earnings multiple of over 20 times, according to Bloomberg data, a steep premium to those of its Asian peers. Companies will have to deliver earnings growth to justify this expensive valuation.
