Markets
Stocks have soared but where are the earnings upgrades?
Summary
Earnings were downgraded for most sectors, as analysts woke up to the reality of 2nd waveIndian firms kept their eye on the ball under difficult circumstances and posted decent earnings for fiscal 2021, largely because of massive cost rationalization efforts. Results were also helped by benign raw material prices, which kept operating margins in good stead. In Q4FY21, volumes also got a push from recovery in demand and a favourable base.
Profit after taxes (PAT) recorded 246% growth year-on-year in Q4FY21 for 112 companies tracked by Nomura Financial Advisory and Securities (India) Pvt. Ltd. On a two-year compound annual growth rate (CAGR) basis, PAT growth was healthy at 30.5% and net earnings were 10.6%, ahead of consensus estimates, said the Nomura report.
There were other themes that played out well during the year. Listed companies saw a shift in market share from cash-strapped unorganized firms. Also, cheaper cost of funds prompted companies across sectors to repair their balance sheets by deleveraging. Still, FY22 and FY23 earnings estimates indicate that the Street is not too gung ho on the growth trajectory.
“Since March 2021, for the Nifty universe, consensus earnings estimates for FY22/FY23 have been revised up by 3.6%/2.7%. This has been led by metals. Excluding metals, FY22/FY23 consensus earnings estimates for the Nifty universe have changed by -0.8%/0.4%," said the Nomura report. In other words, barring metal firms, earnings estimates have largely been flat for the rest of the market. An analysis by Motilal Oswal Financial Services Ltd shows that among the stocks it covers, there were 1.6 firms where earnings were downgraded by over 5%, for every firm where earnings were upgraded by over 5%.
With the Nifty 50 trading at a one-year forward valuation of more than 20 times, the lack of earnings upgrades is a matter of concern. “For India, the risks are from a combination of growth slippage, inflationary pressures, fiscal stress and policy change following covid. The market is trading at 20.5 times one-year-forward earnings, above the historical average of 16 times. Revival of earnings growth and lower cost of capital have supported market valuations. We expect market valuations to settle somewhat lower in the high teens," analysts at Nomura said.
Management commentaries, especially in cyclical and discretionary sectors, indicate that the Q1FY22 result season is likely to be a washout due to covid-led curbs. Firms expect demand uncertainty to remain in the first half of FY22.
Second, commodity costs have now turned from a tailwind to headwind as prices continue to inch up. The days of stellar margins may be behind for some sectors as input cost inflation would start reflecting in earnings in FY22, analysts cautioned. A further pressure on operating margins could come from employee costs and promotional expenses as business normalcy resumes. Many companies have passed on the burden of increased costs to consumers. However, the quantum of hikes may not be sufficient to prevent the erosion of margins.
Metals firms led the charge on earnings upgrades, with an increase of 60% in FY22 earnings estimates. However, earnings were downgraded for most sectors, as analysts and investors woke up to the reality of the second wave of the covid-19 pandemic. Metal companies benefitted from higher realizations because of demand revival and supply side constraints.
Meanwhile, an upside to earnings estimates could come from a sustained pick-up in the pace of vaccinations, analysts said. That said, the recently flagged risk of a potential third wave would be a dampener.
