Last week may have bought some relief to the markets just as the state elections drew to a close. Early-bird results from the behemoths reveal improved performances, a tick ahead of the Street’s expectations. But the incumbent Bharatiya Janata Party’s struggle to hold its seat-count in the recent state elections seem to be upping the markets cautiousness.
Nevertheless, the second-quarter results exude optimism. The Street had already factored in the cut in corporate tax, and some positive takeaways have arisen due to lower costs. Operating performances have improved thanks to lower input costs. The cut in corporate tax has given a slight fillip to net profit, aided by some reversals in the higher provisions regarding corporate tax in the first quarter. “Q2 FY20 results so far have been better than anticipated, with companies surprising the markets regarding gross margins and taxes, muddied by reversals of higher taxes paid in Q1 FY20," said Kotak Institutional Equities in a note to clients.
Net profits of the NSE-50 companies which have announced results so far show a decent 2.1% rise in net profit in Q2 above consensus estimates. A somewhat similar increase in net profit, of about 1.8% over the market consensus, can be seen for BSE Sensex companies. Also, surprisingly, the year-on-year growth so far in net profit has been about 9.8%, upbeat to say the least. (See chart: On the ball)
On the policy front, though, expectations are running high. The incumbent party’s recent struggle in the state elections could undermine these better-than-expected results as investors will focus on how the government revives demand. “We believe that the drubbing in the state elections may partly reflect broader economic disenchantment with the government on the growth front. The BJP’s under-performance in rural constituencies is reminiscent of the struggle it has been facing in multiple state elections since 2018, where adverse terms of trade have dented rural incomes," said Nomura Financial Advisory and Securities in a note to clients.
That said, as the model code of conduct has been lifted, the government can now pursue demand revival measures to lift sentiments in the economy. However, the markets are factoring in some of these reform measures as the valuations, at least for the frontline companies, seem to be quite expensive.
“A weaker-than-expected performance by the BJP in the recent state elections may possibly spur the government to focus on demand-revival and/or structural reforms. However, the market is already expecting a fiscal stimulus to consumption in the form of GST/individual income tax rate cuts," notes Kotak.
Kotak further notes that large-cap stocks are already trading at higher than fair-valuations, which may cap Nifty’s gains.