Pandemic fatigue is aiding earnings recovery

Pandemic fatigue is real; it’s spreading and aiding recovery in corporate earnings. Pent-up demand ahead of the festive season and continued cost rationalization aided volumes and margins in the September quarter. From the third quarter onward, pandemic fatigue is seen as a key trigger for earnings revival.

“We expect revenue uptick to be faster than expected, given the improvement in overall macros as covid impact is phasing out and pandemic fatigue is setting in,” said Amit Shah, head of India equity research at BNP Paribas.

According to the World Health Organization, many countries have been reporting an increase in pandemic fatigue—where people feel demotivated about following recommended behaviours to protect themselves and others from the virus. Further, news on the vaccine front is also resulting in some people letting their guard down.

An analysis by rating agency Crisil Ltd showed pandemic fatigue is catching up in India. “Overall, the indicator shows retail mobility improved sharply in September in some major states in the east and south, and Maharashtra. In September, despite caseloads rising, mobility improved as curbs eased, recovery rates improved, and there was pandemic fatigue,” it said in a report on 11 November.

In a world still battling covid, there has been a raging debate on whether lives are more important than livelihoods. For Indians, the latter seems to have gained prominence. “In India, given the sharp hit to incomes, employment and the economy at large, livelihood choice appears to have prevailed,” Crisil said.

The increased mobility is also reflected in an improvement in high-frequency indicators such as the purchasing managers’ index (PMI)—October manufacturing PMI pointed to the most robust output growth in a decade. This, coupled with the festive season, should result in a continuation of the earnings recovery.

“One key theme in September quarter earnings was that improvement was faster-than-anticipated. Among large-cap companies, more than 60% have surprised on the key earnings parameter. Margins saw expansion continue to be aided by cost savings. From here on, the focus of the Street will shift from margins to revenue growth,” said Shah.

On the flip side, of course, a lowering of guard on precautionary measures could well translate into a second wave of coronavirus. However, even in that scenario, analysts don’t see the possibility of another national lockdown. They feel authorities are now in a better position to handle a fresh spike in infections, especially given that recovery rates have been relatively better.

But with revenues gradually treading back towards normalcy, investors should note that some costs would also come back. In simple terms, cost savings-led operating margin expansion would be a thing of the past. “We expect some of the benefits of cost savings to reflect in the December quarter. However, we will see margin-normalization from March quarter. Downward pressure is likely from rising commodity prices. But more than that, we see staff costs making a comeback as firms are reinstating salaries and bonus—and that is good for economic recovery,” said Arshad Perwez, vice president at JM Financial Institutional Securities Ltd.

Advertisement and promotional costs are slated to rise as well. Management commentaries of FMCG firms Hindustan Unilever Ltd and Dabur India Ltd indicate they would loosen their purse strings to promote new launches. Note that ad-spends form a large part of the overall cost structure.

Even so, analysts expect the recovery in revenues to drive earnings growth. Goldman Sachs sees further gains in the Nifty to be driven by earnings growth. In a 11 November report, it said, as the economy recovers from the pandemic-induced contraction, we expect corporate profits to rebound 27% next year and a further 21% in 2022. It expects corporate profits to drop 11%in 2020.

But high expectations could lead to disappointments. Considering covid is not entirely out of the way, there can be hurdles to economic recovery. Although Nomura has raised its Nifty target to 13,640, nearly 7% upside from the current level, it is wary of the widely held positive view around earnings revival.

“Consensus is now factoring in a 20% earnings CAGR over FY20-23 against a 7% CAGR over FY15-19. There are potential risks to current earnings estimates, mainly a slower-than-expected revival in economic growth and the adverse impact of a rise in commodity prices. Based on bottom-up analysis, we are factoring in 4-5% risk to current consensus estimates for FY22/FY23,” Nomura said in a 11 November report. CAGR is short for compounded annual growth rate.