Quarterly preview: Markets to see sustainable earnings growth after years

It would be interesting to decipher how the sequential numbers pan out as the impact due to GST would be behind us

As a new year beckons upon us and as we reflect nonchalantly over the stupendous returns that the markets have delivered in the year gone by, it is time to introspect and reflect upon what the markets can deliver in the quarters to come.

There is a silent anticipation and an inbuilt optimism about earnings recovery, which is expected to start taking shape beginning this quarter. This is expected to pave the way for a sustainable earnings growth that has been eluding the markets over the past few years. Albeit, when one compares this quarter’s numbers against last year’s numbers, the obvious assumption of a low base due to the ripple effects caused by demonetisation (last year working in favour of the reported numbers) shall be evident - both - on an absolute and relative basis. 

What would be interesting to decipher, however, is how the sequential numbers pan out as the impact of destocking/stocking due to GST would largely be behind us and the core ingredients of volume led growth pointing to a recovery in discretionary led demand, an important facet to be observed. 

The earning season in its midst shall witness the Union budget and the allocations that the Exchequer does on social schemes, rural allocations, planned capital expenditure on various infrastructure projects (Roads, Railways, power, Affordable housing, Rural welfare, Inland waterways) shall have profound implications for a few sectors associated directly/indirectly with these activities. A key indicator of a well rounded economic growth also hinges on the revival of the private capex cycle. And though many agree that the resurgence might take a few more quarters, some green shoots are visible with few steel companies declaring expansion plans which bodes well for our macro-economic indicators. 

I, shall attempt to enumerate in a terse manner the expectations that are getting laid out for a few sectors:

IT: Though the sector in general gets impacted due to furloughs/Holiday season, the broad expectations of a stable QoQ Dollar revenue growth with no drastic movement witnessed in cross currencies shall ensure that there is no material impact on margins. The aspect that needs to be watched in the management commentaries of various IT companies would be the spending patterns by US Corporates in the BFSI, Retail and Telecom vertical; the momentum around the digital investments that the companies have incurred and the scale of transformation deal wins that the companies might report. Utilization levels and keeping attrition levels at average levels would also be among the key things that need to be monitored. Generally, the commentaries should be good and present a better picture for FY18.

Financial Services:  The large private retail lending banks should continue posting robust growth while the corporate private banking side can continue witnessing higher provisioning though the aggressive mandated recognition over the past few quarters should have the intensity of asset quality pain to recede. Public sector Banks on the other hand should continue witnessing slower credit growth and though reported GNPA numbers would be stable, the hit on the AFS book due to sharp rise in Bond yields, MCLR cuts and ageing related/additional provisioning for NCLT cases would have a marginal impact on NIM’s and spreads, NBFC’ s should selectively witness reasonable growth. As a large part of the universe is moving towards the 90 day bucket window the additional provisioning and higher reported NPA’s should continue. However, better managed firms with strong capital adequacy ratios can continue posting balance sheet growth. The cost of borrowing with yields moving up can impact spreads but since a large universe of NBFC’s have various sources of borrowing, including NCD’s, etc. the impact should be marginal. In general commentaries around credit recovery should be better for FY18,

Pharma: The reported revenues for the sector as a whole should be flattish. However, the continued dual impact of pricing pressures in the US along with higher remedial/remediation costs should negatively impact both the EBIDTA and the bottom-line. What needs to be observed apart from resolution of FDA affected companies is the complex pipeline worked out by pharma companies especially with the heavy R&D expenditure incurred in creating a viable ANDA pipeline. FY18 should be an equally daunting challenge for the universe at large though a significant portion of earnings downgrades have already been priced in the stock prices, which certainly paves the way for selective stock picking with a medium to the long term contrarian investment objective.

Metals: The entire universe had a good run; ferrous, non-ferrous, convertors etc. With the clampdown by the Chinese authorities still continuing the production and supply cuts witnessed can continue over the medium term which is a testimony of the inventory/realization levels on the LME. Also new capacities sprouting up in China selectively have higher labour/electricity costs which reduces the arbitrage that they enjoyed compared to the emerging counterparts. The numbers in this quarter shall also have an element of elevated input costs as iron ore prices/coking coal price inflation shall constrain the margin expansion, though the pass-through of cost in net realization should be evident along with decent volume growth. This will create the necessary operating leverage that the companies across the value chain shall continue to enjoy for the better part of FY18.

Cement: The sector is coming out of a traditional weak Q2 which is marred by monsoons reducing off-take from varied end user industries. The sector has witnessed tremendous cost upheavals with sand mining issues, higher coal and ore costs, pet coke issues which caused flutters in the operating style of most companies and freight/logistics costs which remained on the higher side. The push through of costs in tranches, utilization levels still remaining around that 70-75% mark, demand is picking up gradually. Consolidation in the industry and the impact of the e-way implementation are all the factors to be watched out closely. However, the reported numbers should be reasonable and with expectations of a Government push on affordable housing/infrastructure the consensus of volume and price led demand recovery over the next few quarters should bode well for the dynamics of the industry as a whole. We selectively remain very constructive on the sector over the long term.

Auto: The monthly reported numbers are looking decent, especially coming out of a strong restocking quarter post implementation of GST and the fervour of the holiday season playing positively on the volumes of the auto companies whether two, four or commercial wheelers. Though there might be an element of discounting in this quarter the general consensus of volume growth remaining robust is very much on the anvil for FY18. Though the discussions surrounding the EV impact would be something that the managements of auto companies would be hounded upon, the repercussions related to that would be some time away both in terms of a serious capital allocation by auto companies and the need for the infrastructure spending to support this from the government side. Auto ancillaries should selectively report decent numbers as good demand is reflected both from the OEM’s as well as the replacement market. In general auto companies should report healthy volume growth and the stability in margins should reflect positively on their bottom-lines.

In general, this quarter should reflect a reasonable earnings growth and this should pave the way for a sustainable earnings recovery. Individually, some stocks within all the afore-mentioned sectors might be outliers and some might disappoint. Hence, the premise of picking stocks selectively keeping in mind valuations and the earnings outlook would reflect positively on the stock prices in the future. As I end this note, a small wish to all investors in having a healthy, wealthy and prosperous 2018. Mayuresh Joshi is a Fund Manager at Angel Broking Pvt Ltd. The views expressed are personal.