12-month trailing price earning of Sensex has fallen 25 per cent in 9 months.
Since November, the Sensex has declined 20 per cent. At the same time, the trailing12-month price-to-earning (P/E) of the 30-share index has slipped 25 per cent. Analysts, however, expect earnings downgrade to continue, leading to another correction.
Harendra Kumar, head (research), Elara Capital says, “We expect another 5-7 per cent earnings downgrade in the second quarter to price in the worst of the interest rate increase and demand slowdown, which will be felt the most in the second quarter.”
For growth projections, analysts generally look at the forward P/E multiples. According to Elara Capital, the BSE-benchmark Sensex EPS (earnings per share) for 2011-12 is seen at Rs 1,250 and P/E multiple around 14x. With another five-seven per cent downgrade in the September quarter, the EPS could slip further to Rs 1,180 for 2011-12.
The Sensex 12-month trailing P/E has already been de-rated since it has fallen from 24x in November to 18.3x currently, which is a long-term average. There could be a further P/E de-rating if the Sensex were to correct another 1,000-1,500 points due to local or global events, said analysts.
According to BS Research Bureau, the year-on-year net profit growth for Sensex companies in the June quarter was 21 per cent and net sales growth was reported at 27 per cent. The operating profit margins contracted the most, by 60 bps to 31.4 per cent, from 32 per cent seen during the same period last year. In the past few quarters, there has been valuation de-rating and margin contraction, but volume growth has remained intact.
“Going forward, demand pressures may come to the fore during the September and December quarters. High inflation and increasing cost of capital may moderate demand for commercial vehicles and capital equipments,” said Nilesh Shah, MD & CEO from Envision Capital. Analysts expect earnings growth expectations to get toned down further to 10 per cent from 15 per cent currently.
While, commodities like oil have eased, it is impossible to say with conviction that the decline in crude prices would be sustained because of the high speculation element. The Brent crude September futures fell to a low of $102.5 per barrel in the second week of August, but have rebounded thereafter to $110/bbl. The impact of high raw material costs would continue through the September quarter, said Ajay Parmar, head of research and institutional equities, Emkay Global Financial Services.
The earnings downgrade is also factoring in slowdown in growth projections, from 8.6 per cent to 8 per cent for 2011-12, according to the Centre for Monitoring Indian Economy Private Ltd and a slow recovery in the West. On Thursday morning, Morgan Stanley further reduced 2011-12 growth target from 7.8 per cent to 7.4 per cent, citing demand slowdown. They also cut year-end Sensex target by 15 per cent to 18,850 levels.
There were expectations in the Street that the Reserve Bank of India might increase interest rates by another 25 bps in the September policy, as inflation remained stubbornly high, at 9.2 per cent in July. Analysts said highly-leveraged shares from banking, and infrastructure sectors, and even commodity-related shares from oil & gas and metal sectors were likely to see further earnings downgrade.
Parmar expects 15,300 levels; at around 11-12x 2011-12 P/E to be the likely bottom for the markets. He adds investors should be cautious and not put fresh money into the market, as stocks could be available at much lower prices in the near future, if markets correct.
