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Kotak Institutional Equities expects net profits of the BSE-30 index to grow 6.3 per cent over a year in the March quarter, which is unlikely to be received well by the market. Earnings downgrades are on the way, not only for FY15 but also FY16, proving a negative for the broader markets. Stock picking will become increasingly important for investors, as several sectors are going to struggle to grow profits in the coming year, as economic recovery has been pushed back. Although Indian stock markets have fallen six per cent from the all-time intra-day high of 30,025 on March 4, led by concern on the US Federal Reserve’s moves and a delay in earnings pick-up, Indian equities are still expensive.
This, in the context of the uncertainties staring at Indian markets, makes the risk-reward ratio less favourable. Saurabh Mukherjea, chief executive of Institutional Equities at Ambit Capital, says: “The government has focused on structural reforms, which has impacted economic growth. We expect growth estimates will be cut, as will earnings, which won't be higher than in FY15. Major downgrades are expected in the next few weeks. Anyone who expects earnings to grow by 20 per cent is living in a fantasy land.”
Though many experts believe the markets are in a consolidation mode, which way they will move in the near term depends on earnings and liquidity. Earnings are the biggest risk to the market, as a revival has been pushed back to the September quarter. Also, earnings estimates are more likely to be scaled down. This means share prices will have to come down or the valuations will look dearer. In either case, not good news.
Ahead
Dhananjay Sinha, co-head of institutional research at Emkay Global, says: “Investors should always be focusing on high earnings growth companies. There could be high volatility in the markets and earnings are not panning out the expected way. So, there will be adjustments in PE (price to earnings) multiples (valuations), as the evolving situation warrants an earnings cut for FY15 and FY16.”
He says annual earnings growth has been eight to 10 per cent in the past five years, and this year (FY15) would see about five per cent, as against market expectations of 15 per cent. So, we will first see earnings being downgraded. In this context, it is also early to talk of how earnings will pan out in FY17 or even FY16.
As growth has been stymied because of the government's tight spending in recent quarters, demand has collapsed. The March one is typically a good quarter for cement and steel consumption, as construction activity tends to pick up but cement is expected to surprise negatively this time. Two-wheeler demand is cracking, too. The usual suspects —information technology (IT), pharmaceuticals and select banks — will drive earnings growth in Q4 of FY15 and FY16.
As the hope rally is headed for a large dose of reality, the flight to safety has begun. Stocks that have run ahead of fundamentals on hope of a revival will correct sharply. The sectors to watch are mainly cyclicals and industrials, unlikely to see their fortunes change. The performance of cement, construction and infrastructure stocks need to be watched closely in the quarter.
Among sectors that might feel the pinch are fast moving consumer goods and consumer stocks, especially the ones with rural focus, as income growth and, hence, demand in rural India are expected to taper. Part-rural plays in the automobile space will also bear the brunt and are expected to under-perform. Likewise, companies from the capital goods space will under-perform, as the investment cycle is yet to pick up. However, those in the EPC (engineering, procurement and construction) businesses, more particularly in the roads segment, with a reasonably strong balance sheet should do well, given the pick-up in order flows. Likewise, export-oriented companies from the IT services and pharma sectors will continue to do well.
Market mind
Says Mehraboon Irani, head of the private client group business at Nirmal Bang Securities: “The only factor the market looks forward to is corporate earnings. Now, it is going down in the minds of markets that earnings are not going to improve in the next two to three quarters. What has happened is that analysts, after elections last year, projected a sharp recovery in earnings. Whether things improve in FY15-16 or in FY16-17 is under question. So, valuations have risen ahead of the earnings. The consensus view is that the March quarter numbers will also not be good.”
Among other things, Irani says the market is looking at passing of important legislation by Parliament. “Third is the dollar strength. Fourth is the US interest rate cut, which I think will not happen in 2015. With not many positive triggers and some negative triggers, the markets are likely to correct,” he says.
While the jury is out over when the US Fed will take its first step on rates, certainty over a delayed pick-up in earnings is slowly sinking in. That could trigger a sell-off or at least lead to under-performance of stocks riding the hope rally.
Hence, investors would be wise in being selective while picking stocks. The fact that the markets are sensing many stocks have run up without reason can also be seen in the unwinding across counters. A large number are quoting at prices below the levels in September last year, says Irani.
“So, it is more important to focus on stocks with high earnings growth and reasonable valuations. That’s also one reason why many such stocks are getting expensive,” says Irani. he adds that even as the Nifty will be higher a year down the line, there will be stocks that will be lower than today’s. That would apply to half the market.
