The downward journey continues

Weak global commodity prices as well as domestic demand are hurting earnings

For six consecutive years, earnings estimates have been downgraded from the level projected at the start of the respective financial year. For the current one, for instance, Bloomberg data show the earning per share (EPS) of S&P BSE Sensex was projected at Rs 1,793.43 at the beginning of April 2015, but it now stands at Rs 1,439. Experts believe this trend of declining earnings estimates will continue for a couple of quarters.

Dipen Shah, Senior VP & Head of Private Client Group Research, Kotak Securities, says, "Two-three key factors are responsible for the consistent downgrade of earnings estimates. Firstly, due to the downtrend in the commodity cycle, commodity companies' earnings are being scaled down. Secondly, due to the longer-than-expected delay in economic recovery in India, domestic companies' earnings are also being downgraded."

Others share a similar view pointing to the pain across sectors. Nandan Chakraborty, MD-Institutional Equity Research at Axis Capital, says, "There is very little growth across most sectors; even credit growth has fallen. Since the banking sector accounts for 30 per cent of Nifty earnings, and their growth has halved, it is unlikely that we will see a pickup in earnings any time soon."

Muted corporate results, companies' lack of confidence in undertaking new capex due to weak global and local demand and delay in transmission of interest rates are factors holding back earnings recovery. These factors along with low commodity prices will continue to weigh on earnings growth in the near-term.

  The lowering of earnings estimates for FY16 have seen a similar cut in estimates for FY17 earnings. But, even at these levels, data indicate that earnings for FY17 will grow by 18.6 per cent year-on-year.

The little spike in actual earnings for the trailing 12 months seems to provide hope at first glance, but a large part of it is due to changes in the index. On December 21, 2015, Hindalco and Vedanta were replaced by Adani Ports and Asian Paints in the Sensex. But many experts still believe that earnings growth will, finally, pick up in FY17, pointing to indicators like automobile numbers, etc.

Shah says, "It is difficult to say when global commodity prices will see a bottom, but on the domestic front, sometime in FY17 we should see a recovery in earnings growth. The low base of FY16 should provide cushion in FY17."

IT companies, domestic infra investment-related themes, rural consumption (because the monsoon is expected to be better), and the financial sector should lead the recovery in earnings, he adds.

The gains from the Seventh Pay Commission and One Rank One Pension should also reflect in higher domestic growth in FY17, believe most experts, thereby boosting domestic consumption.

Ajay Bodke, CEO & Chief Portfolio Manager - PMS, Prabhudas Lilladher, who also believes that earnings will start looking up from Q1 of FY17, adds, "The government is contemplating 25 per cent increase in expenditure, on top of a 25 per cent increase this year. That should help revive the capex cycle. Investors can also look at capital goods companies from a three-year perspective. And, if the monsoon is normal, rural demand will also revive." He believes the March quarter should see signs of deceleration in earnings growth bottoming, and hopefully, by the first quarter of FY17, a recovery in the earnings cycle.

Chakraborty, too, expects the earnings pace to pick up in FY17, but adds a caveat. "We expect earnings to grow 18 per cent on the back of growth in the US followed by China, though any hard-landing in China will impact India significantly."

Whether all these expectations will materialise will only be clear as we approach the end of 2016. But, in the backdrop of uncertainty around global growth and events, experts believe investors should focus only on select domestic plays. What's also worrying is that the results of December 2015 quarter have little to inspire. In fact, quite a few of them are below expectations.

Says Deven Choksey, managing director, KR Choksey, "I will not invest in the Sensex, but in companies with good growing earnings. Companies in the auto sector, which will continue to show improvement because of margins, currency and volumes (rising discretionary spends, lower cost of credit), select private sector banks and NBFCs (due to focus on retail), should see 20-25 per cent CAGR in earnings." He believes, cement will also show distinct improvement in earnings because demand is increasing (volumes) and input costs are declining.

Similarly, conglomerates like Reliance (due to expanded capacities and launch of Jio), capital goods players like NPTC, PowerGrid and BHEL and pharma, led by Sun Pharma, should also post better earnings growth in FY17. The underlying message thus is to avoid looking at the index earnings, and focus on reasonably valued companies with high predictability of earnings growth.