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Questions over earnings growth amid market rally

LiveMint logoLiveMint 06-08-2017 Nasrin Sultana

Mumbai: Though Indian markets continue to touch record highs, a recovery in corporate earnings remains elusive. The steady downward revision in earnings per share (EPS) estimates of companies continues. 

Data from Bloomberg shows Sensex companies’ consensus earnings per share forecast for the current fiscal has been pared by 6.76% since April; for fiscal year 2018-19, it has been cut by 2.9%. 

That clearly shows that the current rally—which has seen the benchmark gauges climb close to 22% since the beginning of 2017—is not being supported by fundamentals. The Sensex is trading at 20.15 times estimated earnings for the current fiscal year. 

To be sure, sell-side analysts have mostly been optimistic about earnings performance at the beginning of the fiscal, for the past five years at least, before cutting them as new data points emerge. For instance, in fiscal 2016, earnings estimates for the Sensex had been pared by 3.6% by the end of the first half; for fiscal 2015, it was a sharper 12.3%. 

“Unforeseen events like higher-than-expected bank provisioning and demonetization which had major impact on earnings were not factored in by analysts in their forecasts,” said Dhiraj Sachdev, senior vice-president and fund manager, equities, at HSBC Global Asset Management. Others say that current signs indicate a late earnings recovery rather than more downgrades. 

“Investors are expecting that improving macroeconomic data should translate into uptick in corporate investment and hence would lead to earnings growth. However, there are structural issues which are causes for delay in corporate earnings growth,” said Sanjeev Zarbade, vice-president of private client group research at Kotak Securities. 

The reason for the earnings downgrade for fiscal 2018 is pretty straightforward. The goods and services tax (GST) transition has hit sales in the first quarter. Early trends show that both sales and profits in the first quarter suffered due to destocking and heavy discounts offered ahead of GST implementation from 1 July. According to database provider Capitaline, June-quarter profits and sales of 221 BSE-listed companies (excluding banks, financial services and energy firms) after adjustment for one-time items, was the lowest in at least 14 quarters for which comparable figures were available. Net sales of these firms rose 2.57% in the three months ended 30 June from a year earlier, while adjusted net profit fell 3.64%, the first drop in more than three years. 

These poor earnings have made markets look expensive after the 5% rise in prices last month, said JM Financial in a 2 August note. “Given the expensive multiples based on elevated growth expectations, we believe there is little margin of safety even as short-term momentum remains strong,” the note said. 

In comparison to the Sensex’s high price-earnings multiple, MSCI Emerging Markets Index trades at 12.87 times times. Still others argue that, although high, it is not reasonable to call valuations stretched. “Though the valuations are high, they are far from January 2008 level valuations. The market capitalization to gross domestic product (GDP) ratio reached 170% in 2008, while today it is just 108%. We are not unduly worried at these levels. There is sufficiently good headroom for further appreciation,” said Arun Thukral, managing director and chief executive of Axis Securities.

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