FY18 EARNINGS TO DECIDE TRAJECTORY OF EQUITIES

India has underperformed other emerging markets and is still among the 5 most expensive in the Asia-Pacific; earnings must catch up to justify the valuations

Starting this week, India Inc would again gear up for its busy quarterly earnings period. The question is if corporate India would match investor expectations. With the goods and services tax (GST) taking effect on July 1, the expectations are extremely toned down for the June quarter, the first (Q1) of financial year 2017-18. Analysts at Edelweiss expect a moderate 12 per cent revenue growth for 225 companies under its coverage, while net profit growth might dip by up to 2 per cent, on the back of a 262basis point decline in operating margins.

However, it is essential that at least these lowered targets are met, to keep India’s position among global equities, especially emerging markets. This is particularly important when foreign investors such as UBS, CLSA and Credit Suisse question if Indian equities justify their premium valuations, as earnings growth have remained elusive for over four years in a row.

In FY14, the Nifty companies were poised to post earnings per share (EPS) of ~441; the actuals were about ~386. The narrative was the same in FY15, FY16 and FY17. With earnings growth failing to meet expectations, the FY18 estimates have been cut. In Bloomberg polls, the FY18 EPS estimate is now ~523, from ~539 as on end-March. And, much lower than the initial expectation of ~740 at the start of FY15. The Street usually computes its estimates on a two-year forward basis.

The constant downgrade to earnings has nudged foreign brokerages to take a step back on Indian equities. In a recent report by Credit Suisse, co-authored by Sakti Siva, she mentions that India is part of the ‘expensive four’ among Asia-Pacific stocks and an underperformer on a year-to-date basis. Therefore, the brokerage reiterated its ‘underweight’ call on India, adding there could be continued downgrades to the calendar year 2017 EPS consensus as well.

Switzerland-based UBS was among the first to lower its ‘overweight’ rating on India to ‘neutral’, citing expensive market valuations. “On our models, India no longer looks so attractive, though much of this on the thematic side is down to the impact of demonetisation negatively impacting earnings in calendar 2018 versus this year's bounce-back,” the report says.

Adding: “Unfortunately, the valuation expansion in India has taken the country back to looking less attractive on our fundamental framework. We take it back to 'neutral' for now, though recognising that a big slowing in the rate of upgrades in the more cyclical parts of the region will inevitably draw attention back to India's better structural story.”

CLSA’s Mahesh Nandurkar makes a similar observation. “As against the historical average multiple of 14.7x, the Nifty currently trades at 17.8x, a 20 per cent premium and well above one standard deviation,” goes his report. “Our starting price-earnings versus 12month forward return analysis implies only low single-digit returns over the next 12 months and high probability of negative returns. The earnings growth trend also does not appear to be particularly attractive, with earnings revisions still happening on the downside. Hence, valuation comes up as a key investor concern in most investor interactions.”

For now, the Q1 expectations have been diluted, particularly for consumer-oriented sectors due to the massive de-stocking prior to introduction of the new indirect tax regime. The September quarter results might also be turbulent, as businesses could take a while to readjust. Also, says Vetri Subramanium, group president, UTI Mutual Fund, with the tax regime itself being complex, it is not possible to price in its impact on earnings at the moment.

Therefore, as the Street is not fully pricing in an earnings disruption, lower than anticipated EPS growth would be a drag on equities. With investors already casting doubt on Indian valuations, particularly those abroad, it is important for India Inc to meet its FY18 earnings target. Another year of failed earnings promise might not go down well.