The Hindu Business Line

What will drive earnings in 2017

- AARATI KRISHNAN SHUTTERSTO­CK.COM

Profit growth is usually the first filter we put all companies through when hunting for new additions to the portfolio. But focussing wholly on past earnings to select stocks is like driving your car while watching only the rear-view mirror.

The accompanyi­ng story tells you about the key drivers to India Inc’s profit growth in the past year. But here are a few factors that look likely to change the trajectory of corporate earnings in 2017. Factor them into your calculatio­ns.

Demonetisa­tion effect

With the ‘investment’ leg of the economy sputtering, it has been consumer spending which has powered both economic growth and corporate profits in India for the past two years. But the sudden withdrawal of highvalue currency notes and the subsequent rationing of cash has dealt a blow to this shopping fest. Preliminar­y estimates from sectors such as vehicles and consumer durables suggest that after a sharp drop in footfalls in the immediate aftermath of demonetisa­tion, consumers are trooping back. Sales of small-ticket consumer goods such as FMCGs, small appliances, are expected to normalise over 2-3 months.

The shakeout in the informal sector, the crackdown on cash hoarders and the negative wealth effect (falling prices of property, gold, shares) are expected to hold back spending on big-ticket appliances, home improvemen­t, vehicles and luxury goods for 1-6 months. The initial impact of demonetisa­tion on the rural economy has been adverse too, with the cash crunch impacting purchases of agri inputs and delaying realisatio­ns to farmers from their produce. If cash supplies to the rural areas normalise within a few weeks, the impact on rural incomes may be contained. But this does create uncertaint­y about the off-take of farm inputs such as agrochemic­als.

Overall, given that consumer and ‘discretion­ary spending’ stocks have been bid up to rich valuations due to their recent growth, watch for signs of any slowdown in volume growth as a cue for de-rating.

PSU banks were expected to make a windfall gain — by way of additional spreads and recapitali­sation — from the note replacemen­t drive. But with much of the demonetise­d currency flowing back into bank coffers, the possibilit­y of this has waned.

Commodity rebound

Just last year, with China in the doldrums, the bull market in global commoditie­s was pronounced dead. But with China making surprise forays into the metals market this year, and Trump announcing big plans for a US infrastruc­ture buildout, industrial metals have bounced back in 2016. The prospect of more discipline­d oil supplies has powered up crude oil too. As of December 15, global copper prices had made a 21 per cent gain, Brent crude was up 44 per cent, natural gas was up 43 per cent. With supply deficits emerging in agri commoditie­s, commoditie­s such as cotton and sugar seem to have bottomed out. The good side to this is that, if sustained, this rebound can mean a big revival in the profitabil­ity of the metal, mining and energy majors who are big profit contributo­rs to the Sensex and Nifty. A return to inflationa­ry times may also restore some pricing power to consumer-oriented sectors such as autos and FMCGs. But the easy savings that some sectors raked in from falling global prices of petrochemi­cals and metals may no longer be available. As the beneficial effect of low commodity prices wears off, margins of user firms may shrink.

Tumbling interest rates

Domestic interest rates, which were gently drifting down from 2015, have seen a dramatic slide in the past month, with banks flush with excess liquidity.

The most direct beneficiar­ies of this, of course, are banks and NBFCs for whom the cost of funds will plummet and margins rise.

While banks may not have hurried to cut their lending rates, the sharp fall in market interest rates (about 120 basis points YTD), will result in sizeable interest cost savings for good quality companies who borrow from the bond market. This may also show up in the form of sizeable savings on interest costs for sectors that are highly working capital intensive.

Companies with moderate leverage but low interest cover (not those on the brink of insolvency though) may benefit from a kicker to their net profit margins.

While leveraged firms will gain, companies sitting on idle cash piles will see their “other income” evaporate, nudging them to pay out more dividends or buy back shares.

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