The wait gets longer!
Weak underlying demand delaying earnings recovery
More of the same; 2QFY20 earnings to be tepid and uneventful
* It has been a year since the IL&FS crisis erupted and the repercussions of the same are still being felt, especially in Financials. Besides NBFCs, banks too have started facing asset quality concerns now. Underlying economic momentum has decelerated sharply, as reflected in 1QFY20 real GDP growth of 5% and the RBI’s latest downward revision in the FY20 GDP growth forecast to 6.1% (from 6.9%). Thus, earnings downgrades have remained a key feature of Corporate India.
* The government and the RBI have been taking steps to revive growth. The central bank has cut the repo rate by 135bp since Feb’19 (although the transmission is still very limited), while the government has taken the historic step of a big corporate tax rate cut and also other measures for specific sectors. Fiscal and monetary stimulus are trying to work in tandem to boost growth, the impact of which will be visible only with a lag. High frequency data and our team’s interactions with managements spanning sectors suggest that the 2019 corporate earnings will be a washout and any normalcy will only return in 2020.
* The second-quarter earnings-report season will be more of the same – tepid and uneventful. Underlying demand slowdown in the domestic economy and weak global commodities prices are expected to take a toll on earnings with very few bright spots, if any. However, it is important to look at this quarter’s numbers from a PBT perspective, as the reduction in the corporate tax rate cuts will result in several adjustments in this quarter’s tax numbers (e.g. large corporate banks will make deferred tax adjustments).
* We expect MOFSL Universe’s PBT to grow 2% YoY but PAT to decline 6% YoY, dragged by Automobiles and Metals. The difference between PBT and PAT is exaggerated because of the deferred tax adjustments in Financials. ExFinancials, we expect MOFSL Universe’s PBT/PAT to decline 14%/8% YoY. Private Banks, Consumer, Cement and Capital Goods, however, will provide some respite. Our FY20 Nifty EPS estimate has been cut by 3.8% to INR539 (prior: INR560). We now build in EPS growth of 12% for FY20. Ex-corporate banks, we expect 3% profit growth for the Nifty in FY20.
* Markets have remained weak in 2QFY20, despite the sharp bounce back post tax cut. Nifty’s divergence with the broader markets has expanded significantly, as discussed in detail in our recent note. Earnings risks continue to be tilted to the downside on account of the underlying weak demand scenario in the domestic economy, the uneven asset quality trends in financials and the deflationary trends in commodity prices. At this point, tax rate cuts will largely limit the downgrades rather than driving big upgrades on the earnings front.
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