Earnings upgrades? They look distant

With companies continuing under pressure due to declining sales growth, the much-sought-after earnings upgrade cycle is some time away.

Sensex companies (excluding financials) reported their worst quarter in the last three years with operating margins coming in at a 10-quarter low of 16.9%, while net sales growth at 12.1% was the lowest in the last 12 quarters.

With sales falling faster than the decline in costs, operating profit declined 1.4%. The net profit for all 30 pivotals, however, increased 5.4% on a year-on-year basis.

The second-quarter earnings have beaten estimates marginally on tempered expectations, believe experts.

“The quarterly results have been in line with expectations. Though the revenue growth has fallen to multi-quarter lows as expected, the moderation in input costs and lower forex losses in the last quarter has meant that bottom line growth has been a tad ahead,” said Ajay Bodke, head, investment strategy & advisory, at Prabhudas Lilladher.

The quality of earnings was quite poor, believes the Street, with other income being a large contributor and cash flows being quite weak in several companies.

“Net profit did beat our estimates but largely due to higher other income in a few cases and a large one-off in the case of NTPC. The Sensex Ebidta was 3.3% lower than our expectations,” wrote Sanjeev Prasad, Akhilesh Tilotia and Sunita Baldawa, analysts at Kotak Institutional Equities, in a note last Thursday.

A DNA analysis shows other income for Sensex companies (ex-financials) ballooned 49.6% on-year.
The results season saw no major change in the earnings estimates with breadth of surprises evenly balanced, say experts.

“Since the beginning of second quarter reporting season, consensus earnings estimates for the broad market (MSCI India) have been reduced by about 1% for FY13E. Earnings estimates were increased only for health care, energy and consumer staples sectors. The breadth of earnings revisions for the MSCI India was mixed with 34 companies with EPS upgrades and 38 downgrades for FY13E, but 38 upgrades and 34 cuts for FY14 estimates,” wrote Bharat Iyer Bijay Kumar, Gunjan Prithyani and Adrian Mowat, analysts at JP Morgan, also on Thursday.

Sanjeev Prasad of Kotak believes the second-quarter results provide no evidence of earning upgrades.

“The extent and nature of reforms is open to debate but we highlight that composition of India’s earnings precludes any meaningful increase in earnings of the broad market on domestic factors alone. This is because global-linked, government-controlled companies and regulated sectors account for 57% of fiscal 2013 net profits of the Sensex companies. We rule out meaningful earnings upgrades without strong global economic recovery and favourable policy framework for coal and energy sectors,” he said.

Prasad further believes that reforms may not necessarily translate into strong GDP growth given the myriad problems facing the Indian economy like slowing consumption, declining investment and weak external account.

Bodke, too, doesn’t see earning upgrades cycle to pick pace over the next two quarters at least as he believes that there are multiple headwinds both on the global and domestic front.

“The recent bombing of 2G spectrum auctions and no progress on divestment programme for PSUs has meant that there’s very high probability of government overshooting its fiscal deficit target. This may prompt them to go for extra borrowing which in turn would mean that pace and extent of rate cuts over next six months would be less than expected earlier,” he said.

Kotak Institutional Equities has revised the forecast for earnings growth for fiscal 2013 downwards from 7.5% at the start of earnings season to 5.8%, while cutting the net profit growth for fiscal 2014 from 12.2% to 11.1%.

The brokerage’s current estimates for BSE-30 earnings per share stand at Rs1,192 and Rs1,335 for fiscal 2013 and fiscal 2014, respectively.