With the June quarter profits coming in well below expectations, earnings estimates for FY18 are being trimmed with almost every sector having seen a downgrade. Given how the demand for a host of goods and services remains dull and industry could take time to adjust to the new indirect tax regime, rolled out on July 1, industrial growth is likely to be sluggish and remain a drag on the GDP.
The growth in the GDP for Q1FY18 is pegged at around 6.6-6.7 per cent compared with 6.1 per cent in Q4FY17, which had been impacted by demonetisation. The second part of the Economic Survey released recently noted growth for
FY18 could come in closer to the lower end of the band of 6.75-7.5 per cent.
Net profits for the Nifty set of companies fell around 11 per cent year-on-year in Q1FY18, disappointing the Street.
“Consensus Nifty FY18 EPS growth now stands at 11 per cent year-on-year and we continue to believe over the next two quarters this may fall to single digits,” Credit Suisse wrote.
Profits for FY18 are now expected to grow by just about1.5-2 per cent, according to Kotak Institutional Equities, following the earnings downgrades in several sectors such as banks, metals & mining and pharmaceuticals. “We do not rule out further downgrades if the economy fails to recover quickly from the temporary disruption arising from demonetisation and the implementation of GST,” the brokerage noted. It added that government expenditure can support GDP growth up to a point. Deutsche Bank observes that profits for Nifty in Q1FY18 fell sharper than its estimates of a 6 per cent decline, thanks to subdued domestic growth, an appreciating rupee and the GST hiccup.
“We have revised our Nifty EPS estimate downward for FY18 by 2.6 per cent to Rs 484,” analysts at Motilal Oswal wrote pointing out that H2FY18 has the benefit of a low base on account of demonetisation-related disruption in H2FY17. The brokerage believes that provisions for loan losses at state-owned banks could be higher than anticipated and that sectors such as commercial vehicles would fare poorly. They also forecast more cuts to companies in the healthcare, cement and consumer staples sectors.
More important, while the quality of earnings as measured by the return on equity (RoE) is approximately 200 basis point below the 10-year average, at around 16 per cent for FY18, the markets are trading at a 20 per cent premium to long-term averages. Also, corporate leverage is elevated and the ability to repay loans remains relatively poor. According to Credit Suisse, the aggregate interest cover was down to a low of 2.1X at the end of March 2017 with the weak companies becoming weaker.