With tepid sales growth and good earnings expectations, the obvious conclusion is that earnings growth will probably be driven by margin expansion
The macro numbers are closely related to revenue growth at companies and it’s no surprise then that analysts expect sales growth to be somewhat tempered.
The earnings season for the December quarter has started with Infosys Ltd. declaring its results last Friday. What do the markets expect? What should investors look out for in company earnings?
The macro numbers for the quarter haven’t been good. The Index of Industrial Production (IIP) declined in October and November. The composite purchasing managers’ index (PMI), that includes both manufacturing and services activity, also showed contraction throughout the quarter.
The macro numbers are closely related to revenue growth at companies and it’s no surprise then that analysts expect sales growth to be somewhat tempered. Even the muted growth is largely on account of the weak rupee and the weak base of the year ago quarter. Volume growth should be closely watched.
Still, in terms of profit growth, the December quarter is likely to be the best in several, says the consensus. Citigroup Global Markets, for instance, estimates that earnings growth for the Sensex firms (excluding oil firms) will jump 18.5%, the most in thirteen quarters.
With tepid sales growth and good earnings expectations, the obvious conclusion is that earnings growth will probably be driven by margin expansion. Bank of America-Merrill Lynch estimates that operating margins for Sensex firms will widen by 1.35 percentage points from a year ago. This improvement in margins will be driven by a weak rupee and softer demand for some raw materials. The rupee, while it recovered, was still some 15% down from a year ago in the December quarter.
Which sectors will benefit? The weak rupee will skew growth towards the currency sensitive and export dependent sectors. It is the reason why sales growth is still above 10% year-on-year, says Nomura. The brokerage also points out that the bulk of margin expansion will be contributed by industries such as technology, pharmaceuticals and automobiles. According to Motilal Oswal, Nifty firms that earn a bulk of their revenues in dollars will see a net profit growth of 29% compared to flat profit for other firms.
The upshot is that earnings growth is not going to be broad-based. Growth is likely to be led by sectors with global exposure such as metals, technology and pharma. Citigroup estimates that these industries will account for 90% of the quarter’s growth. Other industries such as metals and telecom will gain from a low base.
Not only will this round of earnings not signal a turnaround, it is also unlikely to cause investors to change their defensive stance from industries such as pharmaceuticals to cyclical sectors. The forecasts for cements, capital goods, real estate and financials all show a decline in profit growth. In any case, investment activity doesn’t seem to have revived in the economy and order inflows should be studied for signs of a pick-up.
What to watch out for in industry-wise earnings and management commentary:
Auto:
The impact of the strong US dollar should be seen in the margins of Tata Motors Ltd. and Maruti Suzuki India Ltd. which would drive overall sector earnings.
Banking:
While asset quality trends are expected to stabilize, close attention should be paid to the provision coverage ratio. One way banks inflate profits is by setting aside lower provisions.
Capital goods:
Order book inflows should be studied in-depth, especially to see which sectors orders are coming from, the type of orders (long-cycle or short-cycle) which would determine the course of future profitability.
Consumer goods: While volume growth is likely to have decelerated in the December quarter, that would have been partially compensated by price hikes. That, to an extent, will explain the variation in margins among firms in this industry.
IT:
A key point to be noted is how low volumes would fall owing to holidays and broad-based furloughs across verticals. With a recovery well under way in the West, companies’ plans to reinvest their gains from the lower currency should be watched as it determines future margins.
Pharma: Markets shares and product mixes in the US generic markets should be studied. The extent of the recovery in the domestic market will have a bearing on earnings as well.
Telecom:
Investors would watch to what extent voice traffic volumes would have bounced back in the December quarter. But the focus would remain on the upcoming spectrum auction.
Utilities: Capacity utilization numbers would be tracked and also the reason for those—whether it be lower demand or shortage of fuel. Merchant tariff realizations would also be of interest given that power demand usually rises near elections.
The macro numbers are closely related to revenue growth at companies and it’s no surprise then that analysts expect sales growth to be somewhat tempered.
The earnings season for the December quarter has started with Infosys Ltd. declaring its results last Friday. What do the markets expect? What should investors look out for in company earnings?
The macro numbers for the quarter haven’t been good. The Index of Industrial Production (IIP) declined in October and November. The composite purchasing managers’ index (PMI), that includes both manufacturing and services activity, also showed contraction throughout the quarter.
The macro numbers are closely related to revenue growth at companies and it’s no surprise then that analysts expect sales growth to be somewhat tempered. Even the muted growth is largely on account of the weak rupee and the weak base of the year ago quarter. Volume growth should be closely watched.
Still, in terms of profit growth, the December quarter is likely to be the best in several, says the consensus. Citigroup Global Markets, for instance, estimates that earnings growth for the Sensex firms (excluding oil firms) will jump 18.5%, the most in thirteen quarters.
With tepid sales growth and good earnings expectations, the obvious conclusion is that earnings growth will probably be driven by margin expansion. Bank of America-Merrill Lynch estimates that operating margins for Sensex firms will widen by 1.35 percentage points from a year ago. This improvement in margins will be driven by a weak rupee and softer demand for some raw materials. The rupee, while it recovered, was still some 15% down from a year ago in the December quarter.
Which sectors will benefit? The weak rupee will skew growth towards the currency sensitive and export dependent sectors. It is the reason why sales growth is still above 10% year-on-year, says Nomura. The brokerage also points out that the bulk of margin expansion will be contributed by industries such as technology, pharmaceuticals and automobiles. According to Motilal Oswal, Nifty firms that earn a bulk of their revenues in dollars will see a net profit growth of 29% compared to flat profit for other firms.
The upshot is that earnings growth is not going to be broad-based. Growth is likely to be led by sectors with global exposure such as metals, technology and pharma. Citigroup estimates that these industries will account for 90% of the quarter’s growth. Other industries such as metals and telecom will gain from a low base.
Not only will this round of earnings not signal a turnaround, it is also unlikely to cause investors to change their defensive stance from industries such as pharmaceuticals to cyclical sectors. The forecasts for cements, capital goods, real estate and financials all show a decline in profit growth. In any case, investment activity doesn’t seem to have revived in the economy and order inflows should be studied for signs of a pick-up.
What to watch out for in industry-wise earnings and management commentary:
Auto:
The impact of the strong US dollar should be seen in the margins of Tata Motors Ltd. and Maruti Suzuki India Ltd. which would drive overall sector earnings.
Banking:
While asset quality trends are expected to stabilize, close attention should be paid to the provision coverage ratio. One way banks inflate profits is by setting aside lower provisions.
Capital goods:
Order book inflows should be studied in-depth, especially to see which sectors orders are coming from, the type of orders (long-cycle or short-cycle) which would determine the course of future profitability.
Consumer goods: While volume growth is likely to have decelerated in the December quarter, that would have been partially compensated by price hikes. That, to an extent, will explain the variation in margins among firms in this industry.
IT:
A key point to be noted is how low volumes would fall owing to holidays and broad-based furloughs across verticals. With a recovery well under way in the West, companies’ plans to reinvest their gains from the lower currency should be watched as it determines future margins.
Pharma: Markets shares and product mixes in the US generic markets should be studied. The extent of the recovery in the domestic market will have a bearing on earnings as well.
Telecom:
Investors would watch to what extent voice traffic volumes would have bounced back in the December quarter. But the focus would remain on the upcoming spectrum auction.
Utilities: Capacity utilization numbers would be tracked and also the reason for those—whether it be lower demand or shortage of fuel. Merchant tariff realizations would also be of interest given that power demand usually rises near elections.
