Firms see earnings upgrades despite steep valuations

Market


India’s biggest companies have seen sharp earnings upgrades amid a recovery in demand from the covid-induced turbulence. However, high stock valuations and impact of cost pressures on operating margins remain a cause for worry.

Analysts’ earnings per share (EPS) estimates for blue-chip NSE Nifty companies jumped 16% from the start of this fiscal. Likewise, BSE Sensex companies saw their EPS targets raised by 14% for FY22, showed Bloomberg data.

Overall, the September quarter marked an improvement in earnings of most Nifty companies, except for a few sectors such as automobiles, cement, and consumer staples, which faced margin pressures due to high raw material costs. Metals and oil and gas sector firms, meanwhile, reported better-than-expected results during the quarter.

“The quarter brought to fore two important trends. An improving demand environment post the opening up of the economy and rising vaccinations, and the impact of rising input costs on operating margins,” said Gautam Duggad, head of research, institutional equities, Motilal Oswal Financial Services Ltd.

“Q2FY22 Nifty sales and Ebitda growth were in line at 31% and 21% year-on-year (y-o-y) while net profit growth came in at 36% y-o-y. Among the Nifty constituents, 48% beat our net profit estimates, while 28% missed expectations. Excluding metals and oil and gas, Nifty profits posted 13% y-o-y growth,” Duggad said.

According to Vinod Karki and Siddharth Gupta, analysts at ICICI Securities, the bulk of the demand as witnessed in sales and volume expansion was visible in core sectors, financials, discretionary consumption and exports. “Consequently, net profit to the gross domestic product on trailing 12 months basis of listed space has reached 4%, highest since FY12. Also, conservative forecast of net profit to GDP ratio based on consensus net profit estimates for around 600 companies and nominal GDP estimates indicates the ratio will reach 4.5% by FY23,” Karki and Gupta wrote in a 1 November note.

Meanwhile, rising valuations of Indian markets are worrying investors, leading to downgrades by a few foreign brokerages. Currently, the Sensex is trading at a one-year forward price-to-earnings ratio of 23.04 times while Nifty is at 21.74 times.

“While headline valuations look rich, they must be seen in the context of depressed long-term earnings,” said Morgan Stanley in a note on 18 November. The brokerage expects earnings to compound 27% annually over the next couple of years and the Sensex to rise 16% in the base case to 70,000 by December next year, albeit mostly in the second half.

Morgan Stanley has lowered its FY22 earnings estimate by 7% though it has kept FY23 numbers unchanged. “We believe the positives outweigh the risks for those willing to take a slightly longer-term view,” Morgan Stanley said. In October, the brokerage firm had downgraded India to equal-weight rating stance.

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