Southward bound

Aditya Narain is talking straight, dead straight. The head of Citi Research believes that after the party on the Street in 2014, it’s time for a reality check in the new year as corporates reveal their report cards for the third quarter of FY15. “Something had to come in the way of India’s 30%+ 2014 surge, its big (and partly fortuitous) macro turn and rising optimism,” writes Narain in his report. His best-case estimate is that the Sensex pack is going to reveal 0% earnings growth for the quarter. “While there’s probably a cushion on margin upsides, you need sales and pricing momentum for stronger earnings leverage and upsides to play through,” Narain mentions.

Though the recent repo rate cut has got the markets excited, and investors are looking forward to an economic recovery, the immediate future is far from rosy. “Q3 will continue to disappoint in terms of growth due to global headwinds and lack of demand pick-up in domestic sectors. Sales, Ebitda and PAT growth are all expected to be in single digits,” says Rajat Rajgarhia, MD, institutional equities, Motilal Oswal Securities.

Not surprising, then, that despite the buoyancy in the market in the past one year, earnings estimates for the fiscal have actually been cut. The Sensex consensus earnings estimate for FY15 came down from ₹1,560 per share in November last year to ₹1,540 per share, according to Motilal Oswal. Compared with FY14 earnings, it shows 15% earnings growth but many feel consensus estimates will continue to trend down further in the last quarter of this fiscal. Prateek Parekh of Edelweiss Securities agrees: “Given the poor earnings expectations in Q3FY15, downgrades are likely in the quarter.” 

Current estimates peg earnings to grow a little over 10% in FY15. “We estimate Sensex EPS growth at 10% in FY15 to ₹1,469. While domestic cyclicals have failed to pick up the pace of recovery, global headwinds are driving the downgrade,” says Rajgarhia.

Potential for further downgrade largely comes from the commodity space, which — including energy and metals — accounts for about 13% weightage on the Sensex. Commodity prices across the board have dropped, hurting index heavyweights such as Reliance Industries, ONGC, Tata Steel and others. 

“Four out of five of the Sensex companies would see an EPS cut, led by Tata Steel, BHEL, M&M, Sesa Sterlite and ONGC. We also cut our Sensex EPS estimate for FY16 by 6.1% to 1,761. Here, again, nearly 80% of the Sensex companies would see an EPS cut, led by M&M, ONGC, Sesa Sterlite, BHEL and L&T,” adds Rajgarhia.

Against such a backdrop, Sensex valuations too, will appear out of whack. For instance, at 10% earnings growth, the multiple will work out to 19 times. That may not look attractive given that the index has traded, on an average, at around 14 times one-year forward earnings. Little wonder, then, that Narain aptly titled his report: A zero can’t be a hero.