It ain't over yet

India Inc's third-quarter scorecard will ensure that rerating of multiples is still some time away

Don’t be lulled by the benchmark indices’ strong surge in the New Year. The ongoing earnings season will prove to be far from comforting, it seems. Aditya Narain of Citigroup believes the third quarter will signal a demand slowdown as sales growth moderates from 20%-plus levels to 12%. “There is a meaningful skew across sectors: pharma and IT should see strong FX gain-driven performance along with the cement sector, while energy, metals and telecom will continue to see strain,” mentions Narain in a report. 

 So, it comes as no surprise that IT bellwether Infosys saw its revenue jump 31% year-on-year (YoY) to ₹9,298 crore aided by a weak rupee. However, the Street’s concerns of weak demand was underscored when Infosys scaled down its revenue growth forecast by 3.3 percentage points to 16.4% for FY12.

While export-focused rupee beneficiaries are expected to do well, analysts believe rising input costs and limited pricing power might lead to margin contraction across the board. Tirthankar Patnaik of Religare Institutional Research feels Sensex (ex-oil) profits are expected to rise 9.2% — a 170 bps margin decline YoY in Q3

Further, the brokerage sees operating profit and net profit margins contracting by 309 bps and 170 bps YoY, respectively, driven by interest rate hikes, rupee depreciation and weak pricing power on the back of slowing demand. “The operating profit margin deterioration for Sensex (ex-oil companies) has been seen to be the highest in the last three quarters,” feels Patnaik.

More importantly, the weak earnings forecast is not just restricted to Q3, analysts don’t see any reason for upgrades in the next fiscal (FY13). Citi has already scaled down its earnings expectations to low teens (FY12-12.5% and FY13-14.6 %) — a sizeable downgrade from the 25% expectations seen for FY12 last July. Patnaik feels that though concerns over input costs and a hawkish monetary stance seem to be waning, earnings in the coming quarters will face overhang of a falling rupee, a slowing economy and rising fiscal deficit.

Thus, it is unlikely that the markets are going to be rerated in a hurry. According to Credit Suisse, multiples are driven by G-Sec yields and GDP growth: the former affects the discount rate, while the latter, forward demand outlook. “Given the fiscal scenario, current bond yields imply a 9-13x P/E range. Also, CS economists expect GDP growth to be sub-7% in Q4 FY12. So, multiples are likely to fall to 11–12x levels,” warns Neelkanth Mishra of Credit Suisse.