Waiting To Charge

Demonetisation might just have delayed the earnings recovery

The last two quarters of FY17 had witnessed decent momentum in earnings growth and the market also had started to count on strong earnings recovery this year and the next, led by 7th Pay Commission, passage of GST bill, normal monsoon, lower interest rates and a recovery in commodity prices. While these factors could have helped, the recent crackdown on the cash economy has led to uncertainty.

"The cascading impact of demonetisation will be visible in the next two quarters. Economic growth will be lower in the second half of FY17. Services sector, manufacturing and consumption both in the rural and urban centers will take a hit," says Madan Sabnavis, chief economist, CARE Ratings.

While pundits are still figuring out the possible impact on the economy, the risk to earnings downgrades has only increased. The present FY17 consensus EPS estimate for the Sensex is Rs.1,500 which works out to a growth of 14% compared to FY16’s Rs.1,320.     

"I do not think there will be any meaningful growth in Sensex earnings in FY17. The economy has already slowed down in recent months. Taking into account the impact of demonetisation, it will be a miracle even if the Sensex is able to achieve 2-3% earnings growth in FY17," says Saurabh Mukherjea of Ambit Capital.

Downgrade blues

The biggest hit is expected to be taken by consumption-related stocks like FMCG companies and automobiles. ITC, HUL, Maruti and others have close to 25% weightage in the Sensex. Because of the cash crunch, consumers might postpone purchases, thus impacting demand.

Cyclicals like banks and engineering companies could also feel the pinch. Banks might have to make higher provisions due to the slowdown. Similarly, a longer payment cycle might slow engineering companies’ execution impacting their revenues and earnings.

While domestic consumption is coming under pressure, exporters aren’t doing great either. Particularly IT, which accounts for a 16% weightage in the Sensex, could come under pressure. Recently, Nasscom lowered its FY17 export growth estimates for the industry to 8-10% as against the earlier 10-12%. This was largely on account of increasing uncertainty after Brexit, elections in the US and lower GDP growth in the developed markets. 

"As of now, there is very little sign of downgrades but around January and February, we could see significant amount of downgrades. It is usually in the third and fourth quarter that the market starts to trim its expectations," reminds Mukherjea.

Meanwhile, the Sensex has already corrected post the announcement of demonetization and the increasing possibility of a US Fed hike. So, what is in the price? "Sensex has corrected about 4% since the two events, so part of these risks of downgrades is already in the price, but there is certainly more downside as large part of this is yet to be factored in," says Kunj Bansal, CEO, Centrum Wealth Management.

An 8-10% earnings downgrade from the current level will take the Sensex EPS to Rs. 1,350-1,380. After the recent correction, the Sensex is currently trading at 17.5x its FY17 consensus estimated earnings, which is above its average PE of 15x in the last ten years.