September earnings on track, but it’s time to tone down optimism says Kotak Institutional Equities

• Earnings season so far is tracking well, with banking and IT services leading profit growth.
  
  
• Second half of the year is expected to be better for commodity consumers as inflation is expected to come off further.
  
  
• Steady downgrades year after year suggest linear thinking among analysts. Time to tone down the optimism, believe some.
  

The ongoing fiscal year may have started on a somber note with multiple headwinds hitting equity markets from all sides, but the second half is expected to be better, if the current earnings season is anything to go by. Corporate India’s performance during the September quarter has largely been on expected lines, with IT services and financials leading the earnings season, while commodity plays have continued to see margin pressures as prices have started to cool. According to HSBC Capital, “The earnings season is tracking reasonably well. Earnings misses are margin led, which should ease in the second half of FY23, as inflation moderates. Overall, we see limited risks to the Nifty EPS growth expectations of 13.3%/14.8% year-on-year for FY23e/24e.”

The earnings season is largely in line with the market’s expectation on the revenue front. While profit growth has been impacted due to higher input costs, sales growth for the early birds has been 22.9% in Q2FY23 against 22.3% in Q2FY22. There have been misses on profit growth, but that is largely due to the pressure on costs. As inflation is expected to moderate in the second half of the year, margins could recover too. Downgrades continue to outpace earnings upgrades, but most analysts believe that a robust festive season bodes well for the December quarter.

Banks and IT services are clearly leading the charge in profit growth, as both sectors continue to report growth in both revenues and earnings. According to HSBC Capital’s strategy report, banks clearly stand out with strong earnings growth of over 35% year-on-year in the September quarter of FY23. This growth has been aided by healthy pick up in credit and expansion in net interest margin for most banks. In addition, asset quality has remained stable, despite the pandemic. Also retail demand for loans has remained strong, even though growth is coming back in the small and medium portfolio. Auto stocks too have started faring well as pent up demand continues to drive sales and easing of chip shortage has helped boost revenues. However, given that rural markets are still reeling due to inflationary pressures, the two-wheeler makers continue to report lower sales. In the FMCG sector too, downtrading has affected several companies claim analysts.

According to analysis done by analysts at ICICI Securities, profit after tax (PAT) growth (year-on-year) within the NIFTY50 index so far is around 3%. Revenue and EBITDA YoY growth (non-financials) stand at 25% and -1% respectively on a free float basis. For the broader NSE200 universe, the free float PAT contraction is 4%. Overall YoY increase in aggregate profit during Q2FY23 for the NSE200 universe so far is primarily being driven by financials, whose profit pool expanded by 47%.

While there is a visible contraction in the profit pools of commodity players like JSW Steel and Tata Steel, which reported sharp declines in profitability, lower commodity costs bodes well for industries like auto, consumption and other industries. So far the beats and misses in earnings are evenly poised for the NSE-200 universe. According to Vinod Karki and Niraj Karnani of ICICI Securities, “In NSE-200, financial and autos are dominating with more beats while cement and metals are dominating with more misses. Technology and FMCG earnings have been neutral.”

Despite the optimism amongst analysts this earnings season, there are serious risks emanating from overestimation of earnings by analysts. For over ten years now, Nifty earnings have seen sharp downgrades through the year after building in double digit earnings growth. According to strategists at Kotak Institutional Equities, this is due to over-estimation of earnings and under appreciation of risks, especially to business models of companies from ongoing disruption.

Sanjiv Prasad and his team at Kotak Institutional Equities have a word of caution for analysts who have consistently gone wrong in their earnings estimates. Says Prasad in his strategy note, “We would believe that continuous downgrades to earnings estimates simply reflect the analyst community’s ‘linear’ modeling and thinking. We would concede that it is not easy to arrive at estimates and identify all potential risks to earnings. Thus, it may be better for analysts and investors to acknowledge and/or incorporate the probability of earnings disappointments through building in some degree of conservatism in their forecasts. The fact that analysts have to constantly downgrade their earnings estimates would simply mean that analysts are starting with fairly aggressive assumptions for whatever reasons.”

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