In an earlier article in BL Portfolio dated March 27, titled “After seven quarters, India Inc braces for earnings downgrade” , we highlighted that Indian equities are entering the earnings downgrade zone. With the June quarter results (Q1 FY23) out, the pace of earnings downgrade has heightened.

CLSA, BofA Securities, Jefferies and Motilal Oswal Financial Services (MOSL) recently slashed their earnings projection for the bellwether Nifty50 index following the Q1 report card. They have reduced the earnings per share (EPS) estimates of Nifty companies by 2.5–4 per cent from their earlier numbers and have pegged the same at ₹843–862 in FY23.

Analysts polled on Blomberg estimate Nifty FY23 EPS at ₹857 now, down 3.5 per cent from the earlier ₹884 levels in end-June. Interestingly, the EPS estimate for FY24 (Rs 995 for the Nifty companies as per Bloomberg), which was untouched till last quarter, has also come under the knife, with the abovementioned brokerages slashing the FY24EPS estimates by 2–3 per cent.

Analysts at Jefferies and CLSA point out that more stocks in their coverage have witnessed EPS downgrades compared to those that have seen an upgrade. For Jefferies, the upgrade-downgrade ratio stood at 38:51 (the lowest in eight quarters), while for CLSA, the proportion was 37:42.

Margin pressure

Big names such as Reliance Industries, ONGC, BPCL, and Tata Motors disappointed the Street by posting lower than estimated earnings in Q1, thus triggering the downgrade spree. Sectors which faced headwinds to operating profit margins, such as metals and cement, took the maximum hit to FY23 EPS estimates. Interestingly, with the churn in manpower at its peak and recessionary trends gripping some key markets such as the US and Europe, IT stocks have also borne the brunt of downgrades.

According to MOSL, the EBIDTA or operating margin of Nifty companies at 14.2 per cent in Q1 declined by 310 basis points (bps) sequentially and 490 bps year-on-year. This constricted the net profit expansion to 23 per cent year-on-year in Q1 as against the expected 31 per cent net profit growth pegged by the brokerage. While this is a tad better than the previous quarter’s net profit growth of 21 per cent year-on-year, Q1FY23 performance was relatively subdued compared to the quarterly profit growth seen from March FY21 (see table). Much of the low-base effect resulting from the pandemic may have fully played out for India Inc.

Green pastures

Financials (banks and NBFCs) continue to support the overall earnings momentum, while in Q1, there was help from sectors such as capital goods, automobiles, real estate, and consumer discretionary. Strong loan growth, buoyant pre-sales demand for real estate, improving order inflows thanks to a mild revival in private sector capex and easing supply-side constraints are factors aiding these sectors. With names such as ICICI Bank, Axis Bank, ABB, Siemens, L&T, Titan, Mahindra & Mahindra, Eicher Motors, and Sobha, posting robust Q1 results exceeding expectations, companies in these sectors saw a reasonable earnings upgrade.

What next?

Easing commodity costs, especially crude oil, cooling off by over 12 per cent down from $100/barrel could offer solace to India Inc. Likewise, base metal prices have plunged by over 30 per cent from the March 2022 highs. While this may not auger well for commodity producers such as Tata Steel, Hindalco, Reliance Industries, and ONGC, consumers of these raw materials, such as FMCG, cement, paints, automobiles, consumer durables, and capital goods sectors, may gain.

However, given that the proportion of downgrades has surpassed upgrades, analysts aren’t reading much into easing pressures yet. Those at BofA Securities say the risk of further earnings cuts persists despite some of the earlier feared factors, such as crude oil prices sustaining at higher levels, a depreciating rupee and rising inflation showing initial signs of moderation. Analysts at Jefferies add that the argument for easing cost pressures isn’t very convincing, given that demand-side forces may pop up due to inflationary trends.

According to MOSL, the upside for the index will be a function of stability in global and local macros and continued earnings delivery.

With much of the post-pandemic recovery having played out, the next leg of growth will again depend on the domestic consumption theme.