Opinion | An earnings recovery is underway but real risks abound

The June quarter financial results of Indian firms that are available so far show that while a recovery in earnings growth is underway it is still at a nascent stage.

According to numbers collated by Moneycontrol, year-on-year (YoY) profit growth for 383 non-government, non-financial firms came in at 13. 7 percent. While that is solid growth, on an aggregate basis it is still lower than the approximately 16 percent profit growth reported by the same set of firms in each of the last two quarters.

One reason for the double-digit profit growth is the statistical base effect. June quarter earnings in 2017 were hit by companies preparing for the implementation of the goods and services tax (GST). For this set of firms, profit decreased by 0.25 percent in June 2017.

However, despite double-digit profit growth, earnings are being downgraded at a broad level. Motilal Oswal, for instance, has cut its fiscal 2019 earnings per share estimate for Nifty by 3.6 percent. The brokerage said while 23 companies it covers have seen earnings upgrade of at least 3 percent, 43 companies have seen downgrades.

These downgrades have happened despite an expansion in manufacturing and panelists in a survey of purchasing managers saying there is strong demand in international markets for Indian goods.

Earnings have been a mixed bag with sectors such as auto and aviation performing below par. Raw material cost pressures have hit industries from auto to cement. High oil prices are still a headwind.

The spectre of a global trade war also threatens external demand after reports said US President Donald Trump is now considering a 25 percent tariff on $200 billion worth of Chinese imports compared to 10 percent earlier.

To be sure,  consumer companies have done well thanks to an increase in rural demand. But company managements are reluctant to call a full-blown recovery preferring to watch how the monsoon rains and the minimum support price implementation play out.

Increasingly, there are doubts whether the monsoons would be normal. On Wednesday, private forecaster Skymet Weather Services said there was a 60 percent chance that the rains would be below normal. That could stymie the recovery in rural demand, increase food inflation and result in further rate hikes which could crimp economic growth.

Consumer confidence is not very high. RBI’s latest consumer confidence survey showed that half the people polled do not expect improvements in income, job prospects and general economic conditions in the next one year.

Moreover, leading indicators are also showing a moderation in demand, at least for the current (July to September) quarter. For instance, Nomura’s composite leading index, fell for the first time in six quarters owing to a slowdown in real money supply growth, slower visitor arrivals, and weaker industrial output growth, the Japanese bank said.

The equity rally is not supported by an expansion in earnings and thus valuations are elevated. India’s premium to emerging markets overall is now close to 60 percent. With earnings unlikely to see a big surge and no support from foreign portfolio flows given tightening financial market conditions around the world, the market seems ripe for a de-rating.