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Q3 FY19 Earnings review and Equity Strategy – February 2019

Highlights:

  • At sector level, Industrials, Healthcare, Financials (corporate lenders), Materials (esp. ferrous) and Energy (ex-PSU Oil refineries) reported strong earnings, while Telecom, and Autos disappointed (part of consumer discretionary). Within Financials, private corporate lenders reported robust results with asset quality improving as stressed asset book declined sequentially.
  • Topline growth beat expectations considerably driven by Energy, Materials (esp. Ferrous) and Industrials sector. In addition, there were a few misses from a few large cap companies which impacted aggregate PAT growth for the NSE 200 universe (Tata Motors & Vodafone Idea). Aggregate Revenue, EBITDA & PAT growth (ex of these two companies) for NSE200 universe came in at 20% YoY, 6% YoY & 8% YoY respectively. Aggregate PAT has witnessed a moderate increase compared to consensus expectation dragged down by Oil PSU refineries (inventory losses due to falling crude prices). However, ex-Oil refineries and PSU financials, normalised PAT growth stood at 15% YoY, which is a relatively decent outcome.
  • EBITDA margin drops YoY: A key disappointment in Q3 FY19 was the YoY drop in operating margins. Compression in margins were driven by weak urban demand for PVs, input cost pressures emanating from depreciating INR (in turn leading to high commodity prices) for most manufacturers, wage hikes and attrition in IT sector, and competitive intensity within the telecom and discretionary consumption space. Of these negatives, the outlook for raw material costs is improving with commodity prices weakening, although oil prices have started inching up in Q4 FY19.
  • Sectoral highlights of Q3 FY19 results:
    • Fundamentals for corporate financials improve: Financials saw recovery in loan growth while asset quality improved further for most players.
    • Consumer staples companies reported decent volume growth despite a strong base but gross margins declined on a yoy basis. Rural consumption growth ahead of urban consumption (FMCG),
    • Passenger vehicles volumes were weak & commercial vehicles saw slowdown in volumes, after a series of strong quarters.
    • Cement volumes were decent while margins remain weak.
    • While Government spend on infrastructure continues to be strong, order booking for capital goods companies slowed down. However, revenues showed strong growth on a yoy basis.
    • Domestic capacity growth seems to have passed its peak in Airlines, strong 4G subscribers addition in Telecom.
  • Outlook for FY20: We expect net profits of the Indian market (Nifty-50 Index) to grow in mid-teens during FY20 primarily led by turnaround in corporate financials and supported by a favourable base given the weak earnings on higher provisioning under new RBI norms in the base quarter, recovery in profits of pharmaceutical companies led by revival in US generic revenues and steady growth in net profits of consumption-related companies (rural consumption growth ahead of urban consumption). However, risks remain as some of the issues continue to linger albeit with lower intensity (pressure on margins due to depreciating INR for domestic oriented sector/companies) and new stress areas emerged – such as the one observed in NBFCs, PV market and weak commodity cycle.

Equity Strategy – Maintain gradual accumulation

  • Current market valuations imply that market is not very expensive zone yet and gradual / systematic investment is the most appropriate approach. Now Indian Equities are moving closer to a zone where one can be more confident of outperformance vs. bond funds over longer term.
  • Customers who are under-weight equities can realign portfolios by taking incremental exposure to equities given reasonable fundamentals in terms of stabilising macros, decreasing rates, mid teen corporate earnings, valuations near to mid cycle, sentiment indicator below average and probability of foreign flows turning positive (towards EMs in general) augurs well for domestic equities.
  • Global volatility induced by probable slowdown in world economic outlook coupled with increased uncertainty as we move closer to general election may indeed lead to some more volatility, thereby providing opportunity. Hence, each dip in the market may be used as an opportunity to build positions towards equal weight asset allocation (in staggered / gradual accumulation being more appropriate strategy).