Markets slippery, companies struggle to protect margins

During the third quarter of financial year 2023, sectors like autos, FMCG and industrials saw improvement with healthy margin expansions, with other segments indicating a wide divergence in margin recovery. Image: Shutterstock
  
With Indian corporates struggling to protect their narrowing margins, the three months ending December led to moderate earnings while a few sectors made shiny performance. Slowdown in the overall consumer demand pinched business performance, even though lower input prices of raw materials helped, but the improvement was not broadbased as weak demand had offset the fall in input prices in a few sectors.
 
During the third quarter of financial year 2023, sectors like autos, FMCG and industrials saw improvement with healthy margin expansions, with other segments indicating a wide divergence in margin recovery. However, it is expected that some benefits of the softening commodity prices are yet to flow through in the fourth quarter.
 
According to Pankaj Pandey, head research, ICICI Direct, margin recovery was the key highlight of Q3FY23. As per Pandey’s estimates, Nifty operating margins (excluding-financials) gained 230 basis points (quarter-on-quarter) to 17 percent, primarily led by savings realised from lower raw material costs as gross margin expanded. This compares to a low of 14.7 percent margin in the September quarter.
 

On an aggregate basis (ex-financials), the Nifty topline in Q3FY23 was largely flat with EBITDA gaining 16 percent QoQ and a net profit rise of 16.6 QoQ. On an annual basis, the Nifty topline was up 16.9 percent while net profit was down 3.9 percent YoY primarily tracking muted profitability in the commodity space (metals and oil & gas).
 
“Management commentary across businesses was positive on demand outlook, especially on the domestic front amid a progressive Union budget FY24 wherein the government proposes to spend Rs 10 lakh crore (up 33 percent YoY) as capex with a tangible multiplier effect that could potentially drive broad-based economic growth domestically. Encouragingly, growth capex was bundled with the path of fiscal consolidation,” Pandey says.
 
A broad-based slowdown in consumption, both staples and discretionary, hit corporate earnings, feels Gautam Duggad, head of research, institutional equities at Motilal Oswal Financial Services. “Corporate earnings for Q3FY23 were below our expectations, led by weak demand environment and macro headwinds, with financials and autos holding the fort once again. Slowdown in consumption is a material concern if trends don’t reverse immediately,” says Duggad adds.
 
Of the 21 sectors under Motilal Oswal’s coverage, four/nine/eight sectors reported profits above/in-line/below our estimates, respectively. Of the 222 companies under their overage, 83 exceeded estimates, 96 recorded a miss, and 43 were in line on the net profit front.
 
“Unlike Q2FY23, easing inflationary pressure in the economy led to a higher EBIDTA margin in the coverage universe (excluding BFSI); however, commentaries of some companies indicate sticky inflation,” says Hitesh Suvarna, analyst, JM Financial Institutional Securities.
 
The IT sector, having the highest exposure to external uncertainties, reported a weak set of numbers. On the contrary, service exports were at a record high in January—software exports forms 50 percent of services exports. Timely price hikes helped consumer companies report growth as volumes struggled to grow.
 
In the December quarter, consumer durables reported one of the slowest topline growths (excluding covid period). Apart from that, significant growth moderation was noticed in other discretionary items—retail, QSR (quick service restaurants). Consumption recovery, post-Covid, was led by urban discretionary items and retail.
 
“With regards to sectors, BFSI stole the show with another picture perfect quarter. Banks reported further expansion of net interest margins (NIMs), strong loan growth and decadal low credit costs, thus, leading to a decadal high net interest income (NII) growth, and profitability ratios,” says Prateek Parekh, analyst, Nuvama Institutional Equities.

Also read: Life after IPOs: From sizzling highs to sobering lows, Humpy Dumpty had a great fall
 

Valuations and EPS   

Duggad has cut FY23 Nifty earnings per share (EPS) by 1 percent due to notable earnings downgrade in metals stocks. He now expects Nifty EPS to grow 11.6 percent in FY23.
 
“Slowdown in consumption is a material concern if trends don’t reverse immediately. Markets are trading flat and valuations are in the fair value zone with Nifty trading at 18 times FY24 EPS and thus offering room for modest upside if corporate earnings do not see material downgrades ahead,” he explains.
 
Going ahead, Parekh expects earnings downgrades to accelerate due to tightening liquidity and weak global growth. “FY23 EPS has seen 1-2 percent cut with downgrades in commodities offset by upgrades in banks. High valuations amid broadening demand slowdown makes us cautious on the markets. We remain defensively positioned,” Prateek elaborates.
 
For companies under coverage by HDFC Securities, aggregate earnings estimates saw a cut of 1.3 percent in FY23 and a marginal upgrade of 0.3 percent in FY24. Projected earnings growth for FY23 and FY24 stands at 9.3 percent and 15 percent respectively, factoring in expected margin recovery and sustained demand momentum. FY24 earning growth is expected to be led by banking, auto, IT and energy.
 
“Nifty 50 index now trades at 20.6 times FY23 and 18 times FY24 consensus EPS which leaves limited upside at index level over the next 6-9 months,” says Varun Lohchab, head of research-institutional equities, HDFC Securities.
 
Post Q3FY23 earnings, Nifty EPS estimates by ICICI Direct have not seen any major change. The brokerage firm still expects Nifty earnings to grow at a CAGR of 15 percent over FY22-25 with our fair value for Nifty at 21,500 which is 21 times PE on FY24-25E average Nifty EPS of Rs 1,020. The corresponding Sensex target is at 71,600.

Also read: Cracking the code for high growth, low inflation
 

Where are the markets headed?   

Independent market analyst Ambareesh Baliga sees a time-wise correction for India’s equities, with a maximum of another 800-1,000 points fall for the Nifty from current levels. “I am more worried about how summer and monsoon activity pans out. If we have a harsh summer and the monsoon rainfall is erratic, it could play on our food inflation,” Baliga told Forbes India. “We have to see how this unfolds.” Economists and analysts fear more rate cuts in FY24 if food inflation spikes and global central banks continue to keep interest rates elevated.   

Also Read: Scorching summer may derail rural recovery, lead to a spike in inflation and interest rates
 
Indian markets have been sailing in rough waters since the beginning of this year, led by major sell-offs in index heavyweights, like Adani group stocks and jitters caused by the panic selling thereafter. Since January, markets have lost over 3 percent even as measures announced in the Union Budget were estimated to be major impetus for the economy. India's Q3 FY2023 GDP grew at a rate of 4.4 percent, lower than the 6.3 percent growth in the preceding quarter.

Private consumption showed the biggest moderation in growth, slowing to 2.1 percent year-on-year from 8.8 percent (YoY) in December quarter of FY23, despite robust high frequency data. This comes amidst ongoing negative growth in government consumption, while overall investment grew by 8.3 percent YoY, based on the ongoing growth in capex spending. Going ahead, even as recovery in domestic economic activity is yet not broadbased, protracted global drags in the form of geopolitical uncertainty, still-elevated prices, El Nino-led risk to agri output, shrinking corporate profitability, demand-curbing monetary policies and diminishing global growth prospects weigh on output,  pressuring the domestic growth story, which still lacks the next lever of secular growth, says Madhavi Arora, lead economist, Emkay Global Financial Services.

However, liquidity may continue to shrink in markets worldwide as central banks are on an interest rate hike regime which will further impact the flush of money into equities.
 
Nischal Maheshwari, CEO (institutional equities) at Centrum Broking, believes the US Federal Reserve’s motto of “higher for longer” interest rate regime will determine all near-term trends. “Global macros will be the most important signal,” he says. “This will impact other central bank action and impact costs, demand and earnings growth. When the Fed will pivot will be a key signal.”
 
While brokerages are expected to factor in an earnings growth cut in FY24, the buying activity is likely to remain higher in FMCG, banking, cement and construction sectors, Maheshwari says.
 
(With inputs from Salil Panchal)