Strategy: Weak quarter sets for the tone for another weak year - Kotak

Weak quarter sets the tone for another weak year. 1QFY18 results suggest that the underlying conditions in several sectors and the broader economy continue to be weak. 1QFY18 net profits of the Nifty-50 Index declined 8.4% yoy, 1.8% lower versus expectations. We now expect FY2018 net profits of the Nifty-50 Index to grow 1.5%. In the context of persistent disappointment in earnings, we find the market's faith in valuations and the Street's ability to value stocks on FY2019/20 earnings remarkable.

Weak start to a likely muted year

1QFY18 results were muted due to (1) continued weak underlying conditions in sectors such as banks, IT and pharmaceuticals and (2) disruption to domestic sales in sectors such as automobiles, consumer staples, pharmaceuticals before the implementation of GST from July 1, 2017. 1QFY18 net profits of the BSE-30 Index and the Nifty-50 Index declined 1.5% yoy and 8.4% yoy, below our already muted expectations.

Earnings downgrades through the 1QFY18 results season suggest flat profits in FY2018

We now expect FY2018 net profits of the Nifty-50 Index to grow 1.5%, following the earnings downgrades in several sectors such as banks, metals & mining and pharmaceuticals through the 1QFY18 results season. We do not rule out further downgrades if the economy fails to recover quickly from the temporary disruption arising from demonetization and implementation of GST. Government expenditure can support GDP growth up to a point. We do not rule out an extended slowdown in consumption, hiring and investment in the informal economy if it is unable to cope with the changes arising from GST and resultant formalization of the economy.

High margin and profitability but low overall profit growth over FY2015-17

We highlight the downside risks to extant high margin and profitability and earnings in several sectors, from weak volume growth. We note that margins and profitability have been robust across sectors due to the sharp decline in input commodity costs from FY2016, which resulted in a sharp improvement in gross margins and profitability across sectors. We generally keep our margin and profitability assumptions at FY2017 levels, which are at historically-high levels.

Valuations are expensive, full, rich ad nauseam

The Indian market (Nifty-50 Index basis) is trading at 21X FY2018E 'EPS' (free-float basis) and 17X FY2019E 'EPS'. Note that we project a very strong recovery in earnings in FY2019 after flat net profits in FY2018. However, we have limited confidence in our FY2019E estimates given (1) little evidence of a strong turnaround in the economy, which can drive volume growth and (2) high margin and profitability assumptions in several sectors, which may be at risk.

Source : Equity Bulls

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