Emkay Global pegs FY19 earnings growth at 10-12%, bets on domestic consumption themes


As the earnings season kicks off, the Street’s eyes are on the March quarter earnings of companies. Several voices see this as one of the crucial quarter which will set the tone for a recovery ahead.

For FY19, Emkay Global Financial Services believes that earnings growth could be better than the near flat performance of the past few years.

“Our base case in somewhere around 10-12 percent. Key tailwinds for earnings performance are recovery in global trade and multiplier effect of higher government spending which in combination should support demand,” Dhananjay Sinha, Head, Institutional Research, Economist and Strategist, Emkay Global Financial Services told Moneycontrol’s Uttaresh Venkateshwaran.

For the market, Sinha expects high probability of a volatile scenario and  mutual fund flows to taper. Edited excerpts

Earnings season has kicked off. What is your outlook for the March quarter?

The positive impact of a demand recovery and favorable base effect in Q3 FY18, when the profit growth of our coverage universe stood at 14.6 percent YoY, is seen fading in Q4 FY18 despite continued strength in demand. This is largely because of higher tax burden, up 33 percent YoY.

Improved demand is seen sustaining, owing to better rural demand and recovery in the global trade scenario. Further evidence of a recovery is seen in a revival in credit demand and higher government spending.

Growth in non-food credit has recovered to 11 percent by mid-March from 5 percent a year back. The consumer space, including staples and discretionary (like autos), is expected to witness fairly healthy performance. The agriculture side of the rural sector is still facing headwinds in the form of weak farm produce realisations and feeble net cash flows, resulting in weak demand for agri-inputs. There also appears to be a modest pick-up in the capital goods sector, largely propelled by government spending.

But notwithstanding these tailwinds, margin pressures appear to be emerging, indicating that pricing power across sectors is still to gain traction. As per CMIE, new investment projects announced by the private sector declined 47 percent YoY during Q4, resulting in a cumulative decline of 50 percent during FY18.

Escalation of global trade conflicts poses a risk to the nascent positive spillover of the ongoing global recovery on Indian corporate performance.

Sales growth for Emkay Universe (excluding financials and oil & gas) is expected to moderate a bit to 9 percent YoY in Q4 from 11.3 percent YoY in Q3 FY18. EBITDA growth is pegged at 11 percent YoY versus 12.8 percent YoY in Q3 FY18). Adjusted PAT is estimated to grow by 4.2 percent YoY as against a growth of 14.6 percent YoY in Q3 FY18.

Excluding the outliers (top three and five companies), APAT is estimated to contract by 1.3 percent and 4 percent YoY, respectively. Sales growth in Q4 FY18 will be led by sectors like auto ancillary (34 percent YoY), engineering and capital goods (21.1 percent YoY) and automobiles (18 percent YoY). Telecom (-10.1 percent YoY) and metals and mining (1.1 percent YoY) are likely to drag sales growth.

How do you expect FY19 to be in terms of earnings and EPS growth?

Earnings growth will be better than the near flat performance of the past few years. Our base case in somewhere around 10-12 percent.

Key tailwinds for earnings performance are recovery in global trade and multiplier effect of higher government spending which in combination should support the demand scenario.

The headwinds will be rise in raw material cost and resultant pressure on margins. In addition, rising trade protectionism will induce uncertainty.

The market is certainly off its record highs seen in January. Is this consolidation trend likely to continue? When is a pullback likely?

Notwithstanding, the improvement in earning, the market scenario will be a function of liquidity conditions arising from FII (foreign institutional investors) and mutual fund flows.

There is high probability of the scenario being volatile. We expect MF flows to taper this year, contrasting the boom that we saw during FY18, on account of spill over effects of demonetisation and GST dislocations.

What do you see as risks to this market? How big are political risks and trade war concerns among those?

Risk to the market comes from a combination of two factors: receding global excess liquidity and intensification of trade wars.

The contrasting combination of accommodative monetary policy and restrictive trade policies of advanced economies since 2008, led by the US, possibly fuelled the paradox of declining earnings growth and valuations rising to an all-time high.

While implications from trade protectionism on EMs in the form of declining productivity, lower return on capital and growth differential over global growth should have resulted in outflows of portfolio investments, the persistence of global low risk free rates have ensured strong allocations to EMs, disproportionately higher than their growth delivery.

In the Indian context, annual earnings growth for benchmark indices averaged 5-6 percent during FY08-18 as compared to the previous 17 year average of 18.6 percent, in line with the decline in trade openness.

Strengthening growth in the US (and other AEs) is benefitting emerging markets and developing economies (EMDEs) by way of better demand conditions. A steeper rise in US inflation could be hastened by trade protectionism and can prompt faster-than-anticipated normalisation of Fed’s monetary policy, thereby tightening the financial market conditions for EMs.

Therefore, the risk to our markets is more on account of valuations as compared to earnings growth.

What advice would you offer an investor in the current market and how should one trade from a near-term perspective?

Our medium- to long-term view is that consumption themes should do well. In the near-term, large cap stocks should outperform mid- and smallcap stocks. Domestic oriented sectors like FMCG, durables, automotive, rural-agriculture dependent stocks and private lenders with higher retail portfolios should do well.

Midcaps have had a weak 2018 so far. Is there a possibility of further downside?Yes, we believe so as we see retail participation flagging off.