INDIA STRATEGY – RESULTS REVIEW 2QFY20: Operationally in line; tax cut drives PAT beat


Nifty EPS estimates stable for now

–       The second-quarter corporate earnings season was in line with our modest expectations. While the corporate tax rate cuts helped in arresting earnings downgrades, commentaries do not suggest any imminent recovery. Demand concerns in the economy are now coming to the fore, a continuation of which can raise the risk for earnings downgrades in FY21.

–       Nifty sales/EBITDA/PBT/PAT grew -2.5%/2.1%/-3.1%/8.3% YoY (our estimate: -2.1%/-2.4%/-3.9%/-8%). Excluding Corporate Banks, Nifty PBT was down 10.6% YoY (our estimate: -11.8%). For the MOFSL Universe, sales/EBITDA/PBT/PAT grew -2% /2.1%/-0.6%/11.7% (our estimate: -1.1%/-1.1%/1.7%/-6.1% YoY). The divergence between the PBT and PAT performance can largely be attributed to the corporate tax rate cut. We, however, note that not all companies have shifted to the new tax regime.

–       Of the 19 sectors that we track, 4/8/7 sectors posted PBT that was above/inline/below our estimates. Financials accounted for 90% of the incremental profits for the quarter. At the PBT level, the contribution of Financials is even starker.

–       Sales for both the Nifty and the MOFSL Universe declined for the first time since Jun’16, dragged by Automobiles, and Commodities like Metals and O&G. Consumer companies continued reporting a deceleration in top-line growth. Cement, Auto, Healthcare and Utilities marginally exceeded expectations on sales.

–       Private Banks posted in-line 46% PBT growth led by Corporate Banks, but loan growth moderated given the weak economic environment. Our NBFC Universe delivered in-line 11% PBT growth led by HDFC and Bajaj Finance, while other players posted moderation in disbursement growth.

–       Auto PBT was down 21% but still exceeded our estimate of a 47% decline. Utilities also delivered an impressive beat with 8% PBT growth. PBT for Metals and O&G Universe declined by 67% and 20% YoY, respectively – a miss to our estimates.

–       Pharma, Consumer and Technology Universe posted in-line 3%, 6% and flattish PBT growth YoY, respectively, while Capital Goods and Cement missed our estimate with -7% and 23% YoY PBT growth, respectively.

–       Despite the cushion of lower taxes, one-third of the MOSL Universe delivered YoY PAT decline.

–       Nifty EPS stable for FY20: Our FY20/21 Nifty EPS estimates have been revised to INR538/INR683 (prior: INR539/INR691). We expect Nifty EPS to grow 12% in FY20. Corporate Banks are expected to contribute two-thirds of incremental FY20 PAT for the Nifty, while Financials are expected to contribute ~95% of incremental PAT.

–       The direction of earnings revision for the broader markets still remains downward, with 80 companies in the MOFSL Universe witnessing an earnings cut of 3%+ and 60 companies witnessing upgrades of 3%+. The ratio has improved sequentially (3x in 1QFY20) owing to tax cuts.

–       For the MOFSL Universe, at the sectoral level, Automobiles, Technology and NBFCs have seen an earnings upgrade of 8.4%, 1.6% and 2.5%, while Capital Goods, Private Banks, Metals and Oil & Gas earnings saw a downward revision of 6.6%, 2.5% and 4.4%, respectively. Consumer, Cement and Life Insurance Universe’s earnings estimates remained stable for FY20.

–       Top upgrades (FY20E): JSW Steel, Maruti Suzuki, Eicher Motors, Tata Steel and Hero MotoCorp have seen EPS upgrades of 29.2%, 17.6%, 15.9%, 12.3%, 9.6%, respectively.

–       Top downgrades (FY20E): BPCL, GAIL, IOC, UPL and Dr. Reddy’s have seen EPS downgrades of 21.2%, 18.1%, 16.5%, 12.8% and 10.8%, respectively.

–       Slow grind ahead; valuations now factoring in sharp earnings recovery: Barring the tax rate cut-driven earnings beat, the 2QFY20 corporate earnings performance was in line but muted. While the government and the RBI have stepped in to revive growth, we believe that their efforts will take time to percolate. Meanwhile, the underlying demand scenario has turned adverse. Recent high-frequency data (IIP, Fuel Consumption, Power Demand, Auto monthly data) clearly signal well-entrenched demand slowdown, which has already resulted in sharp downgrades to our FY20 GDP growth estimates. Hopes for 2HFY20 earnings recovery are driven by expectations of earnings normalization in Corporate Banks, which have received a shot in the arm post the recent SC judgment on Essar Steel’s IBC resolution case. We expect more policy action from the government but do not foresee any sharp recovery in demand.  After the recent rally, we believe that the Nifty at 17.4x FY21E earnings is not expensive but discounting the sharp earnings recovery. Our portfolio strategy remains premised on earnings visibility and valuation comfort.

–       Top Ideas: Large-caps: SBI, ICICI Bank, L&T, Infosys, Bharti Airtel, NTPC, HUL, HDFC, UltraTech, Maruti.
Mid-caps: Indian Hotels, ABFRL, Ashok Leyland, Colgate, Federal Bank, Jubilant Foodworks, JK Cement, Crompton Consumer.