With slow recovery, the market looks over-priced
Most economic indicators, whether it is factory output or loan growth, suggest the road to recovery is going to be a long one. While growth may have bottomed out, as suggested by the stability in sales of commercial vehicles, there is little to indicate it is gaining any meaningful momentum. And while it is early days yet, the first lot of numbers from India Inc, for the three months to June, doesn’t suggest any revival in corporate earnings despite huge benefits from softer prices of commodities. For a sample of 217 companies (excluding banks and financials), net profits have risen barely 3.6% y-o-y compared with 10.4% y-o-y in the March quarter. The malaise, it would appear, lies in the lack of demand for both consumer and capital goods; while surplus capacity across key sectors is stifling sales, the lack of purchasing power is holding back consumer spends. Volumes at cement-maker ACC fell 2% y-o-y while realisations came off by 1% y-o-y with margins tumbling to a decade-low; the lack of pricing power was also reflected in Ultratech’s profits which slid 6% y-o-y. Indeed, most companies operating in the core sector are struggling to make money: at GAIL, revenues dropped 6% y-o-y mainly on account of lower gas marketing revenues while profits dropped 32% y-o-y. Lower demand from state electricity boards caused JSW Energy to miss profit estimates, with the adjusted net profit falling 20% y-o-y.
Also, despite reporting record refining margins of $10.4 per barrel, Reliance Industries profits rose just 4.4%. The weak operating performance of these firms will weigh on makers of capital goods whose order books haven’t seen any significant increase in over a year now. That the capex cycle isn’t picking up is also seen in the contraction in the loan growth in the three months to June—investment had already slipped to 33.1% of GDP in March 2015 from 33.7% in March, 2014. While the slow pace of new projects and the limited job creation has left consumer demand relatively weak—volumes at Bajaj Auto rose just 2.5% in Q1FY16—analysts expect some momentum once government employees get pay hikes to be announced by the seventh Pay Commission.
In the meanwhile, makers of both durables and staples are finding it tough to hold on to prices. Hindustan Unilever (HUL) which should have done well given the gains from softer commodity prices—gross margins expanded 356 basis points y-o-y—was compelled to pass on some of these to consumers in the form of lower prices and some to the trade as higher promotions. While Asian Paints was able to push through volumes—up an estimated 10%—it was lower-end products that sold more. With management commentary cautious, analysts have had little choice but to cut earnings estimates—for some firms like GAIL, the cut has been a steep 14-22%. Guidance from managements has been tempered; JSW Energy said volumes in FY16 would stay flat and realisations from merchant sales subdued. Indeed, the current earnings season is turning out to be no different from the earlier one which means downgrades are possible even if the pace is slower. That makes investors quite vulnerable in a market that is trading at over 17 times FY16 estimated earnings, even if the monsoon turns out to be normal.