Possibility of downgrade in earnings

Deeptha Rajkumar

Mumbai, July 9

With the results season around the corner, analysts predict a near term recovery in equity market sentiment, largely piggybacking on robust corporate earnings.

However even as analysts are talking of a sharp acceleration in earnings growth based on bottoms-up forecast for FY-07, a section of the market is of the view that going forward one may see a downgrade in numbers.

Earnings take a backseat

The rise in interest rates, rising input costs (especially oil); falling global commodity prices and monsoon worries are some factors that may bring about a downgrade in earnings.

"Investor focus over the past few months has been on falling risk appetite and tightening liquidity across the globe. Meanwhile, earnings have taken a backseat. We believe there is complacency on earnings growth in India, partly driven by the fact that EPS growth over past few years has been strong and earnings continue to see upgrades. EPS growth estimates for FY-07 are unrealistic and expect downgrades to numbers. While earnings for first quarter of current financial year will be strong, we expect margin pressure to reflect from Q2 onward," a DSP Merrill Lynch report said.

Reiterating this, a JP Morgan report said the recovery in the equities market is likely to be capped by expectations on higher interest rates, slowing earnings growth and global growth moderation in the second half of 2006.

Yet investment strategist, Mr Gul Teckchandani believes that one needs to look at absolute profitability of corporate India before taking such a call. "It is more of a statistical analysis. One should not get carried away by relative numbers," he said.

According to him, all the factors cited above have been in existence for some time now. "There is no one-to-one co-relation between market and numbers. It is more a question of sentiment," he added.

Another hike

With G-Sec (Government securities) yields having bottomed out over 18 months ago, lending rates by banks to end-consumers have seen a sharp rise only over the past four months. After having hiked short-term interest rates recently, the Reserve Bank of India is likely to go in for another increase, market players say.

Analysts expect this to manifest itself in slower demand from sectors dependant on credit such as autos and housing. In addition to slower demand, earnings growth will likely slow as interest costs for companies rise. A rising interest rate also has adverse implications for valuations.

While auto companies and banks are pegged as the most vulnerable to rising interest rates and a poor monsoon, an increase in input costs can also put pressure on margins for companies especially in sectors with high freight costs.

Additionally, analysts believe that global commodity companies, which contributed nearly 43 per cent to earnings growth in FY-05, could see their contribution come down to 24 per cent in FY-07. "If the global commodity cycle turns adverse, margins will be under pressure. Metal stocks like Tata Steel and Hindalco, petro stocks such as Reliance and refining stocks such as HPCL, BPCL, and IOC are likely to be hit if their respective cycles turn down," an analyst said.

(This article was published in the Business Line print edition dated July 10, 2006)
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