A redeeming feature of India Inc. since the pandemic has been the sharp improvement in earnings profile, marked by not only a trajectory which has reset higher but also by uncharacteristic stability, which was missing for most of the last decade.

Resilience and recovery

Before delving into the reasons and, more importantly, evaluating the sustainability of this earnings profile, it is important to put the numbers in context. Between FY20-23, India Inc. exhibited a tale of resilience and recovery, with the net profit for the Nifty 50 universe expanding by 22 per cent CAGR and for the broader BSE-200 universe by 28 per cent. The projected earnings growth between FY23 and FY25 is 16 per cent. If achieved, FY20-25 could mark the best phase of corporate earnings since FY04-07. This compares to a tepid and subpar earnings growth of 5 per cent between FY10-20, a period marked by frequent downgrades.

What are the factors that have led to this resurgence? Is it just a by-product of a soft base or a favourable macro cycle? The slowdown in the earnings growth was led by a mix of both domestic as well as global factors, which impinged on the performance of key sectors such as banking, commodities, capital goods and real estate. Many of these factors are now changing or reversing, with the trifecta of a strong banking sector, delevered corporate balance sheets and revival of the investment cycle acting as a tailwind.

Decoding factors

A sizeable contributor to the scale-up in earnings trajectory has been the banking sector, which went through a deep write-off cycle exacerbated by overleveraged companies in infrastructure and commodities. However, higher commodity prices over the last few years have ensured strong profitability for capital-intensive sectors such as metals and energy. There is a meaningful thrust towards capital expenditure with government taking the lead (government capex expected to increase to a 17 year high of 3.3 per cent of GDP in FY24). Expansion of the infrastructure is not only boosting economy wide competitiveness (India’s logistics cost to GDP is among the highest in the world) but is gradually resulting in the crowding in of private sector investments. The labour intensive real estate sector, with multiple downstream linkages to other sectors, is also witnessing a revival boosted by structural reforms, consolidation, and rising affordability.

The above factors have all contributed to the deleveraging of the corporate balance sheet. Corporate leverage (gross debt/equity) stands at 15-year lows~0.58 and well below the two-decadal average. India’s banking sector is also at its healthiest in a decade, and large stress is unlikely to come through, implying that the possibility of a massive NPL/write-off hit is unlikely, as was the case between FY15 and 20. Thus, the twin balance sheet problem - overleveraged corporates and stress on banks’ asset quality, which weighed on investment cycle and corporate earnings – seem to be behind us.

Micros and Macros

The emergence of the manufacturing sector, led by the government’s thrust on ease of doing business, is adding to the tailwinds, especially given the scenario that many companies are trying to diversify out of China to minimize supply chain risks. As India’s manufacturing ecosystem scales up, it will create a new set of winners in electronics, auto ancillaries, and industrials, benefiting investments, employment, and, ultimately, corporate earnings.

However, micro factors cannot be ignored. Recent years have witnessed global supply chain constraints, volatile commodity prices and other challenges, such as lack of labour availability. Indian corporates, though, have displayed immense resilience with a focus on technology to bring about operational efficiencies. Leveraging technology to drive business efficiencies (lower logistics, materials and quality costs) is not a one-time effort to squeeze cost benefits to prop up near-term margins but a continuous process that optimizes all cost levers on a sustainable basis. Also, measures to improve the ease of doing business and reducing friction in payments have resulted in economy-wide productivity.

The present global growth environment presents a unique opportunity for India. Despite its recent short comings, when compared to EMs, India’s corporate earnings have been more resilient during each of the cyclical downturns over the last two decades. While most major economies are struggling with low growth in the aftermath of the Covid pandemic, India’s well-diversified corporate universe does present a compelling proposition.

The author is CIO - Equities, WhiteOak Capital Asset Management

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