March-quarter earnings preview Global commodity price deflation holds down domestic corporate profitability :: Nomura research

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Anchor themes Our end-Dec 2015 Sensex target is 33,500. Sector-wise, our key Overweights this year are financials, autos, industrials and technology. Our key Underweights are consumer staples, pharmaceuticals, metals and telecoms. Our top five stock picks are AXSB, HCLT, MSIL, NBCC and UNBK.

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The rupee passes the baton to oil From a top-down perspective, global macro remains a key determinant of the trend in domestic corporate earnings. A favourable rupee base effect that pulled up revenue growth for four quarters starting Sept-13 has now been replaced by an unfavourable global commodity price effect which kicked in a year later, which we expect to reverse in 2HCY15F. In terms of net sales, sectors directly exposed to global commodity prices account for 40-50% of aggregate sales for key market indices. It is not surprising then that the market’s top-line growth (based on our bottom-up analyst estimates) is expected to remain poor for the third consecutive quarter, largely led by significantly weak annual comparisons for stocks in the commodities complex following the collapse of crude oil prices in the Septquarter of last year. However, excluding global commodity plays, the annual growth rate of net sales for remaining sectors, on an average, is likely to fare modestly better in the Mar-quarter (4QFY15F), vs. the preceding quarter, suggesting that a bottoming-out is indeed in the making. We note that sequential q-q sales growth in this quarter is likely to be the weakest in the past five years. Everything else being equal, lower commodity prices are usually not incrementally positive for earnings of the raw material-intensive manufacturing sector in an environment of less-than-robust domestic and global demand. This is because even as revenue and COGS tend to be highly directionally correlated, companies are unable to derive the full benefit of weak input costs when their pricing power is impaired. However, margin expansion is expected to continue in the Mar-quarter for autos and consumer (where pricing power still exists, on an average), telcos and power utilities. In contrast, key sectors likely to report lower operating profit margins y-y are IT services and pharma (adverse cross-currency effects), cement and project specialists in industrial and infrastructure space (sluggish execution and legacy low-margin orders). Our bottom-up analyst expectations – for the 104 stocks in our coverage, but looking at the ex-oil & gas PSUs and ex-financials sub-universe – are the following: net sales down 3.0% y-y, down 0.2% q-q; EBITDA up 4.5% y-y, up 8.0% q-q; net profit up 0.9% y-y, up 11.6% q-q. EBITDA margin +151 bps y-y, +159 bps q-q. We expect the net profit for financials to rise 11.0% y-y and by 17.4% q-q. Please see Fig. 1 for how numbers change excluding oil & gas. Our Dec-end Sensex target of 33,500 is based on ~14% FY16F earnings growth, less than current consensus of ~17%. We expect earnings growth to normalise to a higher level in 2HFY16F as the commodity price base effect dissipates and “catch-up” growth begins to manifest in earnings on the back of a sequential improvement in growth. We note that the market has digested in large part concerns over growth weakness following the correction in Bankex index by 8%—the PSU banks index is down 16%—from the market’s peak on 29 Jan-15 (Nifty is off its peak by 2%).