Edelweiss Forecasts 20% Earnings Growth In FY19
Edelweiss also said that banking sector could be a dark horse in the next financial year.
The Nifty 50 companies may clock 20 percent earnings growth in the next financial year, said Aditya Narain, head of research at Edelweiss Securities. He expects an earnings per share of Rs 490 for the current financial year and Rs 600 for the next.
Commenting on the sectoral performance, Narain told BloombergQuint that the banking sector could be a dark horse in the next financial year, despite the selloff following the Rs 11,000-crore Punjab National Bank scam. He expects the asset sale by various agencies would likely aid lenders in recovering their money.
Edelweiss earnings forecast comes in the backdrop of most banks missing the street estimates during the first three quarters of FY19.
In the December quarter, none of the bank’s earnings, which is the most represented sector in the Nifty, managed to surpass analyst estimates. Two of the country’s largest lenders State Bank of India and ICICI Bank Ltd. missed estimates, while rest reported earnings that just about matched forecasts.
Watch the interview here
Here are the edited excerpts from the conversation:
What did you make of the third quarter?
The aggregate came more and less in line with expectations. To some extent that has been a relief because so far you have been pretending to miss right through. That, in some sense, is relief and comfort. We are beginning to see ride volume expansion and domestic consumption starting to show much more transaction, which is very important as it gives you a sense of the general health of the economy.
On the investment side, you tend to see some patch numbers, but construction companies are beginning to see much more excellent order books. This says that at recovery level you see solid signs of incipient recovery. It is not full-blown recovery but the signs that you are getting of incipient recovery, clearly on consumption side a little bit on the investment side, I think that gives you a fair amount of comfort.
The big swings are the earnings on the commodity side which have been the overall support for the earning system, and there have been some prices on banking side which are brought down the overall average.
So, little bit swing factor is more driven by pricing and provisioning with this quarter of interest rates. So, that is balancing factor. So, if you take that out, then the rest show a certain amount of help from a consumption perspective from an of incipient investment side which I think is positive.
Where are we on estimates that you had for FY18? What are your broad estimates for FY19?
To some extent, we do start factoring in an incipient recovery. Historically, what happened at Indian numbers is that they started at 20 percent at the beginning of the year and they have worn down. Now this year, it is looking a little better because the first was a week, the second was on par, third is on par but above expectations, above the zero-percent level.
I think this trend should by and large continue. At an absolute level, you will have this swings from the banking side, as you don’t know when provisioning will be capped out, whether in this quarter or will it stretch a little bit more. Likewise, on commodities, it is little hard to make that call that whether this kind of momentum will efficiently continue.
At the consumption side, you are beginning to see volumes. You can argue some levels of the investment side. The numbers are not being changed for us in the aggregate of what we are looking at financial year 2018-19, and surprisingly or non-surprisingly it sees like a 20 percent number. It is something that you can increasingly aspire for.
Now, you are getting pockets of growth which you didn’t have, and those are not so much on price but on volume which is where the comfort tends to be.
What is your earnings per share number for FY18?
We are about Rs 490 levels.
Do you think there is a fair chance to hit that number?
I think we should. There is variation as far as the banks are concerned, particularly on how interest rates are playing, and you could well have a situation where it comes off, and you have a certain amount of write-back of all the pains taken in this quarter. But that remains a little bit of variable. But the numbers that we have to post the quarter are Rs 490 levels for this year and Rs 600 levels for FY19.
With that as your base case scenario, would you be comfortable with the kind of valuations that we are trading at? For Rs 600 levels at FY19, you would presume that we are not in the expensive zone but fair valuation zone.
I think so. There are two parts to it, where are we in the valuation zone and where are we at the recovery stage, which determine valuations in many senses. You can argue for much stronger growth and efficiently be on it.
The third is where are we in the economic cycle. We have 5-6 years restructuring that has been gone on. When you get through it, you will inevitably external elements conspire against and efficiently get 3-5 months of decent and long growth. I think we are positioned very well on that front.
Given that where you are, I would argue that the markets could trade at higher levels rather than necessarily be pegged to its mean. The mean is formed when you are at higher levels, and the average is when you are trading at lower levels. I think this is the point when you will purchase at higher levels because you should have an economic tailwind that can sustain for a bit. It is the stage of recovery too. If we got it right, then this is an early stage of recovery which will give you extended run for a couple of years.
There is outside chance that the hikes in the U.S. will be quicker and more than anybody has anticipated. What happens if that plays out regarding flows?
We have to look at it from two elements. One is market or macro component and other is the economic element which is growth element and what is happening in the underlying economy. If you are to look at growth or financial element, we are lagging the broader world. Our economic recovery has been slower and lower than what you see across the world.
So, in some senses, even if you have the cushion than even you were to align the cycle, India has a certain amount of catch up to do. That is primary. Let’s not caught up with the market or macro element or level operates element. As far as the economy is concerned, economic growth and recovery, we are lagging, and we have a certain amount of catch up to do, and we have a certain amount of cushion. This is going to be the story for a current year, and potentially beyond that, the economy and underlying will start doing better, and it has a certain amount of catching up to do. So, it would be a more extended economic cycle domestically.
Your point on bond yield and macro is very well taken. It could have some amount of uncertainty there. You are having some amount of uncertainty there which can keep valuation in flux and can hurt flows. So, that remains the thing that you need to worry a little bit about and watch more closely. The issue with that is it's very hard to call that. This element will create volatility in the market, whether it is event base or rate hike base or general flows that can disrupt markets. That is going to give you opportunities to buy and to trim.
It will be in contrast to what we saw last year where it was all macro without enough micro, but you still got a lot of returns, which means there was very less volatility. This year, probably, you will get much more macro, but it will be less comfortable on micro which you have to make a call that whether it will be an extended cycle, and which will give you opportunities.
What has worked in Q3?
The most robust part of it is consumption which is broad-based, where the volumes are coming back, notwithstanding the fact that there was a base effect. Even on a quarter-on-quarter basis, you have seen volumes come back. That will be the healthiest part of this entire quarter. When you start seeing volumes, it gives you a sense that activity and buzz are going on which tell you that there is vibrancy in the economy. That then leads to the smaller amount of investments, expansions and at the aggregate level it provides you with a big picture and investment, and that will be the biggest positive.
Public sector banks, in fact banks in general, had been a disappointment, recent revelations notwithstanding. The challenge has been twofold that you have been expecting asset recovery or resolution, or asset pricing regarding provisioning, and that has got a push back. It has got combined with time periods when yields have gone up which makes harder for profit and loss statement to support some of these charges that come through.
At macro level, there’s the risk that the micro factors cannot translate into macro investment because the intermediate layer in between has been a challenge, and that is where it becomes a sticking point regarding how you pronounce the recovery.
What do you think of the auto sector?
In some sense, the demand side looks good. Very few company managements want to be bullish. If you look at overall numbers across two-wheelers, trucks and four-wheelers, there is robustness present. So far from market and valuation perspective, it was the only strong sector but now there are other sectors too which are performing well. So there is a little bit of correction. The market has moved, and globally there has been a challenge.
So, the explanation for a market pullback of numbers is predominantly is the fact that the stocks have moved rather than anything that has come out in numbers or commentary which is continuously consistent.
Which are the other sectors looking similarly strong?
In terms of numbers and commentary, then consumer credit side continues to be decent. The construction sector is also looking healthy. They are much smaller businesses, but it is encouraging the way they are getting orders.
Do you think orders came in Q3?
The investors will not like if you show huge order books but are not sure about the money you are making or the margins behind it. You did see a reasonable build up in order books in the quarter, not as much as the biggest bulls would have accepted, but almost everyone showed margin expansion. This shows that the quality of order booking for the guys who are taking them is good and that’s important. The metal sector was also robust, but it can’t be attributed to local factors.
IT was a little bit encouraging. Midcap is already done, but for the large-cap to the commentary that we are getting, and the U.S. is chugging along so well this point, and, in your books, you got a decent amount of digital growth, that combination is playing through well.
Do you like large-cap IT stocks?
Well, selectively but we do believe that as a micro theme, it is certainly coming back. The way their portfolio is put together, for a long time, digital was very small part of your business, and that was showing traction. Now, that has become much larger part of difference if you grow rapidly. In some of the area, the adjustment to cloud and such stuff, and bulk of them is going to happen. There we see a change, but selectively we like stocks there. The midcaps have had a good enough run, so it will be more risk-adjusted opportunity on large-cap side.
In healthcare, is it possible to see green shoots here or is it too volatile?
At a sectoral level, it remains a little early. The U.S. continues to see, at regular generic base, more filing that pricing competition. What changes is the number of people providing it, so it naturally flows through more competition. Complex generics is a little different. People will have much better pricing, but that will tend to have more selective and slower in coming through.
The domestic healthcare sector has been softer than what people would have expected, whether it is GST, demonetisation and balancing on that front. But there isn’t much to suggest that we will get the material delta on that part. You can argue that adjustments are taking place but are you at end of the adjustment cycle is a little presumptive to call it.
There are two elements. The regulatory bit has been very uncertain. Probably, we will get more predictability regarding timelines rather than the decision. The FDA is speeding up and giving timelines that when the decision will come. That brings some predictability regarding when stuff will come.
I tend to believe that the diversion of market focus from a real business will moderate going forward as far as pharma is concerned. So, they will start looking much more at the real business, but the real business is not at a stage yet where you can say at most it’s another quarter, so I am ready to take a chance now.
In cement, ACC and couple of others but the numbers didn’t live up to the mark?
As far as our numbers are concerned, they did much better. Everyone has a view on the cement sector, and it is an important part of what the rest of the economy is tending to do. Our sense is when you haven’t got the pricing and value that you expect, the tightening regarding business regarding how businesses have been operating has been much more significant then people would have realised. That’s why you get a little better aggregate numbers than what the market expected.
It is compared to what we expected, and it was a strong quarter. Not on the topline, not concerning volume and price but the bottom line that is coming through the just better management of cost, logistics and transportation, the number have been better.
Did you think the earnings growth will come in a meaningful way for cement in FY19?
Yes, they could, and their operating leverage is very high in such a business. The numbers could be good, but I don’t think the underlying either concerning price and volume will be runaways. There is a market expectation that you will get a V-shaped recovery at some point in time. But whether it is capex spend or ancillaries that feed in, it will be a more measured U. Because they have created a base where their operating cost has been tightening up substantially, I think the bottom line impact will be higher as long as some of those numbers are coming through.
Are there dark horses for the calendar year 2018 or FY19?
IT is not sensitive. The banks are the function of how they provide. If they are tough and tight in the last quarter, and there are some of the asset recoveries on asset sales, that could give a little cushion. So, that could be a pretty nice one.