The June quarter results of Indian companies have so far been good with net profits of the Nifty-50 Index (25 companies have reported so far) being 5.5% ahead of expectations. But in several cases, the results are helped at net level by non-operating factors, says a research report.
In a note, Kotak Institutional Equities Research, says, "India’s macro continues to look good with the recent sharp decline in crude oil prices, fall in bond yields and decent monsoons. The chances of goods and services tax (GST) implementation are also looking better. Thus, the dilemma over our positive top-down view and dwindling number of good bottom-up ideas has become deeper."
While 1QFY17 results have been good so far, EBITDA is in line with only RIL and ZEE, surprising positively meaningful, the report says. "Also, the outperformance in net profits has come from higher non-interest income (private banks), lower selling, general and administrative (SG&A) costs (IT companies), adventitious gains (RIL), lower finance cost (Bharti Airtel), lower depreciation, depletion and amortization (DD&A) due to change in depreciation rates (Maruti Suzuki India Ltd) and extraordinary gains (HDFC).” Below table gives details of the nature of the earnings outperformance. Without RIL’s adventitious gains, the overall results look less impressive, it added.
According to Kotak, during the June quarter, volume growth continues to be sluggish and summer months may have aggravated demand. It says, "We note that revenue and volume growth has been disappointing in general while cement and consumer staples volumes have been weak in particular (see table below). We note that that 1QFY17 coincided with India’s summer season and water scarcity in several parts of the country, which may have exacerbated an already-weak rural demand. It would be too much to expect high soaps and shampoo usage and construction activity without water."
Due to the good monsoon and the seventh pay commission-related payouts, Kotak hopes that there would be a pickup in overall consumption demand. "For now, we attribute the slowdown in recent economic activity over the past one-two months (see table below) and weak 1QFY17 volumes for the companies that have reported so far to severe weather conditions and water scarcity. Of course, many parts of India including certain cities are now facing floods, which may disrupt demand in 2QFY17 too. As an aside, droughts and floods are a telling commentary on the state of India’s infrastructure and its growth and investment challenges and opportunities, if policies and politics permit," the report added.
Kotak feels that the valuations in the Indian market, except a few areas where stocks are trading near its FY2018-E-based fair valuations, are expensive based on any reasonable parameter or timeframe. "Without a strong economic and earnings recovery in second half of FY17, we see further earnings downgrades, which would make valuations even more expensive. However, valuations hardly matter these days. The more interesting part is that almost all market participants acknowledge the expensive valuations but most are reluctant to act on the same. It seems to us that passive investment has taken a new form," the report concluded.