In its latest “India Equity Strategy” report, Nomura remains very cautious going forward and has painted a bleak preview of the upcoming quarter. Media and consumer discretionary are likely to do well

Stocks are driven by earnings and sentiment. The more important of the two indicators is the former. Hence there’s a lot of anticipation on how earnings will be, especially in the just-concluded September quarter. In its latest note, Nomura Equity Research has painted a bleak picture of the just-concluded September quarter citing that it is the weakest quarter since the sub-prime crisis began. Nomura said, “In inflation-adjusted real terms, sales are expected to grow in mid-single digits, while real operating profit growth is expected to stay in negative territory for the fourth consecutive quarter.” In other words, the worst isn’t over and expect it to be a bumpy ride for the foreseeable future.
 

While the subdued earnings were already discounted by the stock market earlier, what was more surprising was the fact that the market has absorbed much of the positive news announced by the government vis-a-vis reform measures. It seems that, in this case, the government has largely tried the sentiment trick—by announcing various policy reforms, including FDI in aviation and retail. The market reacted immediately, by going up. The report said, “The around 8% market rally since 13 September 2012 and India’s outperformance relative to peers makes us believe that this optimism has been subsumed in recent market action.” The onus is now on earnings to deliver. Will they?
 

Check the charts below: The growth has been trending downwards. This hardly is any cause for optimism unless the government does something extraordinary or companies perform superbly. There are bound to be a few surprises though, which happens every earning seasons. But as far as overall economy is concerned, don’t get your hopes up. The sentiment, is by and large, negative, and policy measures are unlikely to affect this quarter earnings.

Given that the economy has been subdued as is demand, much of the earnings expectations will now rest on external factors vis-a-vis rupee-dollar movement, global factors as well as government ensuring that the reforms go through the parliament, especially FDI in retail which has been the flashpoint of late. With a weakening global economy and recent Fed QE3 (quantitative easing), the dollar has taken a hit already. In other words, the rupee has strengthened against the dollar, and this is bad news for exporters, especially the information technology (IT) sector. However, on the flip side, QE3 meant more foreign capital suddenly making investments in India vis-a-vis FII which boosted markets, only temporally.
 

Nomura opines that the market has not reacted negatively enough in the face of possible earnings disappointment even though the market is current quoting at a discount. It said, “At current levels, the market is trading at 13.6x 12-month consensus-based forward earnings, which translates into a 10% discount to the latest five-year average, and 6% discount to the latest three-year average. While at these levels, valuations do not appear to be sufficiently discounting the much-diminished expected growth scenario over the next 12 months, we would argue that incremental evidence of sustained reform momentum could well offset existing growth concerns, which have lingered for most of this year now.” As per Bloomberg estimates, Sensex earnings was downgraded by 4% from April 2012.
 

Further more, it said, “We remain cautious going into the earnings season, which we think could well drive further the wedge between recent market moves and the reality of continuing growth pressures. We note that the market still lacks meaningful support from earnings upgrades with net analyst earnings revisions remaining in negative territory year-to-date”.
 

The rest of the report delves into which industry and stock are likely to do well and which are expected to face challenges. While sales of its universe of 120 stocks are expected to be flat, overall profits and margins are expected to decline on a year-to-year basis. It remained largely cautious on most sectors but positive on media (in view of recent digitization) and consumer discretionary (lower inflation translating to more purchases). It expects bank shares to correct given they’ve risen sharply in the past few days.
 

Tomorrow: Earnings outlook of specific sectors