Despite the economic shock, Nifty aggregate earnings for the year grew by 14% YoY, the highest in last 10 years, writes Ramesh Mantri, adviser to the Ashoka India Equity Investment Trust.
Consensus expects a 35% YoY growth in FY22 earnings; which, if realised, would be the best since FY04.
Importantly, the beats to misses ratio was broad-based suggesting a strong momentum across sectors. Earnings estimate trajectory for FY22 and FY23 have remained broadly stable over the last two reporting seasons, in contrast to the trend of persistent downgrades seen in the prior years.
Diverse corporate universe
It is noteworthy that India was among the few countries in the emerging markets that delivered a positive earnings growth in FY21 despite a growth shock.
This is underpinned by India’s diverse corporate universe compared to most EMs, with representation across various sectors rather than being dominated by one large sector which can render earnings growth very volatile.
For example, IT Services accounts for 16% in the benchmark Nifty index. Earnings for IT Services were resilient owing to an accelerated adoption of digital technologies during the pandemic.
Similarly, consumer staples accounts for 10% of the benchmark Nifty index where earnings traditionally have been less volatile as compared to the cyclical sectors.
While headline numbers are comforting, it is equally important to gauge whether it is sustainable. Much like other EMs, earnings growth for the aggregate corporate universe in India has been lacklustre over the last five years.
However, if the estimates over the next two years are realised, India’s earnings growth CAGR would be more than 20% which was last seen during 2005-2008.
Trends and shifts
We examine some of the key micro and macro factors which are important signposts in determining the progress of earnings growth.
Over the last few quarters, underlying corporate trends have been encouraging.
For one, there has been an acceleration in the trend of market share shift from the unorganised to the organised segments across a swathe of consumption-oriented sectors like building materials, electrical goods, and durables.
These businesses were better positioned to deal with supply chain bottlenecks and volatility in commodity prices compared to the unorganised segment. Corporates were also forced to take a hard look at their cost line items during the pandemic and many have come out with leaner, efficient cost structures.
The learnings while navigating the first covid wave in 2020 were deployed to ensure minimum disruptions during the second wave – for eg consumer staples companies stocking up distributors.
Contrary to the market’s expectations, corporate balance sheets have improved in the pandemic. Deleveraging continues to gain pace, with net debt in FY21 declining over FY20.
With overall levels of profitability intact, it has meant net debt/ebitda ratios at their lowest levels in over a decade.
As a consequence, the asset quality of banks has also held up well. Strong focus on cost control during the pandemic helped lift ebitda margins and while some of it might be temporary in nature, greater focus on use of technology to bring about operating efficiencies has helped enhance competitiveness.
Consolidation has also enabled the corporates to take selective price hikes to offset the volatility in commodity prices.
Expect a reversal?
While the underlying trends have been encouraging, a favourable policy mix can be a catalyst over the medium to long term.
India’s corporate tax rates are already amongst the lowest in EMs.
There is also a meaningful thrust on expanding infrastructure through the on-going execution of the National Infrastructure Pipeline (NIP) which will help improve the overall competitiveness of corporate India (India’s logistics cost to GDP is among the highest in the world).
Between 2017-2019, a challenging external environment in the backdrop of rising global trade tensions also weighed in on the earnings growth. In that context, an improving global growth outlook will act as a tailwind for some of the export leaning companies.
Over the last 30 years, corporate India’s earnings have grown by a CAGR of 12%.
The path has certainly not been uniform, with intermittent bumps such as the one between 2014-2019 when growth was a sub-par 5%.
Expectations for earnings growth over the next two years do appear high against the backdrop of recent disappointments, but if the confluence of the above factors play out, it would not be unreasonable to expect a reversal in the profitability cycle.
This article was written for International Adviser by Ramesh Mantri, adviser to the Ashoka India Equity Investment Trust.