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India Strategy: Nifty Q1FY19 Review: Consumption, IT and Commodities do well; Financials disappoint

Q1FY19 Nifty PAT increased ~11% yoy versus our expectation of 20% growth. The miss in earnings came from financials (led by high ageing provisions for NPLs and MTM losses) and Tata Motors (weak JLR performance). Excluding financials and Tata Motors, PAT grew 28% yoy, ~1% above estimates. ~32% yoy growth in overall Nifty50 EBITDA hints at broad-based operational strength. Also, consumption PAT grew by 19%yoy on a low base owing to GST led destocking in Q1FY18, but Q117-Q119 CAGR growth stands at 10%, which bolsters our confidence in strength in underlying demand. With robust rural sentiment, depreciating rupee and robust deal wins for IT companies, consumption and IT (respectively) emerge as the two sectors with stable earnings levers for FY19. While commodities PAT grew by robust 43%yoy but concerns on trade wars could continue to dampen the sentiments. Consequently, we upgrade IT to Overweight from Neutral (we are already Overweight on Consumption).  Given the uncertainty surrounding global flows and trade wars, we continue to prefer relatively certain earnings growth stories for FY19. We reiterate our Nifty target range for FY19 at 11550-11980 (consensus at 12120-12220).

Nifty 50 segments with splendid Q1FY19 earnings

• Rural demand to support consumption: Consumption companies reported 19% yoy growth in PAT on a low base (but Q117-19 CAGR PAT growth at 10%), driven by rural demand recovery. Current demand is finding support from a bumper crop in FY18, farm loan waivers and increased government expenditure. We expect MSP hikes, continuing thrust from government (rural expenditure was up 28% yoy FYTD18 until June) and expectation of normal crop in FY19 (Kharif sowing has recovered in last two weeks) to drive growth in rural consumption growth in the remaining part of FY19 (more details ). 
• Depreciating rupee and efficiency gains aid the IT sector: Nifty 50 IT companies registered 10% yoy increase in PAT, outdoing expectations by ~5% yoy. While depreciating currency helped protect margins, utilization levels too have risen. Commentaries by IT companies citing positive deals, improvement in BFSI segment and a depreciating rupee should aid companies in the IT services businesses in delivering robust earnings growth in FY19.
• Oil & Gas and Metals sectors drive earnings growth in commodities: Nifty 50 companies within commodities posted robust 43% yoy PAT growth, led by Oil & Gas and metals & mining segments. While commodities has been is the best-performing segment, we expect trade wars to impact prices of commodities in the near term. Although oil prices have strengthened, there exist concerns on passing on these hikes to consumers. We expect companies within commodities to see pressure near term.

Higher slippages, ageing provisions cause weakness in financials

PAT of Nifty 50 companies in financials fell ~29% yoy, led by losses in Axis Bank, ICICI Bank and SBI. High ageing provisions for NPLs and MTM losses were key reasons for the weak performance in the financial sector. Financials have been a drag on Nifty earnings over last few quarters and we do not expect a change in this trend in the upcoming quarters, due to a prolonged NPA recognition cycle (only some support that may come from NCLT recoveries, but that won’t affect earnings trajectory meaningfully).

Overall operationally strong quarter; broad-based in line performance

Similar to last few quarters, Q1FY19 remained operationally strong with ~32% yoy EBITDA growth (~2% above estimates). Financials and Tata Motors led to the miss in our Nifty PAT estimates. Taking these two segments out, the broad performance for ~38 companies was in inline (~1% above estimates). Moreover, ~29 out of 50 companies surpassed estimates and PAT downgrade/upgrade ratio for Q1FY19 stood at 1.6 against 2.1 in the last quarter (Q4FY18).

Financials could be drag on overall earnings; underlying levers point to superior earnings performance in consumption and IT:

We believe growth levers of consumption and IT services companies are in place for FY19 and expect relatively certain earnings growth trajectory in upcoming quarters. But, financials could continue to be a drag on overall earnings growth, given the prolonged NPA recognition cycle. 

We downgrade FY19E/FY20E Nifty earnings:

In light of overall miss on Nifty earnings, we have cut our Nifty EPS estimates for FY19E/FY20E to Rs 516/Rs645, respectively, from Rs549/Rs682 earlier.

IDFC top picks: Maruti,

Coal India, NTPC, IndusInd Bank, GAIL, HeroMotoCorp from Nifty feature in IDFC top picks (refer to our detailed note on top picks ).