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India Strategy: Nifty Q2FY19 Review: Better-than-expected performance; expect a sustained recovery – albeit at a moderate pace

In Q2FY19, PAT of Nifty 50 companies rose 8.4% yoy, ~2% higher than IDFC estimates. Commodities and consumption companies beat estimates by ~4 and ~5%, respectively. Ex-financials, EBITDA grew 14% yoy and sales were up 25% yoy (supported by commodity companies). Interestingly, ex-commodities and financials, Nifty companies reported fair 10% sales growth. The consumption segment exhibited a dichotomy (in line with our expectations, details ). Autos in particular, reported weak performance (ex-Tata Motors, PAT grew 2.4% yoy) versus FMCG, which posted reasonable 12% yoy PAT growth. Earnings grew in 31 out of 50 Nifty companies, with a total of 23 Nifty companies beating IDFC PAT expectations. While Q2 turned out good despite impact of Kerala floods and the postponement of the festive season (to Q3 in FY19) – most managements have given mixed commentaries for the Q3 festive season, indicating a moderate growth trend in the upcoming quarter. Over the medium term, we expect sustained earnings recovery, albeit at a moderate pace (held by strength in high-frequency indicators, event-related disruption behind us, easing external macro concerns at the moment - given the recent correction in crude prices). Moreover, the easing pace of earnings downgrades (Exhibit 3) in companies over last few years, as seen from PAT upgrades or no estimate changes to downgrades ratio at 1.2 (against 1.1 in Q1FY19 and 0.8 in Q4FY18)further substantiates our view of a sustained recovery.

Earnings beat estimates with overall strong EBITDA growth: Nifty 50 PAT grew ~2% yoy above IDFC estimates, with the two key segments - commodities and consumption - beating IDFC estimates by ~4 and ~5%, respectively. EBITDA (ex-financials) growth, however, is more or less in line with estimates at 14% yoy, which signals operational stability.  

Q2 performance strong, despite Kerala floods and postponed festive season: Q2 surprised, as the quarter was expected to see the impact from Kerala floods and postponement of the festive season to Q3 in FY19 (against Q2 in FY18). As a result, the impact was primarily limited to the autos sector, which posted weak PAT growth at 2.4% yoy (ex-Tata motors) in Q2.

Management commentaries on the festive season mixed (to be observed in Q3FY19), indicate moderate growth: Our analysis of management commentaries across companies, points to a mixed trend for the festive season, with a moderately positive outlook. Hence, we believe that the festive season sales in Q3 will neither be a wash out nor robust, but will remain moderate.

Consumption space exhibited dichotomy; Autos weak while FMCG held up: We observed divergent trends across sectors, albeit not as extreme as we expected (details ). Within the consumption space, the dichotomy was sharper, with the FMCG sector reporting fair growth in volumes due to cost pressures and auto companies (ex-Tata motors) registering mere 2.4% yoy PAT growth. However, management commentaries of auto companies point to moderate festive demand in Q3FY19.

Cost pressures rise and margins compress across sectors, except for metals, telecom and pharma: Overall, Nifty 50 PAT margin compressed ~143bp yoy to 9.8%. All sectors, except metals, pharma and telecom contributed to margin compression, a result of stronger crude yoy (44% yoy growth as of Sep 2018, though crude prices have come off ~20% since then) and other commodities. Consumer goods saw moderate PAT margin compression at 57bp, owing to divergent price trends for underlying commodities.

Commodities do well but price pressure hurts cement sector earnings: Commodity companies posted 26% yoy PAT growth on superior performance in Metals and Mining companies (Coal India and Hindalco did well) and Reliance. Price pressure in the cement space continued, despite strong volumes, which led to weak earnings across the pack.

Growth trajectory to sustain, albeit at a moderate pace, as disruption is behind us and crude concerns have receded at the moment: The pressure on Nifty EPS downgrades has been receding, post sharp downgrades seen in last few years (Exhibit 3). We expect businesses to recover, with disruption (GST and demonetisation) dealt with in terms of business activity and base effect. The recent correction in crude prices (which would ease macro concerns for India to an extent) would provide further support. While we do not rule out volatility and vulnerability from global external factors, other high frequency indicators, which have assumed moderate growth trajectory (details ), will support growth.

Reiterate Nifty target range at 11550-11980 (12300-12500): We reiterate our Nifty target range for Mar-19 at 11550-11980 with ICICI Bank, Maruti, L&T, Coal India, GAIL, Hero as our Nifty top picks.