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India Strategy: Nifty Q3FY18 earnings review - Overall good quarter

For 49 out of 50 Nifty companies that reported results*, sales, ex-financials EBITDA and net profit (PAT) increased by 13%/ 19% /23% yoy, respectively. Adjusting for exceptional one-time gains reported by HDFC Ltd and Infosys(∞), PAT grew 11% yoy, with 36% yoy growth seen in commodity companies and 13% yoy growth in consumption^ companies.  Commodity companies primarily led growth in Nifty earnings, followed by infrastructure and consumer goods. Margin expansion also continued on the back of stronger results by commodity companies and cost structuring efforts by consumer goods. Interestingly, Nifty PAT reported a CAGR of 22% over Dec-15 PAT, indicating a healthy growth over pre-demonetization base. While 9MFY18 Nifty earnings have grown by 13% yoy, we expect moderately lower earnings growth of ~6% yoy in Q4FY18 on a higher base. However, we reiterate our expectation of sharper growth in FY19 (~18% yoy), once structural reforms/stimuli (GST, banks recapitalization, infra and rural push by the government) start bearing fruit. 

Mild beat on PAT growth estimate; Commodities surprise while Tata Motors disappoints on back of JLR: Overall, PAT grew mildly above estimates (beat of around ~1%), led primarily by commodities companies (primarily Oil & Gas and metals), which reported PAT around 14% above estimates. PAT of non-commodity companies was 3.4% below estimates, disappointed by Tata Motors due to: a) weak JLR margins, b) higher depreciation and c) lower profitability from China JV. In terms of breadth of earnings surprise, 25 out of 49 companies reported PAT above their IDFC estimates.

Margin of consumer goods companies’ surprises on cost-structuring efforts: Overall, Nifty EBITDA (ex- financials) and PAT margins expanded 91bp and 99bp, respectively, for 49 companies. Margins of commodity companies found support from strong top line growth and operating leverage, which caused EBITDA margin to expand 166bp. Interestingly, EBITDA margins of consumer goods companies (HUL, ITC and Asian Paints) too expanded 752bp on superior cost control (despite rising raw material costs). PAT margins of 8 out 14 sectors expanded, with EBITDA margin expansion (ex-financials) seen in 10 out of 13 sectors.

Commodities continued to lead earnings growth on stronger prices and global recovery: Companies within Nifty’s commodity sector reported sales/ PAT growth of 20%/ 36% yoy, respectively, led by: a) stronger crude, aiding inventory gains across OMCs, b) relatively strong volumes across GAIL, ONGC, BPCL and IOCL, c) strong gross refining margins (GRM) reported by Reliance, IOCL and HPCL, d) strong metal prices across-the-board along with volume growth. Commodity companies within Nifty accounted for 29% PAT in Q3FY18 versus 26% in Q3FY17.

Demonetization in the base supported revenue growth for consumer companies: Consumption (autos ex-Tata Motors, consumer goods ex-ITC, ex-telecom) companies within Nifty reported 12.2% yoy revenue growth, finding support from demonetization in the base quarter. Though companies in the consumer goods sector reported robust PAT growth of 18% yoy, PAT growth of automobiles companies ex-Tata Motor came in low at 7.6% yoy (led by lower other income across most companies).  

Pharma, telecom report earnings decline due to industry-specific issues: Nifty pharma companies reported the highest PAT decline at 43% yoy, owing to: a) weak revenue growth on a high base, b) tough operating environment (slow/delayed ANDA approvals, looming FDA issues). Earnings within Nifty telecom too fell by 17% yoy on weak operating performance reported by Bharti (cuts in interconnection usage charges (IUC) and ongoing downtrading) and higher-than-expected tenancy drop reported by Bharti Infratel.

Q4FY18 could see relatively lower earnings growth on a high base; we estimate FY18E growth at ~11% yoy with a steeper growth trajectory in FY19 (~18%yoy): 9MFY18 Nifty earnings grew 13% yoy and we expect FY18E Nifty earnings to grow at ~11% yoy, indicating relatively milder growth in Q4FY18 at ~6% yoy (on a high base, Q4FY17 Nifty earnings grew at 25% yoy). We expect earnings to grow by ~18% yoy in FY19, driven by expected recent reforms by government (GST, non-performing assets (NPA) resolution, key infra projects and rural push, etc.), which we believe should begin to impact economic growth.

Reiterate Nifty target and top picks: We reiterate our Nifty Mar 2018 target at 11,300 and expect to roll over to Mar 2019 post results declared by Ambuja Cement. IDFC top picks within Nifty 50 are Maruti, ICICI Bank, HPCL, Hindalco Industries and Aurobindo Pharma while Bajaj Auto is our top Sell.