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India Strategy: Nifty50 Q3FY20 Review - Demand weakness persists, continue toexpect a recovery FY21 onwards

Nifty50* Q3FY20 continued to see a fairly segmented performance led by a) weak earnings reported by commodity oriented companies, b) strong show by financials and c) strong base effect support from Tata Motors (TAMO). Ex-TAMO, Nifty PAT grew 22%yoy (6% above IDFC estimates and 1% above consensus estimates). Ex-financials, commodities and TAMO, PAT (for 24 out of 50 Nifty companies) increased by 8%yoy, about 1% above consensus estimates. Led by overall weak demand environment in consumption as well as commodities space, overall Nifty revenue was broadly flat yoy. While weak demand and revenue continued to be the key theme of season, marginal beat on estimates can be viewed in positive light. Going forward, we expect a recovery in demand environment and thus corporate earnings in FY21 led by sustained government expenditure and strength in commodity prices (as global event based risks recede). From our top picks from Nifty 50, HUL, ICICI Bank, HDFC Bank, Dr. Reddy’s, UPL, L&T, and NTPC exhibited healthy earnings growth and we maintain them as our top picks.

Top line remains tepid, leading to a muted EBITDA and PAT performance: Overall Nifty-50 ex-financials and TAMO revenue declined by 1.5%yoy, primarily on back of 7%yoy decline in commodities companies’ revenue and a mere 0.6%yoy growth in consumption companies’ revenue. Commodities companies PAT declined 22%yoy leading to a 4%yoy decline in PAT for Nifty ex-financials and TAMO.

Marginal beat on consensus estimates: Sales and PAT for Nifty (ex TAMO) saw 1.5% and 1.3% beat on consensus estimates, which is encouraging in our view. Financials, IT, Consumer goods, Petchem, Power, Autos were key sectors within Nifty that saw beat on consensus PAT estimates. On IDFC Nifty sectorwise PAT estimates - Consumer goods, Metals, Financial and Power saw a beat while Cement, Media and Pharma were below IDFC PAT estimates.

Commodities, financials and TAMO were the outliers: a) Commodities on account of weak underlying prices, b) financials on account of lumpy recoveries and c) TAMO on back of a low base, were the outliers for Q3FY20 earnings season. Commodities saw 22%yoy decline in PAT while Nifty50 financials (ex-Yes bank) saw 87%yoy growth in PAT.

Demand environment for FMCG remains weak leading to moderate volume growth across companies, we believe levers for recovery in rural consumption in place: FMCG players saw moderate volume growth on account of weak demand environment which led to a 5%yoy increase in revenue for FMCG players, while Autos ex TAMO saw a 2.5%yoy decline in revenue. While commentary of most players remains cautious, indicating a prolonging pain, we believe levers for recovery in rural consumption are in place, particularly, a) robust growth in Rabi sowing (up 9.5%yoy), b) strong price recovery for farmers as food inflation is high and c) strength in government spend led by rurally and socially focused ministries, which is up 22%yoy on FYTD20 basis. These levers in-turn should aid in rural consumption recovery Q1FY21 onwards.

Growth in financials led by lumpy recoveries: Nifty50 financials PAT grew 87%yoy, deriving strength from recovery income. While we expect recovery income to support going forward too, timing of recoveries remains uncertain (whether Q4FY20 or FY21) at this juncture.

Commodity companies’ earnings suffer on account of weak commodities prices: Weak underlying commodities prices was the key reason behind a 7%yoy decline in top line for commodities companies and 22%yoy decline in PAT owing to operating leverage impact.

Continue to expect a recovery in FY21 led by recovery in commodity prices and support from government expenditure: We expect recovery in commodity prices (as coronavirus threat and concerns on global economic growth recede) and continued government expenditure in FY21 to drive the recovery. This would mean resurge of strength in top line albeit with a downward pressure on margins.