Margins at 8-Year Low Signal Earnings Bottom: Corporate
Indian equities are attracting the highest foreign flows in the region as investors speculate that the worst may be over for the nation’s biggest companies after profitability slumped to an eight-year low.
Offshore funds plowed a net $12.3 billion into Indian shares this year, the most among 10 Asian markets outside China tracked by Bloomberg. The average profit margin before interest, taxes, depreciation and amortization of the 30 companies in the BSE India Sensitive Index, or Sensex, narrowed to 19.5 percent in the June quarter, the lowest since December 2003, data compiled by Bloomberg show.
Earnings forecasts this year are being cut at a faster pace in Brazil, China and Korea, while profit for companies in the MSCI India Index has stayed stable, Deutsche Bank AG said in a Aug. 24 report. Government data last week showed Asia’s third- largest economy unexpectedly rebounded from the slowest pace of expansion in three years after the Reserve Bank of India cut borrowing costs to support growth.
“With China’s growth slowing, India looks the best among BRIC countries year to date,” Taina Erajuuri, a fund manager in Helsinki at FIM Asset Management overseeing about $1.2 billion of emerging-market assets, said by phone on Aug. 31. “India’s economy is less dependent on exports to Europe than China and Russia.” Erajuuri said she’s been a buyer of Indian equities this year, without naming any stocks.
The last time profit margins for Sensex companies were this low, in 2003, the benchmark index soared 73 percent as economic expansion exceeding 8 percent lured foreign inflows of $6.7 billion into equities. This year, the gauge has climbed 12 percent, compared with the 0.2 percent gain in Brazil’s Bovespa (IBOV) Index. The Shanghai Composite Index (SHCOMP) has fallen 7.1 percent after China’s economy grew at the slowest pace in three years last quarter.
Overseas funds were buyers of local stocks for 23 straight days through Aug. 30, the longest stretch of net buying since a record 41-day streak through Oct. 27, 2010, according to data compiled by Bloomberg.
Funds have flowed into India even as Prime Minister Manmohan Singh struggles to revive his reform plan amid a logjam over attempts to open up the economy, corruption scandals and elevated inflation. The $1.8 trillion economy expanded 6.5 percent in the year ended March, the slowest pace since 2003, government data show.
India’s main opposition party has stalled parliament for 11 days, demanding Singh’s resignation after the chief auditor Aug. 17 said the government may have lost $33 billion awarding coal blocks without holding auctions. Singh was relying on the parliamentary session to pass legislation to allow foreign investments into retailing, aviation, pensions and insurance.
“Foreign investors are decoupling macro from the micro,” Sam Mahtani, who oversees about $5 billion as director of emerging markets at F&C Asset Management Plc (FCAM) in London, said by phone on Sept. 3. “The macro has been terrible in terms of the GDP growth, but in the micro you can still find good quality, long-term stories. We are not banging the table but we think India will do well relative to the other emerging markets.”
F&C has been adding to its holdings in companies including cigarette-maker ITC Ltd. (ITC), HDFC Bank Ltd. (HDFCB), the largest lender by value, and Tata Consultancy Services Ltd. (TCS), Asia’s biggest software services company by value, Mahtani said.
Earnings forecasts for the MSCI India Index have been cut by 2 percent this year, compared with a 15 percent reduction for MSCI Brazil and 5 percent for MSCI China indexes, according to Deutsche Bank. Sensex earnings grew 14.6 percent in the June quarter, exceeding Bank of America Corp.’s estimate of a 13.7 percent gain, Jyotivardhan Jaipuria, Mumbai-based head of India research, said in a Aug. 17 report.
“Falling margins have driven downgrades in the past 18 months, and we think margins may be close to bottoming out,” he said. “Earnings will be slow and there will be downgrades but lower than what we have seen in the past five quarters.”
The Sensex trades at 13.7 times estimated earnings. While that’s 30 percent more than the MSCI Emerging Markets Index’s valuation of 10.7 times, it’s still below the 15.8 multiple the gauge traded at in February, data compiled by Bloomberg show.
“India has always traded at a much higher multiple versus China or even some of the Asian or other BRIC markets,” Suresh Mahadevan, managing director at UBS Securities India Pvt., told Bloomberg TV India on Aug. 28. “Sitting in India, it feels like things are really deteriorating but on a relative basis versus other BRIC nations or global emerging markets we are not that worse off.”
Government data on Aug. 31 showed gross domestic product grew a faster-than-expected 5.5 percent in the June quarter as the Reserve Bank of India cut interest rates in April after raising them a record 13 times from March 2010 to October last year. Wholesale-price inflation eased for a second month in July to a 32-month low, spurring forecasts that the central bank may pare funding costs when it reviews policy on Sept. 17.
“A combination of slowing revenue growth, falling EBITDA margins and rising interest costs has caused” earnings growth to slow, Morgan Stanley analysts in Mumbai led by Ridham Desai wrote in a Aug. 27 report. “Macro indicators are showing positive change for these drivers and hence, incrementally, a better earnings picture.”
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