Gautam Duggad, Head – Research, MOFSL, says there has been a very broad-based improvement in earnings. Out of the 18 sectors that he tracks, 17 have beaten expectations.
In Q2, we were looking for a lot of bounce back. The economy started opening up and suddenly comparatively everything was looking good. But Q3 was the question of sustenance and festive demand. Are you seeing those themes play out among different companies representing a wide section of sectors?
You are right. The second quarter was more about bouncing back from a 4-5-month-long lockdown. There was a lot of cost cutting because travel was not happening. Companies were conserving their cost elements and the second quarter was the first quarter. Let me give you a context; for the last six years, earnings have disappointed and for that matter even during 2010-2020, earnings for the 50 largest companies have grown at a compounded rate of just about 6% and that is one-third of what we had done in the 2001-2010 decade when it was 16% CAGR.
So we had gotten used to disappointments, companies missing earnings estimates and analysts downgrading on estimates. September came as a breadth of fresh air where for the first time in last many, many years we had to upgrade our estimates and companies had beaten our expectations. The fear in September was this may be a one-off quarter and then as costs came back and demand petered out after the initial pent-up demand, things may go back to usual. Thankfully that has happened.
The acceleration that we had seen in September has further picked up pace in the December quarter. The numbers are staggering. I will give you just one data point. Our expectations for the 30 companies of Nifty which have reported earnings so far was just 4% profit growth. What we have got so far is 25% profit growth and for the broader universe which includes midcap, small cap companies that we cover, out of the 105 companies that have reported, we have seen a profit growth of 32% versus expectation of 13%. What is more pleasant is the fact that it is coming from a variety of sectors. This is not a one company or one sector led earnings up move. Every sector that we track. has participated and has beaten our expectations and therefore we have had to upgrade our earnings once again. We have upgraded in September. We have upgraded before this quarter began in January and as we speak we have once again upgraded the numbers.
So there is an all-encompassing demand recovery. Every sector has seen demand recovery. Cost containment has continued. The margins that you see across different sectors which are part of the index have all expanded their margins between 300 and 500 bps and consumption has revived — be it discretionary consumer companies or staples — all FMCG companies have reported stupendous volume growth performance. So yes, fingers crossed. This is by far, the best earning season in a decade that we have seen.
Not to spoil that party but there’s a question mark on sustainability. Are we looking at this from a relatively lower base? Secondly, is this also reflecting the festive season which is traditionally a higher consumption period? Third, is there still a continuance of the trend of companies boosting their profits by cutting costs?
So let me answer that one by one. First of all, it is not on a low base. In fact, September quarter benefited from a low base. Relative to the September quarter, the December quarter has a higher base and that is why our expectation was just about 4-5% growth against which we have got 25%. So the base is not helping.
Number two, when you mentioned festive demand, we are doing a like to like comparison of October, December quarter this year versus the October, December quarter of 2019 and that effect evens out because you are comparing on a YoY basis not sequential on a quarter on quarter basis. Of course, there is some element of pent-up demand because consumers have come back with vengeance after six months of being locked inside their homes. But that still does not explain a 33% volume growth that we have seen in Asian Paints or a 40% top line growth that we have seen in Havells or a 15-20% volume growth in companies like Dabur, Marico, Emami.
I think there is a bit of a myth here because this second quarter narrative about companies cutting costs has become a very dominant narrative. In the second quarter, we had seen a massive 600 bps of gross margin expansion. While there was an overhead cost reduction, that was not the driving force for earnings growth. The driving force was gross margin expansion.
In the third quarter, companies have maintained their cost initiatives but some costs have come back now. For example, consumer companies B2Cs, have started advertising spends once again. Companies like Hindustan Lever, Dabur have reported 15-30% growth in advertising spend which is an expense. IT companies have given wage hikes to their employees. At the margin, because of inflation, some of the commodity costs have gone up and therefore gross profit margin which is essentially sales minus the raw material cost have come off a little bit in some of the sectors.
But because the demand has come back so massively, the impact of commodity cost increase has been nullified by the operating leverage which comes from a higher volume growth. Clearly, what we are seeing is demand getting stronger and what we have seen in the budget gives me a lot of hope that this demand can sustain going ahead as well. So even if some of the overhead costs come back as travel and offices resume, because demand is also improving and there is an element of inflation in the top line revenues because companies will increase prices, they will balance each other out. That is why we expect 35% profit growth for FY22. In FY21, we will do 15% profit growth for Nifty which in itself is a commendable number because this is a year when for five months, the economy was locked down. Compare this with FY16, FY17, FY18, FY19, FY20– which were normal years and we did just about 4-5% profit growth. If I can stretch that argument a bit, in April we were thinking that in FY22 if we get even FY20 earnings back that will be an achievement because FY21 was looking very bad then. We were thinking it might go down 20% on profit terms. Instead. it is going up by 15% and on that base we are expecting a 30% plus profit growth for FY22.
Clearly it will not be the same story in every sector and every company. Could you say this is a broad-based improvement?
It is a very broad-based improvement. In fact, this is as good as you can get it. Out of the 18 sectors that I track, 17 have beaten our expectations. It has never happened in the past that it is such a broad based performance. Yes, at the margin, cyclical sectors like cement, metals are having a much stronger momentum because they have been stagnant for a long period of time and now commodity prices are going up and investment demand is coming back and they are clearly benefiting from that.
But banks and consumer companies have beaten our expectations. So have auto and cement companies. IT companies have been beating for the last three quarters in a row. So it is as good as you can get it. You can just hope that this sustains for the next couple of years because India really had a decade of earnings recession. It is important that this earnings delivery continues for at least a couple of more years because that is what will propel the markets forward. There are a lot of news on a day-to-day basis. End of the day what matters most for stock markets is corporate earnings because they act as mother’s milk for the bull market and it gets highlighted often that in the long run, stock markets always are slaves of earnings.
So as I said. In the first decade of this century we saw 15% earnings growth and markets gave 17% return. In the second decade, we saw 6% earnings growth and markets gave just 8.5% return. That is what matters in the long run and we are seeing a recovery after a long, long time.
