The upcoming results season of the first quarter in the current financial year 2018-19 (Q1FY19) has become more interesting because it is coming at the back of two years of sagging earnings growth. Will the market excuse another year of postponement in earnings recovery? Or will earnings growth finally begin to kick in at an aggregate level? Remember, the base quarter last year had a lot of business volume suppression owing to the goods and service tax (GST) transition. So it is only likely that we may see significant growth this time around in several sectors. However, this may still not ignite full-fledged hopes of earnings recovery as GST related restocking will kick up the base in the coming quarter.
Macros are not helping. Interest rates are creeping up (the 10-yr government securities - GSec - is at ~8% already). This is because of fiscal risk along with global tightening cycle (ECB, Fed). The oldest textbooks on equity will tell you that higher interest rates push down equity valuation multiples. Moreover, costlier commodities (esp. crude), can drive down currency value and stoke inflation in big net importers like India.However, India is now structurally better placed than any time in recent economic history: GST is in place, direct tax compliance has significantly improved, massive infrastructure is being built, governance is getting more rule-based. Meanwhile, the RBI has a huge dollar stockpile for intervention, so INR depreciation will not get out of hand. Finally, the government should be forgiven for some fiscal slippage in an election year.
Among financials, we are clear that Q1FY19 will see private banks gaining further on public sector undertakings (PSUs). This is because PSUs are injured and lack capital. Asset quality pain may continue to play out in most corporate lenders since some of them are still carrying sub-investment grade advances in their books. Some non-banking financial companies (NBFCs) seem overvalued, but pockets of excellence do exist. Q1FY19 should see the resurgence of NBFCs and small finance banks (SFBs) that have niche capabilities and reach since they will continue to grow sustainably in areas that remain underserved by banks.
The insurance vertical is due for growth moderation over FY19. Private Individual New Business Premium CAGR has been ~26% over FY16-18. Owing to a higher base (helped by demonetisation last year), a run-up to election year, higher interest rates (making fixed income more attractive) and uncertainty in domestic and global markets (as ULIPs still form a significant portion of overall insurance sales) we reduce our outlook for individual new business growth and now forecast 11-14% growth vs 15-18% earlier.
Apart from financials, we have been gung-ho on the IT services sector for quite some time. Here, the outlook remains positive with digital traction accelerating (higher deal size and wins), improving demand environment (especially in the US), strong balance sheets, cash generation and buybacks. Digital is now 25-30% of total revenue for most companies and growing at 25% YoY providing overall revenue acceleration. Q1FY19 is a seasonally strong quarter, organic growth rates will accelerate, while the dollar strength will absorb salary hikes.
Autos will have the advantage of a low base of last year (particularly in two-wheelers (2Ws) and commercial vehicles (CVs) owing to pre-buying in Mar-17 before BS-IV transition and GST related uncertainty). We also sense a strong recovery in rural areas and a revival in construction/e-commerce activities. No wonder that 2W volumes in the first quarter of FY19 are expected to grow by ~9-10% YoY, Cars/UVs by ~23% on a poor base and CVs by ~50% YoY. EBITDA margins will expand, owing to operating leverage and price hikes taken by most OEMs. This can be a blowout quarter in reported performance, but investors will surely take into account the base quarter effect, rising fuel prices and slowing global trade (important for CV volumes).
Oil & Gas should see a troubled quarter and this is reflected in stock prices (esp. Oil marketing companies (OMCs) for some time now. Brent crude has jumped ~11% QoQ (and 47% YoY) to $74.5 per barrel in Q1FY19 (avg). We expect inventory gains of ~$2-2.5 per barrel for refining companies. We expect strong GRMs for Indian refiners despite the fall in Singapore GRMs since diesel cracks are high. However, OMCs did not pass on the full impact of rising oil prices in Q1FY19 to auto fuel consumers (on account of state elections). So we expect lower marketing margins.
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