Credit-Suisse: India Strategy: Sensex FY10E EPS at '6xx'?

Sensex FY10E EPS at '6xx'?

■ Bottom-up consensus estimates for Sensex FY10 EPS have come off by 25% in recent months. Finally, it is forecast to be below the record level in FY08. We expect it to fall another 25% to between 600 and 700 as the year progresses.

■ December 2008 was the first quarter in the cycle to see a revenue deceleration. The deceleration was sharp but the cycle has just begun. We expect top-line growth to reduce from around 15% to less than -5% in 2009.

■ As revenues decelerate, margin pressures will intensify. With simultaneous other income pressure, overall profit for FY10 could fall further by 25% making FY10E ROE around 12-13%, still higher than the lowest 10% ROE recorded in each year between 1998 and 2001.

■ Financials’ profits as a percentage of total reached the unsustainable and record high 30%+ level. In both the bull and bear cases, their profits should underperform in the quarters ahead.

■ We do not think FY10E EPS downgrades will depress the equity market further as long as the hopes of a sharp FY11 bounce stay high. The positive medium-term recovery expectations hinge on the new government and its policies. For now, we maintain that the market will likely ignore the possibility of FY10E EPS of ‘6xx’, and hover around the Sensex level of 9,000; whether the next stage is priced on a recovered FY11 earnings or depressed FY10E EPS will depend on the election results in early June.

Much more potential downside to FY10E earnings

Revenue collapse begins

The most distinguishing feature of the latest quarterly results is the first drop in revenue growth for the cycle. The drop was quite sharp too: for the universe of all non-financial companies, sales growth is down from almost 40% in the previous quarter to barely 10%. While a part of this was due to falling commodity prices, a volume decline on the account of a demand slowdown also played a role, particularly in autos and property. Worryingly, sales growth is likely to deteriorate further because of the continuing economic deceleration and worsening high base. We expect revenue growth to continuously fall to reach the lowest recorded rates at less than -5% in 2009.

Profit fall to worsen on top-line pressure

Profits declined in Sep-quarter at a historic rate due to oil losses. The pace of the decline in the Dec-quarter was same as the previous one, but the reasons were more broad- based rooted in the economic slowdown. Effectively, ex-oil universes’ profits have started contracting only now. The worst hit have been companies and sectors with high operating and financial leverage. The trend in other income has also reversed sharply and could deteriorate further in the coming quarters because of falling interest rates, weak financial markets and overall economic conditions. The only exception has been financials with YoY PAT growth of ~30%, which is unlikely to be sustained going forward. Overall market profit could remain in deep negative territory at less than -20% YoY for the rest of 2009.

Financials’ profits untenable

The financial sector’s profits as a percentage of total had never been higher at 32%. For financial s’ profits to grow at over 30% YoY while the rest of the corporate world is witnessing a contraction of the same magnitude is unsustainable, in our view. Financials’ profits were not just from mark-to-market gains on bond portfolio, but strong loan growth, margin expansion and strong fee income also contributed to over 30% net interest income and net profit growth. A likely 250-300 bp decline in interest rates over the next few months could lead to substantial margin pressure. Government banks’ bottom lines could see more pressure as their asset-liability mismatch is larger. A loan demand deceleration and weaker fee growth are likely the other outcomes of a weak economic environment. Most importantly, it is unlikely that NPLs and provision ratios could remain near the all-time low level in this environment despite regulatory forbearance. Risk for earnings (FY03/10E) is a significant 15-90%, on sensitivity of 200 bp higher NPLs. We remain UNDERWEIGHT on the sector and expect it to be the main contributor to depressed FY10E earnings.

FY10 estimates still off by 25%

Since November, estimates for Sensex’s earnings for FY09 have been down more than 15% and for FY10 nearly 25%. While we had been expecting a decline in consensus estimates, the magnitude was a surprise. Yet the downgrades are far from over, in our view. With revenue deceleration likely to continue, YoY PAT declines of as much as 30- 40% in some quarters in the next year cannot be ruled out. This would mean at least another 20-25% downside to current FY10 estimates and possibly Sensex EPS of between 600 and 700 with the market’s ROE falling to low teens for FY10. Will this matter to the market? We think the market will begin to trade at a low P/E on FY10E EPS (i.e., Sensex below 7000) only if the hopes of medium-term or FY11E EPS growth vanish. If economic growth returns, the prospects of near 40-50% EPS growth in FY11E will help investors ignore the current year’s numbers. Essentially, we deem a sharp decline in FY10

Sources: Credit-Suisse.com