Warning bells! FY23 set to be a washout year for India Inc?

After a bonanza in the last two fiscals, there has been a big downgrade in FY23 and FY24 earnings forecasts for some of India Inc’s biggest companies, which have declared results for the March 22 quarter so far. These giants include Infosys, TCS, HDFC Bank, Nestle, ACC and HCL, among others.

This is expected to weigh on India Inc's overall earnings for FY23 and F24. “Looking at the initial batch of corporate results for Q4FY22, we expect a 15-20% cut in the Nifty 50 companies’ forward earnings estimates for FY23,” says Dhananjay Sinha, MD and chief strategist JM Finance Institutional Equity.

Analysts now expect Nifty50 EPS for FY23 to be around 15% lower than the current forecast of ₹873. This in turn may translate into a flat or single-digit growth for Nifty companies’ overall earnings in FY23. Nifty50 EPS tracks the combined net profit of India’s top 50 listed companies that are part of this index.

India's second-biggest IT services company, Infosys, for example, reported a net profit of ₹5,695 crore in Q4FY22, against a street estimate of ₹5,900 crore. Similarly, TCS reported a net profit of ₹9,959 crore, missing the Bloomberg consensus estimate of Rs 10,077 crore.

Sub-par profit growth by IT majors has triggered earnings downgrade by brokerages. Prabhudas Lilladher cut Infosys earnings per share (EPS) for FY23 by 10%, while Emkay Global has cut it by 7.2% from their earlier estimate. Similarly, TCS forward EPS for FY23 has seen a 2% cut by brokerages.

In banking, brokerages cut their forward estimate for HDFC Bank after its Q4FY22 earnings. "We cut HDFC Bank FY23-24E earnings by 2-3%, due to slower-than-expected credit growth amid weakening macros due to the Ukraine-Russia conflict and decline in margins," Anand Dama and Heet Khimawat of Emkay Global Financial Services said in a report.

The overall corporate earnings face heat from high inflation and a sharp rise in bond yields and interest rates in both India as well as in the US.

A sharp decline in interest rates from April to July 2020 was instrumental in a jump in corporate earnings in FY21 and in the first half of FY22 besides lower material and energy costs. This was especially true for banks, non-bank finance companies, metals and mining and power companies.

Both these tailwinds are expected to turn into headwinds in FY23 as central banks across the globe battle to control raging inflation.

Sandeep Bhardwaj, CEO, Retail, IIFL Securities, says the central banks have been behind the curve in controlling inflation. US CPI was 8.5% in March, which was the highest in four decades, while Germany’s Producer inflation shot up to a record 30.9% in March.

India, too, has recorded a 14.55% WPI in March, which means that WPI has been in the double-digit territory for 12 consecutive months. “Controlling inflation would be a priority now to keep the economic recovery on track. If effective steps are not taken, the excess commodity cost pressure will dent the margins of the companies,” he says.

Moreover, says Bhardwaj, rising energy and commodity prices not only lead to lower margins for the producers, but also higher prices for the consumer. “As the price of goods and services keeps increasing, it leads to a demand shortfall. Hence, we expect the earnings are likely to be on the lower side for FY23 and FY24.”

Yesha Shah, head of equity research at Samco Securities says FY23 would be a mixed bag for corporate India. “All the consumption-oriented and FMCG companies will be facing a lot of pressure due to inflation, very bleak rural demand scenario, and there are chances that inflation going ahead could dent volumes. From where we stand currently, we don’t see a pick-up in commodity consuming sectors in Q1,” she says.

In the FMCG space, Nestle India's gross margins were down 313 basis points year-on-year during the Q1CY22 quarter leading to a 1.3% Y-o-Y decline in its net profit during the quarter. “We cut CY22/23 EPS estimates by 2.1% due to gross margin slippage. We expect near-term margin pressure to sustain, given the high inflation," says Amnish Aggarwal of Prabhudas Lilladher, in a note. Nestle India follows January to December fiscal year, and Jan-Mar was its first quarter for CY22.

Industry leader Hindustan Unilever reported a 300 basis point decline in gross margins in Q4FY22 but managed to beat earnings due to higher other income and a 220 basis point decline in ad-spends to sales that may not be a compensating factor going forward.

In the cement sector, ACC reported a steep 29.7% Y-o-Y decline in net profit in its Q1CY22 due to a sharp decline in gross margins and a decline in sales volumes.

Bhardwaj says the yield on 10-year US treasury inflation-protected securities has turned negative and the inversion of the US treasury yield curve has historically acted as a warning signal for decades. “Oil price shocks have sped up the process and India, being a large importer of oil, is more likely to be under stress. An impact on the margin would lead to an earning miss and invite a downgrade for many stocks.”

The turmoil will not be restricted to margins and earnings though. As revenue and profits of a company decline, the company would also reduce hiring. “To cut costs, companies would further reduce marketing expenses, invest lesser in R&D; halt new product rollouts due to uncertainty, and so on. Hence, a slowdown does not affect a particular company or a sector. It has a cascading effect and eventually affects most sectors,” Bhardwaj adds.

Shah agrees that there could be some impact on expansion plans but it cannot be gauged fully right now. “Should inflation turn out to be transitory and the rural demand comes back, companies may not delay their expansion. But if they view these headwinds as persistent, then they may put capacity expansion plans on hold,” Shah says.

The impact of rising inflation, higher commodity and energy prices and the interest rate hike will, however, vary from sector to sector. Like banks are seeing healthy growth in unsecured products, working capital (higher commodity prices), SME loans, and mortgages. “Recoveries and upgrades are likely to outpace slippages,” says Bharadwaj.

But the power sector fundamentals could worsen if strong reforms are not initiated to revive the financial health of SEBs. The power demand is set to grow, but supply-side issues will linger (shortage of domestic coal plus expensive imports) leading to higher power cuts, payment delays, etc. Meanwhile, rising input costs, interest rates, and other execution issues pose risk to RE capacity-addition targets, he adds.

Shah says automakers are also facing supply-side constraints and while some of them have announced price hikes, it is too early to say how the rising inflation and lower disposable income will affect them. “The first quarter of FY23 will see a tremendous pressure on earnings in commodity consuming sectors and the auto sector is no exception,” she adds.

Rising commodity prices will have an impact on the margins as many companies would not be able to transfer the full price impact to their consumers, says Bhardwaj of IIFL.

For the IT majors, the underlying demand is strong but they are facing supply-side pressure. “There is some re-rating, which the market is factoring in as the growth will not be as high as it was during COVID in the last two years,” Shah says.

It would be interesting to see how stock markets react to it. Shah believes the stock markets have already pencilled in most of the growth and earnings upside. “So room for error is limited. Even a minor miss on margins vis-a-vis the expectations of market participants can result in magnified reactions,” she says.

This has been already seen in the case of IT bellwether Infosys’ results. Though the demand scenario was strong for Infosys, the stock market reacted adversely because of the company missing margin expectations and the entire IT index went down. Overall too, IT stocks have been under pressure largely due to a decline in demand (compared to COVID years), overstretched valuations and high attrition rates.

As for the second half of the year, a lot will depend on how inflation pans out and on the situation of the Russia-Ukraine war and COVID, Shah adds.