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Sensex earnings growth on fast track

India Inc’s earnings have gathered pace, with the rising Sensex in the past two quarters. As profitability improved in these quarters, Bloomberg consensus FY16 earnings per share (EPS) estimates for the BSE Sensex have been raised by 4.2% to Rs 1,873 versus Rs 1,791 at the end of the June quarter. The June quarter had also seen the EPS estimates being upgraded by a little less than a% compared to mid-May 2014 (the end of Q4 earnings season).

Interestingly, the EPS is expected to grow at a compounded annual rate (CAGR) of 17.2% over FY14-16 which is double as compared to 8.7% witnessed over FY12-14. This indicates that strong growth in earnings will continue and should reflect on the market as well.

“Though the year of windfall gains (for market) is behind us, Sensex will witness decent growth in the next two years. Our March 2015 Sensex target stands at 30,000, about 13% higher from current levels. We like cyclicals such as auto, construction and real estate and remain cautious on banks which will see challenges in FY16”, says Saurabh Mukherjea, CEO-Institutional Equities, Ambit Capital.

A large part of the earnings growth is expected to be driven by domestic cyclical sectors, which are still trading at a discount to their historical average price/book, believe analysts.

Rajat Rajgarhia, MD-Institutional Equities, Motilal Oswal Securities, says, “We have raised our Sensex FY16 EPS estimates by one% to Rs 1,854, up 21% over FY15. Earnings growth in FY16 earnings will be driven by cyclicals such as financials, capital goods and energy sectors.”

As private investment picks up and given that rupee has stabilised, cyclicals are likely to see improvement in earnings. Even as defensives stand to benefit from improved fundamentals such as pick up in domestic demand (FMCG) and global deals environment (IT and pharma), most analysts believe their earnings estimates may not see significant upgrades from here on; they will continue to grow at healthy rates seen in the recent past.

For FY15, Bloomberg consensus estimates Sensex EPS at Rs 1,565, an increase of 16.6% over 2013-14. Most experts, however, say that the current fiscal earnings have little significance as these are already factored by the market, and that the impact of policy measures by the new government will kick in only from 2015 onwards.

Earnings upgrades have been followed by upward revision in Sensex target as well as valuations. “Post Q1FY15 earnings, we raised our earnings estimates for FY15 and FY16 by six% and seven%, respectively”, says Dhirendra Tiwari, Head of Research, Antique Stock Broking.

With rising earnings growth, valuations too tend to increase. Currently, Sensex is trading at 18.8 times FY15 and 14.1 times FY16 estimated earnings. These are lower than the 20 times one-year forward PE multiple witnessed by Sensex in earlier periods of robust economic growth, indicating headroom for further upsides to valuations.

As per a Reuters’ report on August 13, foreign research house Nomura raised its Sensex target to 30,310 by end of August 2015. It said that cyclical pick-up in growth is being ignored by the market obsessed with bold policy and reform moves by the new government.

Factors such as stable government at the centre, improving macro-economic indicators and better earnings outlook are key positive for the markets going forward. The key risks are the policy initiatives and the pace of its implementation.

Interestingly, the June 2014 quarter saw quite a few positive signs. For instance, earnings growth in non-export companies improved to 12% as against low single-digit growth in the preceding ten quarters. Barring capital goods, most sectors posted double-digit revenue growth in the quarter. Pick up in economy and consumption demand will act as enablers for higher revenue growth going forward, believe analysts. Both revenues and earnings growth are likely to be more broad-based from here on as cyclical sectors see a recovery.

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