Market Will Test Your Patience

India was hoping to overcome this weak economic trend by undertaking corrective stimulus measures. But this expectation has been prolonged by the conventional approach of the final budget which has given priority to fiscal prudence than expending extra funds through borrowing to support the weakening economy. The optimism still holds good, but the economy will have to go through pain in the short-term before it revamps. The domestic market may recover by the second half of the fiscal year subject to normal monsoon, ease in oil prices and start of post-election business activities. At the same time, global market may improve led by a reduction in interest rate and quantitative easing measures indicated by world central banks.

Final Budget was below market expectation

There were high expectations from the budget given the larger and decisive electoral mandate of the new government. This excitement met with the realistic financial position, limiting the government’s bandwidth to announce eventful measures. Though below expectations, the announced measures provide a prudent plan for FY20 with a conservative approach not to overspend during this slowing phase.

On a positive note it surprised all of us with a better fiscal target of 3.3% for FY20 while the market was hoping for some dilution in the short-term to support the economy with backing measures. Though fiscal target improved, government spending is likely to be muted in FY20, which is not a positive sign for equity market and revival in economic growth. Within which an inherent positive is that spending will be tight and oriented towards priorities like PSU Banks and NBFCs. A strong support is provided to PSUBs with Rs70,000 crore recapitalization and a backup to sound NBFCs through additional guarantee.

Similarly, borrowing plan is likely to be measured and a portion will be sourced externally. This can reduce the crowding-out effect of domestic corporate borrower and reduce bond yield which is positive for bond market and economy in the long-term as cost of funding reduces. The 10 year Government bond yield has reduced by 50bps in the last one month to 6.55%. Also, allowing AA graded bonds as collateral is a positive step for development of bond markets.

The key areas mentioned in the budget where Bharatmala, Sagarmala and Grameen Bharat. Beneficiaries could be PSUBs with higher than expected Rs70,000cr recap and NBFCs with one-time guarantee to buy bonds and support liquidity. Real estate is also given sops over investing in affordable houses. Infra is marginally positive due to higher work-order from NHAI & cheaper cost of funds. Opening up of FDI/FPI in Aviation, Media, Insurance, REIT and proposal to ease local sourcing norms in single brand retail sector are positive forethoughts. But for real benefit more reforms have to be done on labor and high taxation system of the country. Losers could be the auto sector due to lack of clear reforms for combustion engines as focus is on Electric Vehicles and jewelries due to increase in gold duty.

Expectation met with reality…

A concerning factor in the budget finance is that revenue assumptions of FY20 seems to be on the higher side. The financial statement is not updated with the actual numbers of FY19 provided in media and economic survey which shows a clear shortfall of whopping Rs1.67 lakh cr in net tax collection for FY19. When we compare the actual revenue of FY19 provided in the economic survey document with the forecast of FY20, it shows a growth of 25% compared to 6% in FY19. This gives a sense that the government hopes to overcome this shortfall by increasing rates on direct tax, excise duty and custom duty in spite of the fact that economy is still weak.

The market was hoping for supportive actions from the government, which were not provided in the budget. This was undoubtedly due to the bleak fiscal position on account of slowdown in domestic & global market. Given the lack of incentive to invest, equity market may be lackluster in the short-term. Going ahead, market will start to react to the actual performance of Q1FY20 results for which the outlook is muted.

Muted expectation for Q1FY20…

In Q1FY20, revenue and net profit for Nifty 50 is estimated to grow by 8% and 11% respectively on a YoY basis. After adjusting the financial sector, Nifty50 PAT growth turned to a de-growth of -8%.  The finance and cement sectors are expected to be strong performers, while weaker ones are likely to be auto, metal and oil & gas sectors due to weak consumer demand, lower realizations and slowdown in the global economy.

The banking sector growth is expected to continue on the back of low base in Q1FY19 in which ICICI and SBI had reported huge net losses. Private Banks are expected to see better asset quality, less competition from PSU banks and reduction in NPAs. Cement volume growth was mere 2.5% YoY, impacted by general election & partly by base effect. However, cement prices have grown strongly by average 12%-15% in various regions which will support revenue growth & margins. Additionally, on the cost front, fuel prices softened since Q3FY19 quarter and will benefit in the quarter.

The I.T sector is expected to see a mixed performance in the coming quarter as constant currency revenue is expected to be positive for few companies while wage revisions, higher visa costs, investments and absence of rupee benefits could slightly impact margin in the near-term. Tier 1 IT companies are likely to post flat to positive results but Tier 2 and 3 will be mixed. Weak consumer demand and sluggishness in the rural markets may lead to muted volume growth for the FMCG sector.

Auto sector will continue to see weak earnings in Q1 & Q2. The economic downturn, slowdown in rural demand and financing crunch have lowered the volume growth. During Q1, the industry witnessed a negative growth of 10.5% in which passenger and 2/3 wheeler segment de-grew by 15%/10% whereas commercial vehicle declined by 13.6% respectively. Costs are expected to further increase on account of regulatory changes (enhanced safety features & transition to BS-VI) and margin will remain under pressure. We expect the situation to show some respite as the dealer inventory level is correcting, but CV will remain elevated. The government focus action plan on infrastructure development, improving rural demand and pre-buying due to change in emission norms can be the growth catalysts in H2FY20E.

In the metal sector, volumes are expected to improve on a YoY basis but lower metal prices combined with a 19% increase in global iron ore prices during the quarter is expected to negatively impact the bottom line. Correction in the Brent crude prices from $65/barrel to $50/barrel during the last quarter could result in refining and marketing inventory losses for OMCs in 1QFY20.

We lower our forecast

We had a one year forward target of 12,700 for Nifty50 which was based on the stronger political mandate reducing the political risk and expectation of revival in economic growth in FY20. We had factored Nifty50 EPS of Rs615 and Rs708 for FY20 and FY21. But post the budget, the expectation for a revamp in economy has reduced given the lack of supportive measures from the government given a conservative approach to manage the weak fiscal position. Updated economic data and business outlook suggest further downtrend in sentiment. This trend is likely to continue for some more time which is matching with the preview analysis of Q1FY20.

Based on this preliminary analysis we are marginally cutting the expectation for Nifty50 by 4% to EPS Rs590 and Rs679 for FY20 and FY21 respectively. This is subject to the actual performance of Q1 as the market still hopes for an earnings growth of plus 20% in FY20 while Q1 is expected to be around 11%. On a one-year forward basis the market is trading at a P/E of 19x based on our EPS expectation which is at a premium. We are thus cuting our one-year target of Nifty to 12,400.