As expectations are low, we are beating estimates with a few misses: ICICI Sec

The FY21 earnings were cut almost by 30% over this period and because of that, we had noted that going forward the estimation error would be lower because the expectations are pretty low, says Vinod Karki, V-P, Equity Strategy.

Which of the sectors would you have expected economic activity to have contracted the most and how have the results played out so far?
GDP is going to contract 15% to 20% in Q1 and that is the broader expectation. In the light of that, everyone would have expected that to be a quarter of large misses on whatever expectation we had put out. But some time ago, we had analysed how the forecast numbers are moving and we had noted that since March. In fact, we have had the largest downgrade cycle so far after the global financial crisis.

The FY21 earnings were cut almost by 30% over this period and because of that, we had noted that going forward the estimation error would be lower because the expectations are pretty low. Now this phenomenon is starting to show up in numbers so far where the expectations are pretty low now. Whatever numbers we are getting are broadly beating estimates or are in the neutral zone with very few misses.

Having said that, there is expectation versus what actually comes out but even in terms of growth, while GDP is going to contract by around 15% at least, the sales growth is also in that number. If I look at the Nifty-50 free float numbers including the banks, operating profits is largely flat and whatever we are hearing from individual companies seem to suggest that there has been a lot of what you should beat on the operating on margin side largely driven by cost cutting measures across companies and pretty healthy margins across and input costs has been also pretty okay. They have not risen that fast except for one or two things, which is basically cement was a little higher but otherwise the input costs have not been a problem.

So on the profit side, on the PAT side, obviously there was no growth but they are well above expectation. So net-net, it is a case of slow recovery in the economy. We saw some momentum being lost in July. The PMI number dipped a bit and we saw GST collections dip a bit as well. If you look at the Google mobility data, we saw some momentum being lost in July. The reason is that the monsoon really picked up in July and Covid was expanding across the country. So all in all a slow recovery.

Just wanted to get in your take on the financial sector. In the report, it is mentioned as a case of paradox. Can you elaborate on that?
There is a thought experiment in quantum physics where unless you open the box, you do not know whether the cat is dead or alive. That is the case for financials. When I say that it means that unless we end the moratorium period, we would actually know how much damage was done, which banks really took proper provisioning and covered their losses. So all that will come to, we will get a better picture only when the event is fastest.

The body language from large banks and their commentaries seem to suggest that things are not as bad as originally thought to be and that gives us confidence. However, only time will tell whether the estimation is right. RBI’s latest report suggests that NPAs are going to rise from 8.5% to 12.5% next year. However, from the commentary from banks, I do not see that kind of warning coming in so far. That is why I say that it is still uncertain over there but at least some of the better banks will tide through this crisis better than the rest of the pack.

Have you been positively surprised by some of the earnings that we have seen in pharma sector?
Definitely it has been a positive surprise. I was just doing an analysis on which parts of the domestic economy have held through this crisis. One is the essentials. The unorganised segment, the mom and pop stores who are selling essentials including food and medicines have done pretty well compared to organised retail. It was spoken about by the largest organised retailers like D-Mart and all.

Most of the domestic business of these pharma companies have really boosted the performance. Globally also, the regulatory overhang used to have a significant amount of observations. It might be a situation where the environment for pharma is on the mend after several years of a challenging environment. So let us see but it is a surprise for sure and that is how the stocks are reacting. They are at the upper end of the valuation range historically that we have seen so far. That is being reflected in the stock prices, yes.

What about cement? The outlooks have been sounding a lot more positive. What has been your takeaway there?
One can directly correlate cement with the gross fixed capital formation and capex in the economy. The private capex cycle is in a slump. Government spending would not have picked up significantly in Q1 except for releasing payments where there has been some information as they are frontloading the borrowing programme. Payments are getting released but the one interesting point was that individual home building in rural India, especially after the return of migrant workers as they needed additional space and that has driven a large amount of cement demand during Q1.

It is getting well balanced in the agri rural sector individual home building and all in the rural space is holding on to demand to some extent in this challenging period. We see the urban areas also pick up and the government spending also pick up from here and that could balance the rest of the portfolio. So, it is well placed in my view. Broadly, from a demand and pricing perspective, it has been noticed by everyone that the pricing was buoyant. That is not an issue. So, we remain positive on this space. Actually one of our best picks is from this space -- UltraTech Cement.