Worst is behind India Inc, revenues to grow in double

As we welcome an early Diwali this year, one cannot help but notice the slight moderation in India's macro story – weaker than expected GDP growth for 1QFY18, higher crude prices and some teething troubles pertaining to GST implementation. Yet, I believe the worst is behind for India Inc.

Recent high frequency indicators like PMI and our own proprietary Economic Activity Index (EAI) point towards a recovery in GDP growth.

After falling into contraction zone (reading <  50) in July and August 2017, services PMI for India moved back into expansion territory last month (at 50.7).

The manufacturing PMI in September – at 51.2 – was unchanged as in August, but better than 47.9 in July 2017.

Our monthly EAI also confirms that India’s economic activity grew 3.5% YoY in July-August 2017, same as in April-June 2017. With the festive season beginning early this year, we believe economic activity will have improved in September.

Even if our EAI grows 6% YoY in September, it indicates a real GDP growth of 6% YoY in 2QFY18, higher than 5.7% in 1QFY18.

The pessimism about the central government’s fiscal situation could be short-lived. We do not find any indications of stress on the central government’s budgeted tax receipts. While non-tax receipts are likely to be lower than estimated, there is still a good chance that it could be made up by higher-than-budgeted tax collection.

Indirect tax receipts up to August 2017 were 39.5% of full-year budget estimates (BE), marking the highest collection in the first five months in any fiscal year (barring FY08) since FY01.

Even if there is only 1% YoY growth in total indirect tax collection in the last seven months of FY18, the government will slightly overshoot its FY18 BE.

Implementation of GST has expectedly resulted in some teething troubles pertaining to compliance, tax return filing for SMEs, wholesalers and retailers. However, our channel checks and conversations with corporates in our coverage universe suggest 2QFY18 will benefit from re-stocking of trade supply chain.

We also expect 2HFY18 to be much better than 1HFY18 for B2C sectors like consumer, autos and durables, as trade settles down with GST. Low base – demonetization in 2HFY17 – should also help.

The hardening of commodity prices could, however, pose a threat to India Inc’s margins. India Inc had benefited from commodity cost tailwinds in FY15, FY16 and 1HFY17.  Prices of base metals, crude as well as agro commodities have hardened of late.  

The reversal in commodity prices is driven by supply-side measures and unexpected improvement in demand conditions in China. Steel demand has grown estimated 15% YoY in July-August, aluminum production growth has contracted, while zinc concentrate supply is hit due to checks in China.

Operating margins of sectors like Consumer, Cement, Automobiles, and Durables will be at risk, especially since companies have been reluctant to exercise pricing power in an environment of moderate demand scenario.

We expect revenue growth for our coverage universe to be 11% in FY18 against 0% CAGR during FY14-17. FY18 will be the first year of double-digit revenue growth after three years of flattish sales performance. It will be driven by BFSI, auto, metals and oil & gas.

We expect IT to see sharp deceleration in growth. Overall, we expect Ebitda margin for our coverage universe (ex-OMCs, financials) to stay flat at 20.3% in FY18; profits should grow 15.4%. Nifty PAT is likely to grow 16% in FY18 against 6% in FY17, and record 19.5% CAGR over FY17-19.

We continue to like the BFSI, auto, energy and healthcare sectors. We find the OMC story attractive – the recent improvements in GRMs are yet to reflect in valuations.

The writer is CMD, Motilal  Oswal Financial Services