Domestic consumption to drive growth

The BSE Sensex has reported an earnings growth of 18 per cent after four quarters of decline. While the base impact of October-December 2008-9 has contributed to this growth, several sectors have also witnessed a strong recovery that helped deliver these earnings.

The earnings growth is even more impressive because financial companies, which generate 25 per cent of total earnings, saw no growth in profits. The impact of various fiscal and monetary stimulus measures continued to be positive. While the auto and FMCG sectors reported their highest ever profits, others like engineering and cement also grew well. The big change in aggregate earnings came from global commodities, which led to a significant jump in the profit of all metal companies. The two sectors that reported a decline in earnings were real estate and telecom.

Going forward, we expect acceleration in growth rates. While the fourth quarter is likely to see a much higher growth (due to the base impact), in 2009-10, we expect the Sensex EPS to decline by 2 per cent to Rs 800. After two years of no growth, we are entering a period of strong earnings surge. Our current estimates factor in the EPS CAGR of 27 per cent over 2010-12. While a part of the growth is fuelled by a spike in the earnings of companies dependent on the global economy, we expect companies in domestic sectors to perform well too. Global stability, domestic demand, higher spending by government in large projects, infusion of low-cost capital and a pick-up in consumer sentiment will be the key drivers for corporate earnings in the next two years.

The important event to watch out for in 2010-11 is the withdrawal of government stimulus. On the monetary front, the first round of tightening has happened (cash reserve ratio hike of .75 per cent) and more will follow.

Two sectors crucial to the aggregate earnings growth are banking and global commodities. Together, they contribute over 50 per cent to the aggregate corporate earnings. We expect profits of the banking sector to grow at 20 per cent CAGR. Stable interest rates and limited delinquency ratios are key to delivering this growth.

On the global commodities front, the sharp volatility in the past few years poses a significant risk to estimates on either side. An important part of the earnings growth in metals is driven by the commissioning of new capacities.

Among the sectors that are likely to underperform the aggregate earnings growth are cement and telecom. Though both these sectors depend on domestic demand, pricing concerns are leading to a drop in profitability.

Overall, the growth phase in corporate earnings has begun and we expect a CAGR of 27 per cent over 2010-12. Market valuations after the recent correction are back to long-term averages. Our preferred sectoral bets are financials, infrastructure, metals, pharma and telecom.

Rajat Rajgarhia is Director, Research, Motilal Oswal