Q1 Profit Growth Out-Paced Revenue Growth: Nuvama
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00:00Prateek Parekh, Director Equity Strategist at Newama Institutional Equities joins in
00:04with what he made of India Inc. in this quarter. Morning Prateek, thanks for joining in. Prateek,
00:10first start with what your expectations were from the first quarter of this financial year and how
00:14well has India Inc. fared? Yeah, thanks Amita for having me over. It's always a pleasure being on
00:20the show. I think if you look at Q1 right, Q1 is quite different from what we had in FY24.
00:28FY24 was a very unique year which has played with large amount of divergences and heterogeneities.
00:34For example, in FY24, we had BSE 500 top line growth growing by 8% but profit growth grew by
00:4120%. You had within top line as well large divergence between consumption and capex
00:48oriented names or cyclicals. Like FMCG companies saw low single digit growth, top line growth
00:54whereas cyclicals like autos and industries saw very high teens growth. I think those divergences
01:00are now reconciling. In Q1, we have seen a lot more homogeneity in variables. This is a quarter
01:08where top line and profit growth have reconciled. Top line growth remains stuck at 8%. Profit
01:14growth which was in very high teens or 20% for last year has slowed down to 10%. And going ahead
01:20as well, we expect this reconciliation to continue. Further, within top line as well,
01:26you have had reconciliation between cyclical top line as well as that of defensives. So,
01:31in some sense, if I have summarized the quarter one in one way, it is reconciliation of divergences
01:36that we had in FY24. And going ahead, top line will be the key monitorable variable that will
01:43dictate the earnings outlook for SESAMTA. Right. Pratik, that of course was on a larger
01:51universe in terms of what you made of the earnings. And from what I take away,
01:55you seem to be fairly impressed. Profits have outpaced your growth, has far outpaced revenue
02:00growth. Now, while profit has grown significantly for a lot of companies, it is coming on back off
02:05or on the heels of operational efficiency. If revenue growth is not keeping pace, are you
02:12concerned? Do you feel like the profit uptake while looks good may not be organic and may not
02:17be sustainable then for the rest of the financial year? That is absolutely right, Samita. In fact,
02:23entire post-COVID earnings, if you look at it, has been a function of margins or operational
02:28efficiency. Further, within margins, you had big tailwinds coming from banking sector credit costs,
02:34which were very depressed, which have gone down to very low levels. From here on, I think those
02:40tailwinds are behind us. Input prices are largely stable on a YY basis. Banking sector credit costs
02:46have seemed to have bottomed out and whatever the commentary is, seems like there's going to be
02:50marginal upside risk rather than downside risk. And finally, operational efficiencies on working
02:55capital improvement and a lot of that has been extracted. From here on, I think for whatever
03:00profit growth will depend on demand and there, unfortunately, the outlook is not seeming to be
03:05very great. Despite deflation going away, top line is not moving higher. Top line growth remains
03:12stuck in single digits for the fifth straight quarter and this is not good news. And that is
03:17where I think for FY25, there are more downsides to earnings than upside because consensus is
03:22forecasting mid-teens earnings growth. And if top line growth remains in single digits, it's
03:27difficult to see how that earnings growth number can be delivered. So to that extent, yes, FY25 will
03:33be a bit more challenging year in terms of earnings because your operational efficiencies have been
03:38extracted and demand continues to remain subpar versus Amitabh. Prateek, good morning. Neeraj here.
03:44You're overweight on private banks. Is it a factor of any green shoots or good signals that you saw
03:52in quarter one? Or is it based on a hypothesis that credit growth at some point of time will
03:57pick up because of CapEx or otherwise? Yeah, that's a good question, Neeraj.
04:03See, I think what has happened last year has been very unique. Last year, if you look at it,
04:07generally private banks tend to outperform when there is a cyclical meltdown. Last year is probably
04:12the only year in last 20 years where you had cyclicals like industrials, autos, even metals,
04:18you know, significantly outperforming and rising, but private banks actually underperforming.
04:23And our view has been that, you know, margin pressures have been quite high.
04:27Going ahead, our overweight on private banks is a function of three variables. First, we think that
04:33margins are likely to bottom out while credit growth will slow. But I think margins could most
04:39likely bottom out. Second, we expect earnings growth of broader market to moderate. So the
04:45earnings differential between private banks and the rest of them is going to narrow meaningfully
04:49and that process has already begun. And third, in the entire market, this is the only space
04:55where we find valuations quite reasonable on absolute basis. So, you know, keeping these
05:01three factors in mind is why we are overweight private banks, despite our cautious view on the
05:06demand and on the overall earnings per se. Okay, so that's fair. Now, I just want to understand
05:16what surprised you, Prateek, this quarter? I mean, it could be on the downside, it could be on the
05:20upside, but maybe it's a pocket, maybe there are specific stocks, I'm not asking for recommendations.
05:24But where did earnings really surprise you? Or maybe commentary really surprised you?
05:32So I think earnings were on the downside, you know, the surprise has been, I think,
05:36has been on the cyclical part. Now, some of it is associated with elections and heat waves.
05:42But I think, in general, some of the high end consumption that is slowing down, I think that's
05:47a negative surprise, if you ask me in this quarter. For example, luxury hotel space or
05:53the industrial space, or even the auto SUV space, where growth is clearly tapering down,
05:58I think that's a negative surprise. The view was that this growth should momentum should contain
06:04and hopefully the rest of them will improve. On the positive front, on the commentary,
06:09where we think there is scope of improvement is on two aspects. One is the durables consumption,
06:16that I think seems to be coming back after a big pain for quite some time. And that has been a
06:20very big positive surprise this quarter. And second is I think on the lower end consumption
06:25as well. The FMCG, or even the IT part of it, which has been a big pain point until now,
06:32I think their signs of stability are clearly visible. And that I think is also a positive
06:37surprise of source person Neeraj. So I think overall, my main point is FI24s, the leaders or
06:44stars, I think their negative surprises have begun. And FI24s are guards, which is like FMCG
06:50and IT. There I think at the margin, signs of bottoming out are visible. And if anything,
06:56there are more positive surprises than negative surprises for us.
07:01Very lastly, two sectors. One is IT. We did talk to a few managements, and I'm sure you talk to
07:09even more, where there was an indication that they are seeing green shoots. Now you also have
07:13the much anticipated US elections, which usually brings with it, post the event of course,
07:18some sort of clarity in terms of orders for the IT sector. What is the outlook? And what do you
07:25make of the earnings? And what do you anticipate for the sector going ahead? And talking about
07:29green shoots, the other one is rural consumption, which we've seen a bit of an uptick in terms of
07:36reporting this quarter. Taking a cue from what we've seen and the commentary of management,
07:41how would you approach both these sectors in terms of earnings expectations for Q2?
07:46Yeah, so I think for IT, clearly I feel last year was a very painful year. In fact, the dollar
07:54revenue growth or CC growth that we've seen in IT and FI24 is probably one of the lowest on record.
07:59It almost feels like recession was felt by these companies. Our view on IT is that the earnings
08:05downgrade cycle is largely behind us. Now, the improvement and the reason for that is twofold.
08:12One, on the demand part, we clearly feel that the IT demand has bottomed out. How much it will
08:19improve and the pace and the quantum of improvement, I think that remains uncertain.
08:24But where we still believe that the earnings downgrade cycle has ended, I think is on the
08:28margins part. I mean, these companies are having very low attrition and they're able to protect
08:33margins even at very low top line growth. That's a clear sign that companies have already moved
08:40ahead of the downturn. And as and when recovery comes in, there will be operating leverage.
08:45But from a broader perspective, earnings expectations are not running very high in the
08:49space. Obviously, the recovery is not going to be linear and there are still uncertainties on the
08:55anvil. But I think on a relative basis, I think IT clearly is one of the spaces where we feel the
08:59earnings downside risk is much more limited going ahead. Second, I think is on the FMCG and the
09:06rural recovery. Yes, that is again a spot where we expect things to improve. And our expectations
09:12remain on two factors. One is the statistical base effects have been very low. So to that extent,
09:18really, things should bottom out. And second is there seems to be clearly a shift in spending
09:25pattern of the government. If you look at not only the central government, but many state
09:29governments have given cash transfers of sorts like Maharashtra has announced a big cash transfer.
09:35Similarly, we expect state governments to focus a lot more on transfers rather than necessarily
09:42capex. And this, in turn, should probably help support consumption at the lower end, per se,
09:48Samitha. So I think from both these factors, we feel for FMCG as well, the worst is behind.
09:55Recovery is there. But again, base and the quantum is not yet very certain. But nonetheless,
10:02directionally, it is headed for the better days going ahead, per se, Samitha.
10:06Thank you, Pratik. It's good to get some perspective on how Q1 has been and what the
10:10outlook for Q2 is.