The last 15 months have been most turbulent for investors across the globe by all counts. Nifty fell by 23 percent in a single month in March 2020, the highest single-month decline, only to be preceded by a 26 percent decline in a month in October 2008, the pinnacle of the Global Financial Crisis.
The steep decline was probably the outcome of a sharp cut in Nifty earnings for FY21 which were cut to Rs 450-460 in April 2020 versus over Rs 650 as at the end of Q3FY20.
However, FY21 will also go down in history as a year that shows the sharpest earnings growth upgrades for Nifty in the last 10 years. Thus, by Q3FY21, the Nifty earnings are likely to, in fact, grow at 13-14 percent over FY20 at over Rs 540.
We believe that the earnings growth cycle which commenced in FY21 is likely to continue for the next few years. Of course, FY22 will be benefiting more from a favourable base, at least in the first half. However, we see multiple triggers to earnings growth as we move into the next 2-3 years viz.
–The robust bounce back in earnings is an outcome of strong growth in aggregate demand in the second half of FY21 as well as smart lean sizing of costs by the corporates. We expect the benefits of this lean sizing to continue for the next few years. The organised players across sectors have also used the pandemic to right size working capital cycle and the resultant reduction in interest costs will only aid earnings.
–The Union Budget 2022 was truly unconventional in various aspects. (1) budget for FY22 has clearly outlined the fiscal path for next the 5 years and assured the economy of continued support to consumption from a fiscal standpoint. (2) The ratio of capital expenditure to GDP is likely to jump to 2.5 percent after hovering at 1.6-1.8 percent of GDP for the last 10 years.
–Rural India has by now seen multiple robust crop cycles and robust spending in MNREGA has just added more firepower to rural cash flows.
–Contrary to popular perception at the beginning of the pandemic, the financial savings have grown at a robust pace. The total deposits with banks have grown at 12 percent YoY for FY21, one of the highest in the last 7 years if one excludes the demonetisation period. This would support consumer spending as well as investments as we go forward.
While the robust aggregate demand growth will help the earnings, we also expect that real demand along with some inflation will help the better utilisation of capacities and may result in renewed CAPEX cycle, which has until now eluded us for the last 10 years.
According to our estimates, a 6 percent real GDP growth along with 4-4.5 percent core inflation will lead to near peak asset turnover ratios by FY24. This means that the corporates will have to start thinking about putting up new capacities by end of FY22 or early FY23.
Can this robust demand lead to runaway inflation as it happened during 2013? There is still significant slack available in production capacity as well as labour market. Thus, RBI’s OBICUS survey suggested that aggregate capacity utilisation in the economy still stood at 63.3 percent as of Q2 FY21. If one looks at another source of inflation, viz. wages, the slack in the labour market is also very high. The labour force participation which stood at 46-47 percent pre-Demon is still lingering at 39-40 percent currently which means that if needed, there is still 7-8 percent of the working-age population which can be brought into the labour force if needed without impacting wages.
Thus, strong savings growth, supported by union budget spending and moderate inflation augurs well for the overall earnings cycle for not only FY22 but for few more years to come. The use of pandemic by corporate for right-sizing the costs as well as the balance sheet will only help further. Thus, for the investors going is only getting better.
