After Infosys dampens, cyclicals seen lifting India shares

Higher consumer spending, a sharp jump in government investment in infrastructure, falling interest rates and good rains are set to underpin a wide spectrum of sectors

18:13 October 15, 2016

Disappointing earnings outlook from software bellwether Infosys Ltd took the shine off Indian shares, but investors should take comfort from other sectors that are revving up while slowing inflation strengthens the case for another interest rate reduction.

Information technology companies depend upon exports for their growth and the gloomy global economy is a major roadblock. So expectations on profit and revenue rise were running low. Still, when Infosys, the country’s No. 2 software services exporter, lowered its full-year revenue forecast for the second time in three months, it rattled some investors.

Infosys, which is also listed on New York, cut the revenue growth guidance for the financial year to March to 8-9 per cent in constant currency from 10.5-12 per cent it had said in July. Importantly, the July forecast was also a downgrade from around 13 per cent it expected at the start of the financial year in April.

“During the course of Q2 we have seen signs of cautious client behaviour,” Chief Executive Vishal Sikka said on a conference call. The loss of a potential contract when Royal Bank of Scotland decided to shelve a plan to list a new bank in Britain also contributed to the lowering of revenue guidance, he said.

Infosys shares shed 2.4 per cent on Friday. Bigger rival Tata Consultancy Services beat market expectations on September quarter profit that rose 8.4 per cent, but its revenue grew just 7.8 per cent from a year earlier, reflecting the difficult business conditions in its main markets of the US and Europe.

On a sequential basis, revenue nudged up 0.1 per cent, the slowest pace in the company’s history for the second quarter, Emkay Global said in a report.

N. Chandrasekaran, chief executive of TCS which has some 317,500 staff on payroll, said he was optimistic about the outlook. “I am tempted to say that Q3 and Q4 this year will be better than the usual years,” he told a news conference.

“Results from tech majors such as Accenture and Cognizant have indicated mixed demand environment, with stronger adoption of digital technologies,” brokerage Prabhudas Lilladher said.

“However, market will be concerned about the impact of Brexit and the resultant impact on demand in the short term. US elections will also create uncertainty for the sector. Structural growth drivers for Indian IT continue to be in place, but in the short term there is increased uncertainty on demand outlook.”

Cyclicals upbeat

Earnings are expected to be driven by beaten-down cyclicals as economic activity picks up steam. Higher consumer spending, a sharp jump in government investment in infrastructure, falling interest rates and good monsoon rains are set to underpin a wide spectrum of sectors.

Finance Minister Arun Jaitley is likely to seek parliamentary approval to spend about $7.5 billion more on roads, railways and other public programmes over the next five months, Reuters reported quoting two government sources. It would also coincide with the run up to a crucial state election early next year in Uttar Pradesh, India’s most populous state that is home to more than 200 million people.

“Momentum in auto volumes have picked up, whereas cement is into its first year of up cycle. All these will increase share of cyclicals in the earnings of corporate India,” analysts at Motilal Oswal Securities said in a preview.

The brokerage forecast that companies would post positive sales growth after nearly two years, with companies that it covers seen reporting 12 per cent earnings rise, the highest in several quarters. The share of cyclicals in earnings is expected to hit a 30-quarter high of 40 per cent, the securities house said.

While good monsoon after two successive years of deficient rainfall would bolster farm output and rural incomes, a hike in salaries and pensions for central government staff would provide a boost to consumer spending.

“In the short-term, we expect higher agricultural sector growth in second half of 2016-17 and award of the 7th Pay Commission to propel a U-shaped consumption driven pick up in GDP growth,” Ambit Capital said.

UltraTech Cement, the leading maker of cement, is scheduled to report quarterly earnings on Monday, followed by rival ACC Ltd on Friday. Havells India, a maker of electrical items and favoured by foreign funds, announces results on Tuesday. LIC Housing Finance and Biocon Ltd are set to release their quarterly numbers on Thursday.

“We expect sectors focused on urban and rural consumption such as automobiles and retail to record double-digit revenue growth,” an executive at a foreign fund said.

Wipro Ltd, the third-largest software services exporter, will unveil results on Friday, the same day when energy explorer Cairns India, which is facing heavy headwinds from the fall in oil prices, releases earnings.

RBL Bank, which went public in August, announces results on Wednesday.

IndusInd Bank, controlled by billionaire Hinduja family, reported a 26 per cent rise in quarterly profit, riding on strong net interest margin of 4 per cent. Gross non-performing assets as a percentage of total loans stood at a healthy 0.91 per cent at end-September, little changed from the previous quarter.

Inflation cools

Retail inflation slowed to a 13-month low in September as food prices fell, providing more elbow room for the central bank to loosen monetary policy. The Reserve Bank of India this month cut its main policy rate by a quarter point to 6.25 per cent, the lowest in six years, and many economists expect another 25 basis points reduction in December or in early 2017.

The consumer price index rose 4.31 per cent last month from a year earlier, its slowest pace since August 2015, and below market expectations of 4.8 per cent. In August the index, which is the key indicator watched by RBI, climbed 5.05 per cent. Food inflation slowed sharply to 3.88 per cent, the government said, from 5.91 per cent in August.

While equity investors should have reason to smile by the downward trajectory of inflation, the feel-good mood would be tempered by the prospect of a rate rise by the US Federal Reserve, either in November or December. Higher US rates tend to stem the cash flows into emerging markets such as India.

Foreign funds have bought a net $7.7 billion of domestic shares since the start of January, more than double the $3.3 billion inflow in 2015. The purchases were the main reason for benchmark indices, the top-30 Sensex and the 50-share Nifty, to jump a fifth from their February lows.

The author is a journalist based in India.