Idea in Focus, December 2024

Decoding India Inc.’s Q2 FY25 Performance

Introduction

Corporate earnings act as the anchor point of stock markets. They directly reflect a company’s profitability, growth potential, and ability to reward shareholders. In equity markets, valuations are fundamentally tied to earnings. Metrics like Price-to-Earnings (P/E) ratios are derived from the relationship between stock prices and corporate earnings. When earnings grow robustly, markets typically rally as they signal strong economic activity and corporate health. Conversely, a slowdown in earnings growth often triggers corrections, as investor confidence wavers.

Earnings also shape sectoral trends and influence capital allocation. For instance, sectors with accelerating earnings attract more investments, while sectors witnessing earnings contractions tend to underperform. In the Indian context, where domestic liquidity often supports premium market valuations, earnings growth is even more critical to justify these levels.

In this edition of Idea in Focus, we will discuss the slowdown in India Inc.’s Q2 FY2025 earnings, starting from what led to the slowdown to what is in-store for the markets going forward.

Earnings Slowdown in Q2FY25: A Detailed Breakdown 

Before we begin talking about the earnings slowdown, let’s define the universe within which we shall dissect the issue. And this universe is the Nifty 500. However, we have only taken those companies from Nifty 500 which have earnings data going back to Q2 FY2021. This is because we need to have sufficient history to gauge the earnings trend or else it won’t be conclusive. Hence, after applying this filter, we were left with 424 companies spread across 11 sectors.

Now, let’s take a look at the revenue and profit growth trends for these companies. 

Source *Internal

Source * Internal

If you take a look at the charts above, you will notice that from a revenue standpoint 4 out of 11 sectors have witnessed an earnings slowdown in Q2 FY2025 compared to the same quarter last year. Having said that, what is even more concerning is that, once you move down the income statement and check from a net profit standpoint, this number increases to 7 out of 11 sectors. These sectors which have witnessed slowdown has been highlighted in the charts above.

And the comparison is not just with last year. Even if you go back to FY2022, you will notice the dip in growth. The chart captures this rather aptly as the taller buildings are at the start (i.e. 2022) for almost all the sectors.  

What’s driving the slowdown?

To be honest, Q2 FY2025 has been a peculiar quarter for all sorts of businesses. The reason we say that is if you start reading the management commentary of different companies from different sectors, you will notice how each sector is grappling with its own set of challenges. Let’s discuss a few of them – 

1. Consumer Discretionary – Companies in this sector are facing issues like lackluster demand, mass segment products not finding any takers, consumer budgets not expanding, unorganized sector eating into the market share of the existing incumbents, and intense competition.
   
2. Consumer Staples – The tug of war between rural demand and urban demand continues to dominate the story of this sector. While one quarter, rural would overpower urban, the very next quarter it will die out that quick. Another huge issue that the sector is facing is category saturation. Players like HUL , Dabur, & Bajaj Consumer Care are finding it extremely difficult to expand in their existing categories (as they are already so big) and at the same time are not being able to come up with any new category in order to find growth.  
   
3. Automotives – Again a classic example of consumer sentiments turning around rapidly which is leaving the auto manufacturers second guessing. Since COVID, Passenger Vehicles’ (especially SUVs) demand picked up meaningfully while simultaneously the preference towards two-wheelers died down entirely. However, now since the last two quarters, two-wheelers have begun to see significant demand interest and on the other hand PVs have started to struggle. Another thing that’s playing out in this space is India’s EV paradox. India’s total EV subsidies amount to 40-50% of vehicle prices when accounting for GST (goods and services tax), road tax benefits, state subsidies and production-linked incentives while its adoption is one of the lowest in the world at 2% as compared to China’s 24% and US’s 8%. 

While local factors more often than not dominate the prospects of our companies, sometimes global factors can also have a meaningful impact. Let’s talk more on this in the next section. 

Current Valuations & Road Ahead

Our markets have corrected since the start of the year. A large section of the market was in favour of a correction and the rally gave an indication of over-exuberance, which is never a good sign. However, the worrying aspect is how different market segments (largecaps, midcaps, smallcaps) have been diverging from each other, especially from a valuations perspective. 

With markets correcting from its peak, we have seen largecap valuations cooling down and currently trading below the YTD average. Take a look at the valuations chart of Nifty 50. 

That being said, if you check out the valuations for the midcaps and smallcaps, the story is extremely different. In spite of the recent correction, the valuations have not cooled down at all. This should be concerning as this is not reflective of the underlying earnings fundamentals and could signal unchecked exuberance. Both midcaps and smallcaps are almost trading at their YTD peak valuations. 

However, the pertinent thing to keep in mind is that ultimately earnings (and eventually those converting into cash) is the driver of stock prices. No matter how good the story you sell, if you cannot show earnings growth, the markets are not likely to reward your share price. Therefore, this slowdown in corporate earnings is extremely concerning and more so because it is broad-based. As mentioned earlier, each sector seems to be having their own set of problems which cannot be cleared at a system level. Hopefully, the festivity led Q3 will bring good fortunes for Indian companies and they would be able to deliver the much needed growth! 

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