3QFY25 earnings season was disappointing, with single-digit PAT growth for the Nifty and BSE500. This triggered another round of downgrades, though less severe than in Oct-24. The markets remain volatile, with SMIDs selling off 15.6% since 1-Jan. We expect the market to stay under pressure through this quarter, but to recover from 1QFY26 as earnings stabilize and global stresses ease. We see the Nifty in a buy zone at ~22.5k, with Discretionary, Healthcare, and Telecom our key OW sectors.
Q3FY25 results – Muted, but sequential improvement
Q3FY25 results for BSE500 and Nifty companies were muted, though with some sequential improvement. PATg was 7.1%/5% YoY for BSE500/Nifty, driven by stable sales growth and a modest EBITDA margin expansion of 18bps. This indicates earnings may be bottoming out and showing early signs of recovery. The weak single-digit growth is an improvement over the contraction in Q2FY25. Discretionary, Energy, Materials, Telecom, and Real Estate outperformed while Industrials, Staples, and Financials were weak. The share of negative surprises also improved sequentially in 3QFY25.
Earnings downgrades continue, though pace is slowing
Contrary to our expectations, earnings forecasts did not hold up well during the quarter. Consensus Nifty estimates for FY26 were cut by 3.9% from 1-Jan-2025, with poor breadth – 36% of 491 companies (coverage by +5 analysts) faced FY26 EPS cuts of +5% vs 40.2% in Oct-Nov 2024. The expected stability in earnings forecasts has not played out yet. We maintain that the downgrade cycle is largely done, especially if there is a consumption recovery in FY26 based on easier monetary policy and improvement in employment trends (refer to Exhibit 8 for sector-wise comments).
Valuations – Froth gone, but not touched rock-bottom
The Nifty is now trading at a 1YF P/E of 19.3x, near its 10Y LTA. The savage correction in SMIDs has derated the Nifty MidSmallcap400 Index P/E to 30.1x (TTM), below LTA of 37.9x; individual mid and small cap indices are also trading below the LTA. The median PER of the SMID index has also fallen, by 8.8% since 30-Sep-2024 to 30x. The %age of BSE500 stocks trading below 30x PER (TTM) has gone up, from 30.4% on 30-Sep-2024 to 39.4% after the correction.
Institutional flows resilient
In our opinion, the YTD Nifty collapse of 3.4% has more to do with valuations and earnings downgrades than with institutional flows. Domestic flows have held up (at least till January), and even SMID funds have not seen any major bleeding. FPI selling has started to ease – the SMID sell-off indicates that the source of market weakness is not FPI selling. We expect flows to stabilize once earnings downgrades abate and valuations moderate, which is already unfolding.
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