While the sharp correction in the market may suggest attractive valuations, we note that the pace of corporate earnings downgrades has intensified in the recent results season. We see downside risk to bottomup derived 15% earnings cagr over FY11-13 and even greater risk to the street estimates as we are 3-5% below consensus. We lower 12-m Sensex multiple to 13x to factor in the earnings downgrade risk. 

We increase our Under-weight on banks, industrials

The sectors that look vulnerable to earnings are PSU banks (asset quality concerns), industrials (slower order flow), private utilities (lower utilisation rates and fuel availability)

We cut industrials to UWT by removing L&T from the model portfolio. The stock has held-up well despite the ordering slowdown and we see greater risks to its earnings / multiples. The slowdown in the investment cycle will impact banks' earnings through lower credit growth and uptick in NPLs. We increase our UWT on banks by taking off 2 points from Bank of Baroda

To maintain our UWT on IT, we have taken out e-Clerx. The stock has O-PF the markets by 20% since its inclusion in Jan-11.

We are taking out Adani Power as we see downside earnings risk on account of continued fuel shortages and Indonesia coal costs. Replacing with more defensive Power grid. We also bring in JSPL as the stock has corrected by c.20% over the last one month and downside appears limited.

Pace of earnings downgrades has intensified

We have lower FY12 and FY13 Sensex EPS estimates by 5.6% and 10.6% respectively since the beginning of CY11.

The pace of downgrades have increased during the recent result season with a downgrade of 3% and 5% respectively. This also indicates that the there would be more downside to our FY11-13 earnings cagr of 15%.

Downgrades so far have been driven by margin disappointments and revenues have held up well, which could be at risk going forward. We also saw interest cost led downgrades in 1QFY12 for the first time and full impact is yet to be seen.

We are 3-5% below consensus

Our new FY12 & FY13 Sensex EPS of 1,181 and 1,338 are 3% and 5% lower than the street (Bloomberg consensus) respectively.

On the negative side, our estimates are substantially below street on cement cos, telcos, Pantaloon, Suzlon Maruti, Tata motors and HCL Tech and believe that the consensus will likely see more earnings downgrades.

Lower 12-m Sensex multiple

Lower target multiple builds in the risks associated with more earnings downgrade.

Key downside risk remains faster slowdown of growth while the near-term upside risk would be potential loose monetary policy in the west.

We will continue to stay cautious on the markets till we see some evidence of investment demand picking-up.