Some bright spots amid gloomThe 30 per cent rise in sales and 12 per cent profit growth managed by leading Indian companies (320 of the BSE 500) for the September quarter may only reaffirm the gloomy earnings picture that the market is factoring into stock prices today.
In a bear market, such as the present one, while negative news is magnified by the lens of pessimism, positive aspects are often ignored. That a good 152 of the 320 companies recorded earnings growth of over 15 per cent could possibly come as a surprise for those who expected a sweeping profit slump.
This article discusses the divergence in performance of companies and sectors in the September quarter and highlights the possible reasons for such variations. A compact universe of companies from the BSE-500 (that represent 93 per cent of the exchange market cap) was chosen to analyse various drivers of costs and income for Corporate India. The set consists of stocks with a market capitalisation range of Rs 100 crore to Rs 1,90,000 crore. Also in focus are key sectors and companies that are conspicuous for their exceptionally good, or particularly poor, performance. Sales zoom, but margins pressured
Before moving to specifics, here’s a look at what the averages suggest. Sales, possibly ignited by an inflationary environment, clocked a far higher growth rate of 30 per cent (year on year) than the 19 per cent growth seen in September 2007.
However, the same inflationary trend, reflected in raw material costs ensured that operating profit growth halved to a moderate 15 per cent. Drastic reduction in ‘other income’ and losses on extraordinary items (as against profits from this segment in the previous year) dragged net profit growth down to 12 per cent.
A study of the key cost components suggests that the impact of the commodity price meltdown is yet to trickle down to corporate margins. Raw material costs were up by 43 per cent in the September 2008 quarter over a year ago. The similar increase in September 2007 was a mere 8 per cent.
However, raw materials as a percentage of sales (leaving out companies in the services space, with no raw material costs), was a whopping 56 per cent — 5 per cent over last year. The comparable number in September 2006 was 55 per cent, only 100 basis points lower than the latest figures.
In other words, the current proportion of cost to sales is not too different from 2006 levels, suggesting that selling prices may have offset input cost hikes. The operating profit margin too, at 27 per cent, was similar to the 2006 levels.
Earnings quality improves
Employee expenses as a percentage of sales declined marginally to about 8.2 per cent for the latest quarter, on the back of sedate hiring activity in the service sectors. However, for public sector companies such as BHEL, Bharat Electronics or SAIL, the pressure on profitability following implementation of the Sixth Pay Commission’s recommendations was discernible.
Despite rising interest rates and tightening liquidity, interest cost as a percentage of sales saw a mild dip to about 14 per cent, the ratio helped mainly by the cash-rich or low-debt companies in the universe. However, specific sectors, discussed later, have shown a steep increase in interest costs.
Windfall ‘other income’, primarily driven by forex gains (arising from revenue as well as borrowing transactions) in September 2007, gave way to extraordinary losses, either from forex hedging or the lack of it in the past quarter. Net profits, adjusted for such losses, nevertheless, grew at a modest 12 per cent. While the above averages provide some cues on India Inc’s growth trajectory, they only offer a sketchy picture. A break-up into sector and stock-specific trends makes things clearer.
Revenue growth remained robust in most sectors, barring interest-sensitive segments such as auto and auto ancillaries or sectors with weakening demand and price, such as cement. While the former took a mild dip in operating profits in the latest quarter, compared to a year ago numbers, cement companies bore a sharp 9 per cent fall in operating profits. Most of the companies in this universe, located in the Northern region, have been witnessing sharp declines in cement prices, compared to early 2008.
Metal margins slide: Manufacturers of another key commodity, steel, had a different story to recount. While volumes could have remained robust, as suggested by a 40 per cent increase in revenues, the average operating profit margins dipped sharply to 29 per cent from 35 per cent a year ago. With steel prices coming off sharply in recent months, the coming quarters may pose a real challenge for these companies.
Banking, IT stable: Sectors such as banking and IT have turned in far more stable results than expected, despite being boxed in by concerns. While banks faced a liquidity crunch, escalating costs and concerns about lower credit off-take on the back of high interest rates, the software sector was engulfed by its share of concerns arising from the global turmoil.
Both sectors have shown more moderate revenue and net profit growth, though profit margins did not throw up negative surprises.
Surprise from infrastructure: Interestingly, infrastructure, among the most beaten-down sectors in the recent fall, put up a respectable show, with a 39 per cent growth in sales and a 62 per cent growth in net profits.
Stocks from these sectors were beaten down on the back of concerns about high raw material and borrowing costs and an order-book slowdown.
However, price escalation clauses in most projects have allowed these companies to partly cope with rising costs. Order inflows, too, have been robust, especially for the larger infrastructure companies.
Less fortunate: The engineering and capital goods sector was, however, less fortunate as both operating and net profits grew at a noticeably slower pace. Neither infrastructure nor engineering was spared a sharp spike in borrowing costs, which rose by over 50 per cent.Beating expectations: Overall, banking and infrastructure sectors featured several companies that demonstrated better results than the market expected. Software, aided by a sliding rupee, too registered comfortable growth. These sectors, with their respective average earnings growth at over 20 per cent, have clearly done better than market expectations (the BSE-500 price earnings multiple is at about 11 times).
Stand-out performers
A few other trends, not specific to sectors, also emerged from the analysis. For instance, among the companies that notched up higher sales and net profits, 105, or one-third of the universe, saw net profits grow at a faster pace than sales. Were these companies supported by ‘other income’ outside of operations? Not really, as the other income declined in this universe as well.
The average operating profit margins for these companies jumped 300 basis points to a whopping 40 per cent in the latest quarter compared to a year ago, suggesting that volumes, pricing power and cost management could have been the key factors for superior performance, rather than any freak “other income.” See Table ‘ Strong show’ for a few such companies.
Interest costs, although stable, forms about a fifth of sales for these companies — far higher than the ratio of 13-14 per cent of sales for the whole universe. This suggests that these could be highly leveraged companies, starting to reap the benefits of expansion.
To balance the above with some negative trends, about 18 companies in the universe reported a decline in sales on a year-on-year basis.
About 11 of them also skidded into losses in the recent quarter, from net profits a year ago. These companies account for 3-5 per cent of our universe of 320.
Interestingly, both the above categories were part of the under-Rs 2,500 crore market capitalisation segment, once again reiterating the ability of larger companies to manage tough times better.
Source:BL