The Hindu Business Line : Brisk sales growth amid rising input costs

Corporate India saw a brisk pace of growth in net sales during the first quarter, no doubt; but an analysis of the results reveals that the increase in input costs and the rising interest burden are holding back earnings growth for India Inc.

Robust sales, led by prices

For about 2,000 companies analysed, sales in the first quarter of 2008 grew a robust 38 per cent over the same period of last year. This is much higher than the 17 per cent managed in the June quarter of 2007. The sales growth managed by India Inc presents quite a contrasting picture to sagging industrial production (IIP) numbers month after month. This suggests that either the IIP is not reflecting some of the fast growing segments of the economy or that listed companies are managing to do much better than the overall industry.

The sales growth this quarter has been led by such sectors as engineering, construction and steel, which individually witnessed topline growth of 46 per cent, 40 per cent and 37 per cent respectively. Software, telecom, media and pharma did not fare badly either, growing 25-30 per cent.

But a closer look reveals that this growth may have been led more by price increases than by an actual rise in volumes, the auto sector being a case in point. Faced with rising prices of inputs such as steel and aluminium, auto-makers raised prices during the quarter.

Tata Motors, for example increased prices by 7 per cent during the quarter. This has helped the company post a 15 per cent growth in net sales although volume growth for the quarter was about 8 per cent.

Sales of Ashok Leyland too grew by 16 per cent, but backed by a mere 2.4 per cent growth in volumes. Ditto with Maruti, for which sales grew by 21 per cent but volumes only by 12 per cent.

Similarly, although the IT sector witnessed about 29 per cent growth in topline, billing volumes were at lower-than-expected levels for the top companies. Rising prices helped companies in the steel sector post good growth due to higher realisations. The trend of rising prices suggests that India Inc has attempted to pass on input price increases to its consumers, but whether consumers continue to take higher prices in their stride will only be tested, by volume growth, over the coming quarters.

‘Other income’ growth shrinks

Besides the strong growth in sales, this quarter also saw a marked reduction in the growth of ‘other income’, lending greater credence to the quality of earnings. “Other income” grew only by 2 per cent in June 2008, after a whopping 48 per cent growth in the June 2007 quarter. The huge growth in ‘other income’ last June continued unabated into this year. In September and December 2007, aided perhaps by gains on forex transactions and improved treasury returns, other income grew by 42 per cent and 82 per cent respectively.

The first signs of slowing growth in ‘other income’ was seen in the fourth quarter of 2007-08, when it grew just 23 per cent. The near-flat growth in the current quarter has brought down other income as a percentage of total income by one percentage point, to 3.5 per cent. The tapering off of “other income” is a sign that the 5.3 per cent profit growth managed by India Inc in the June 2008 quarter, though modest, is of a more sustainable nature than the preceding quarters.

Profits edge up

Overall profit growth for the 2000 companies stood at just 5.3 per cent year on year, compared to the 36 per cent managed in the June 2007 quarter. Besides, although the number of loss-making companies grew by about 13 per cent from last year, losses made by these companies (excluding oil marketing companies) have grown by a whopping 80 per cent. With depreciation and tax costs showing no significant change, interest costs remain the principal reason for the fall in net profit margins to 8.5 per cent from 11 per cent in the same quarter last year.

Expenses escalate

One of the main reasons for a PAT (Profit After Tax) growth of only 5.3 per cent is the 43 per cent increase in expenses compared to 2007. For the same quarter last year, expenses had increased only by 13.3 per cent over June 2006.

While part of this is due to companies recognising hedging losses in the ‘other expenses’ head, the impact of rising input costs cannot be ruled out. Sample this. Raw materials consumed are up 40 per cent on a year-on-year basis. For the same period, fuel and power costs are up 32 per cent. Given this escalation, expenses as a percentage of net sales are at 80 per cent now, compared to 77 per cent in the quarter ended June 2007.

Operating Margins – Oops!

The impact of cost pressures witnessed by companies becomes clear at the operating margin level. For the quarter ended June 2008, the overall operating margin for the companies analysed hovered around 20 per cent, falling by a good three percentage points from 23 per cent, a year ago. Auto, cement, real estate and telecom were some of the sectors that witnessed a sharp fall in margins.

The auto sector was one of the worst affected by the slowdown and rising interest costs. Almost all auto ancillary companies witnessed a fall in operating margins year on year. Motherson Sumi’s margins declined about 7 percentage points. Margins of Tata Motors fell to a thin 4.7 per cent from 8.7 per cent a year ago. Hero Honda was the only company to report about 1.5 percentage point growth in margins, thanks to improved sales of new models and cost control efforts.

Marigns of Reliance Communications fell to 31.6 per cent from 40 per cent a year ago. Bharti Airtel, Idea and MTNL also witnessed margin pressures.

Losses on trading portfolios due to rising interest rates and increasing costs took a toll on the margins of banks as well. Axis Bank, SBI and ING Vysya witnessed sharp fall in margins.

The operating margins, however, did not deteriorate from the March quarter, remaining flat though the raw materials consumed inched up by 13 per cent. This shows that companies have been able to hold their margins by either passing on the cost increase to the customers, as discussed earlier, or by undertaking cost-control measures — as sequential expenses have grown only by 3.5 per cent.

Another reason for companies being unable to translate top line growth into better earnings is the rising interest burden on profits.

Interest burden inching up

Interest costs have increased by 33 per cent, year on year. For the companies under consideration, interest costs account for 40 per cent of the PBIDT (profit before interest, depreciation and taxes.).

This is five percentage points higher than June 2007 (35 per cent of PBIDT). Dalmia Cement, Saurashtra Cement, Wipro, HCL Technologies, Hindustan Construction, Unitech, L&T, Sona Koyo Steering and Tata Steel were some of the companies whose interest costs, as a percentage of operating profits, witnessed a sharp rise.

The analysis also reveals that interest cover has reduced from 2.8 times in June 2007 to 2.5 times in the current quarter. Interest cover, calculated as ‘Profits before Interest and Taxes / Interest charges’, indicates whether a business earns sufficient profits to service interest costs on its debt. With interest costs rising and interest cover falling, companies will now have to set aside more of their already diminishing operating profits to meet interest costs.

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