The Hindu Business Line : Recovery tempered by challenges

Falling commodity prices and cost savings helped Corporate India grow its profits by more than a third over the previous year, and the lower interest burden also helped.

Srividhya Sivakumar

A strong earnings rebound, swelling margins, but poor sales growth. This best describes India Inc’s performance in the just-ended September quarter. The 1,622 companies (on the basis of standalone financials excluding banks and other financial institutions), that reported their numbers, grew their profits by a whopping 39 per cent, registering a strong recovery from the decline of September 2008.

So, does this mean India Inc is firmly back on the growth path? Well, though profits show a mighty leap from the tepid levels of last year, a breakdown of the quarter’s performance shows that challenges still remain. Demand recovery is not yet broad-based and there remain big sector divergences. Profit growth was largely driven by lower costs. Here are the key takeaways:

Sales slump...

India Inc registered a 9 per cent decline in net sales during the quarter, with significant divergence across sectors. While auto, cement and consumer goods companies reported strong sales, led by improved volumes, others such as metals, steel and realty players reported a fall in sales, due to depressed realisations .

A closer look explains the overall performance better. For one, commodity prices having fallen considerably from last year’s levels significantly impacted realisations and consequently the sales reported by steel and metal companies. Second, given that sales had peaked in last year’s September quarter, a high base may also be partly to blame for the suppressed growth this time round. Companies had reported a 38 per cent growth in revenues in September 2008.

Another comforting factor is that India Inc managed to grow its revenues sequentially. Compared to the June 2009 quarter, companies put up a strong 9 per cent growth in sales, way better than the 2 per cent sequential decline recorded in the earlier June quarter. The recovery in commodity prices (over the quarter) appears to have aided producers of such commodities as steel and metal, which charted a sequential growth in sales.

Select companies in realty, auto components and engineering too bettered their sales sequentially; telecom disappointed sequentially. Auto, pharmaceuticals and IT sectors, however, registered top-line growth, both on a year-on-year and a sequential basis.

There was divergence in growth trends across market capitalisation categories too. While large-cap companies (market cap of over Rs 8,000 crore) saw a steeper decline in yearly sales (12 per cent), the mid-cap companies arrested the sales decline to 7 per cent. On a sequential basis, however, the large-caps led sales growth, followed by the mid- and small-cap companies.

Fairly sharp divergence was apparent among companies within a sector too. For instance, within the pharma universe, while companies such as Dr Reddy’s, Lupin and Aurobindo Pharma reported strong growth in sales, others such as Sun Pharma and Divi’s Lab saw declines.

In the engineering space, while ABB, Suzlon Energy, EKC and BEML saw a fall in sales, others such as BHEL, Crompton Greaves, Areva T&D and Engineers India recorded growth.

…but margins to rescue

So, how did India Inc manage the double-digit profit growth in spite of the decline in sales? Through lower costs. The decline in prices of commodities such as steel and aluminium and better cost-management helped companies improve their profit margins.

Reduction in excise duties as part of the Government-sponsored stimulus plan too helped expand margins in some sectors with companies preferring to keep the savings rather than pass them on to customers.

On an aggregate basis, excise duty declined by 12 per cent during the period. Companies from sectors such as auto, auto components and cement, besides select engineering companies, reaped the maximum benefit from excise duty cuts.

On the whole, the ‘total expenditure’ shelled out by companies dropped 13 per cent over the year, while raw material costs fell by 14 per cent.

This, in turn, helped companies expand their operating profit margins by 4.5 percentage points to 15.3 per cent, as end-product prices corrected less than inputs in quite a few sectors.

On a sequential basis, however, the operating margins of the universe deteriorated marginally (by 1.4 percentage points from the 16.7 per cent reported in the June quarter). During the period, while the ‘total expenditure’ component grew by 10 per cent, raw material costs inched up 24 per cent. That companies could contain significant declines in operating margins despite the increase in costs hints at the return of some pricing power. Realty companies may be a case in point.

Trends in operating margin performance too were diverse across sectors. On a broader plane, that the operating environment continues to remain different may explain the divergent performance. While better product mix and increasing volumes helped auto companies scale a 7-percentage-point expansion in OPMs over the year, a steep decline in sales (both volumes and realisations) of realty players put downward pressure on margins.

The bottomline

While cost savings undertaken by Corporate India helped grow its profits by a whopping 38 per cent over the year, profits were also helped by the falling interest burden on companies. Interest costs declined 11 per cent, year on year, putting companies in a better position to meet their interest obligations.

Besides, the interest cover, which reflects the number of times a company’s operating profit covers its interest costs, improved from four last year to six now. Here, again, there was disparity based on market capitalisation categories. Large-cap companies bettered their interest cover significantly, from five times last year to 10 times.

However, their mid- (4 times) and small-cap (3 times) peers saw little improvement on that front, suggesting that these small- and mid-sized companies may not yet have had easy access to liquidity.

Net profit margins too expanded 3 percentage points to 8.4 per cent. On a sequential basis, however, profit growth declined by 5 percentage points while NPMs fell marginally.

Other takeaways

Earnings growth was a function of size too, with larger companies reporting improved profit growth but lower sales. Profit growth at about 50 per cent came in much stronger for large-cap companies, than mid- (4 per cent) and small-cap (22 per cent) companies.

While the overall quality of earnings has been satisfactory, with little contribution from the non-core ‘other income’ component, it still leaves a lot to be desired, especially since profit growth came largely from Corporate India’s margin expansion. Trends in revenue growth in the coming quarters, therefore, bear a close watch.

Though sales growth declined for India Inc, this was largely due to suppressed realisations across sectors such as steel, metal and realty.

Falling contributions from select sectors seem to have skewed the average as, otherwise, six out of ten companies grew grow their revenues.

Related Stories:
India Inc manages to make profits on lower sales in Q2
Net profit growth rate doubles in Sept quarter
Sept quarter scorecard: So far, so good
Corporates prop up direct tax collections

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