On the mend

India Inc’s Q3 FY21 report card brings welcome evidence that the profit rebound of the preceding quarter wasn’t just a flash-in-the-pan. An analysis by this paper shows that for 1,772 companies that have declared numbers, net profits (adjusted for exceptional items) jumped 52 per cent year-on-year on the back of operating profit margin expansion (17-21 per cent) though revenues barely changed. Soft material prices and wage cost savings seem to have aided profitability; rising input costs, though, may begin to pinch from the current quarter. Overall profit growth was striking with dramatic turnarounds from losses to profits reported by leading public sector banks, and steel and industrial companies, too. Muted bad loan recognition played a role in standout bank numbers while the upbeat commodity cycle propped up profits for commodity players. On these scores, the sustainability of profit growth bears watching.

Though weak growth in total revenues (0.2 per cent) seemed to show a lack of aggregate demand, there was significant sectoral divergence. Consumer-facing sectors such as durables (18 per cent sales growth), automobiles (11 per cent), paints (23 per cent) and telecom (17 per cent) impressed. This trickled down to auto ancillaries (25 per cent), cement (30 per cent), steel (15 per cent) and tyres (19 per cent). But continued demand contraction in retail trade (minus 24 per cent), media and entertainment (minus 26 per cent) and hospitality (minus 54 per cent) underlined that many services are still badly hit by regulatory restrictions and cutbacks in discretionary spending. Steel and cement firms saw operating leverage lift profits as capacity utilisation perked up. Banks delivered strong profit performance helped by ultra-low borrowing costs and low provisions, despite weak loan growth. While the real picture on Covid-induced loan stress will only be evident after the lifting of the apex court standstill, corporate banks seem to be reporting muted defaults while retail lenders are bearing the brunt.

Overall, Q3 numbers do offer some hope that India Inc’s depressed earnings may finally be playing catch-up with steep stock valuations. But it is by no means a certainty that the pace of Q3 profit growth will be repeated once the virtuous combination of low input costs and ultra-low interest rates changes. It also remains to be seen how much of India Inc’s savings on employee costs, ad spend and overheads can be retained once demand and competition normalise. For stock market investors, Q3 earnings offer some room for optimism that the breathless bull market may finally find some fundamental support. But they will still need to approach their equity allocations cautiously. With the market consensus now expecting Nifty earnings to finish FY21 with a 25 per cent increase from here and deliver a further 33 per cent growth next year, there’s still room for earnings to disappoint and trigger that much-needed valuation reset.