A case for investor caution in Q4

A lucky combination of circumstances has helped India Inc report a bumper profit performance for the fourth quarter of FY21. Aggregate numbers for 1,190 listed companies including financials show profits (excluding one-offs) jumping 160 per cent over the same period last year, even as operating profits expanded 63 per cent and sales 17 per cent. But investors assessing India Inc’s prospects need to be wary of reading too much into these numbers.

Corporate India’s sales growth has benefited both from a base effect and market share gains. Listed firms have been gainers from the Covid-induced shift in business from small, unorganised players to large organised ones. Three factors have helped double-digit revenue growth translate into a three-digit bottomline expansion. One, commodity firms in sectors such as steel, mining and cement have enjoyed windfall profits in Q4 from the twin effects of operating leverage and surging global commodity prices. They contributed as much as 40 per cent to the overall profit pool of the sample. Two, consumer-facing sectors such as autos and FMCG, given the muted demand, were ruthless in economising on employee, selling and administrative expenses. Staff cost savings contributed in a large measure to expanding the bottomline of both the organised and unorganised sector enterprises. Three, a significant bout of deleveraging by cyclical giants on top of record-low interest rates, resulted in interest savings. Some of these profit props for Q4 are no doubt sustainable — the shift in business to organised sector, the benefits of deleveraging, fall in staff costs and lower tax rates, for instance. But there were clearly one-off factors at work too. With the base effect waning and consumer sentiment taking a hit again, sales growth in the coming quarters is unlikely to sustain at double-digits. With the listed universe featuring more commodity users than processors, spiralling input costs will begin to hurt profit margins from the current quarter onwards. Having pared employee and selling costs to the bone, companies may also have limited leeway to effect further cuts.

Given this backdrop, stock market indices continuing to scale new highs on the hopes of Nifty earnings upgrades needs to be viewed with some caution. The jury is still out on whether the global commodity spiral will hold out in face of sluggish demand recovery. Companies catering to discretionary consumption and high-contact services are already signalling distress and awaiting succour from the government. Though financial companies have emerged better-than-expected from the first wave, they have expressed concerns about their retail and MSME books taking a sharper hit from the debilitating second wave. Overall, Q4 results provide no reason for stock market investors to abandon their caution about pricey equity valuations as the indices break new records.

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