Big Story

How the economic slowdown has impacted India Inc

The economy decelerated in the first half of FY20, and the impact is evident in many industries. How did India Inc fare in this period? Will it be able to successfully navigate the maze? We look at the first-half performance of key sectors to find out what lies ahead for the rest of the fiscal

Banking: Lending little comfort

It has been one hell of a year for the financial services space. Just about a year ago, the IL&FS, and the subsequent DHFL crisis had taken the sector by storm. While the liquidity crunch that hit the NBFC sector offered banks the perfect opportunity to gain lost ground, persisting asset-quality challenges and weak capital proved dampeners for most banks.

The spill-over effect of the NBFC crisis and heightened stress in a few corporate groups also took a toll on banks’ asset quality — even on once-fancied private sector banks such as YES Bank and RBL Bank. The fallout? Still muted credit growth, high provisioning and weak earnings for many banks. The worsening slowdown over the past six months has only exacerbated the situation. Bank credit growth has always been a function of the overall growth in the economy. Bank credit clawed back to a double-digit growth of 12 per cent by March 2019, after four straight years of single-digit growth, but it slipped once again to 8-odd per cent by September.

While growth in retail loans continued to remain resilient at 16 per cent levels, credit to industry slipped to about 2.7 per cent by September. Even within retail, while credit card and personal loans grew 20-25 per cent, vehicle loan growth has been a mere 4-5 per cent. While well-capitalised private sector banks such as HDFC Bank, Axis Bank, ICICI Bank and IndusInd Bank have bucked the trend and delivered healthy loan growth (led by strong retail portfolios), asset-quality concerns for a few are yet to abate.

Optically, growth in bad loans have fallen considerably in the first half of the current fiscal (vis-à-vis) the previous year; in the case of PSU banks, bad loans have shrunk 8-odd per cent at the aggregate level. But this is only because bad loans had galloped last year.

After doubling in FY16, bad loans for PSU banks grew about 20 per cent annually in the following fiscals. For private sector banks, too, the modest 3 per cent growth in NPAs in the first half of FY20 has come on the back of a 21 per cent growth last year.

The bottom-line picture for PSU banks and private banks has been mixed. While strong core net interest income growth has aided private banks, one-time deferred tax asset (DTA) impact on account of moving to lower corporate tax rate has impacted the earnings of ICICI Bank and Axis Bank in the latest September quarter. This has resulted in a somewhat muted 11 per cent growth in profit for the listed private bank universe.

On the other hand, for PSU banks, despite the weak core performance, the relatively lower provisioning and not moving to the lower tax (hence, no sharp DTA write-down) has led to modest profits (from losses last year). Given the still elevated slippages and provisioning, weak credit environment, and the impending impact of DTA on PSU banks, the earnings picture for the second half does not look very encouraging. However, the Supreme Court ruling in the Essar Steel case would offer big relief to banks. But for substantial improvement in earnings, more such recoveries under IBC (Insolvency and Bankruptcy Code) will be important, alongside pick- up in credit growth. A few stocks for the long run are HDFC Bank, IndusInd, SBI, Axis Bank and ICICI Bank.

Automobiles: In first gear

A fall in rural demand, problems in availability of finance and higher upfront cost of vehicles have been taking a toll on car and bike sales over the past year. Sale of trucks has also been affected due to lower freight availability due to the general economic slowdown, quicker turnaround times for trucks after GST, and the permit to carry higher loads for existing vehicles (ie, the revised axle load norms).

New vehicle sales volumes (wholesale) dropped 17.8 per cent in April-September 2019, a far cry from the 10.07 per cent volume growth seen a year ago, in April-September 2018.

The pain from the slowdown in automobile sales is visible in the results of vehicle manufacturers for the first half of this fiscal. Aggregate net sales for auto companies dropped 11.1 per cent in the first half of this fiscal year, over April-September 2018.

Although raw material costs remained somewhat flat, lack of operating leverage due to poor volumes, as well as discounts and price cuts to boost sales, took a toll at the operating level. Maruti Suzuki’s operating margins, for instance, contracted by over 5 percentage points. Other frontline companies such as Hero MotoCorp, Bajaj Auto and Ashok Leyland also saw operating margins shrink sharply by up to 3.5 percentage points.

Overall, a 73 per cent growth in ‘other income’ and 38 per cent fall in tax burden due to corporate tax rate cuts were a positive. Yet, profitability was affected due to poor operating performance. The aggregate adjusted net profit for the sector dropped 33 per cent during the same period.

October wholesale volumes are no better, having dropped 12.8 per cent. But the fact that retail sales have moved into positive territory in recent times is encouraging. Retail sales showed 6-8 per cent growth in the past two months, indicating that the worst may be over for the industry. However, uncertainty due to the impending transition to BS-VI emission norms by April 1, 2020, may impede a strong recovery in sales in the second half of this fiscal.

Infrastructure: Weakness persists

While infrastructure companies are key for economic revival in a country, they are also among the first ones to bear the brunt of an economic slowdown.

However, on the face of it, 1HFY20 numbers posted by many in the sector have a different story to tell. Where the revenues for almost every sector tanked, infrastructure majors such as Larsen and Toubro, KEC International and RITES saw 15-plus per cent growth in their top- line.

A deep look into their numbers reveals that the growth predominantly came from international orders and execution in the long- pending railway (both domestic and international) order book. Clearly, most of them saw a standstill in domestic order execution in the September quarter.

While this may be considered a tale of the past, weak order inflows in the domestic infrastructure segment signal gloomy times ahead. Except for L&T, the growth guidance for order books in FY20 seems to be a stretch.

Talking about pure-play road construction companies, only Ashoka Buildcon has reported its 1HFY20 numbers. While the company saw 12 per cent growth in its top-line, mounting interest costs led to higher losses than the corresponding period last year. As evident from NHAI’s (National Highways Authority of India) data, the company’s order inflows remained weak, leading to a 23 per cent drop in its order book from September last year.

The same is likely for other companies in the road construction sector as well. No respite came from toll collections either. For instance, Ashoka Buildcon reported a 6.3 per cent drop in toll collections from its BOT (build-operate-transfer) projects in the last September quarter. Despite weak revenue numbers, many infrastructure companies posted healthy growth in profits. A major contributor for this was the Centre’s move to cut corporate taxes. However, for a few players, the effect of this was set off due to write- back of MAT (Minimum Alternate Tax) credit and DTA (Deferred Tax Asset ).

Since these were one-time write- offs, profits could be higher in 2HFY20. That said, demand revival in domestic infrastructure is highly questionable. While those depending on diversified streams may continue to survive, others may face even higher losses, given the mounting debt in their books.

Real estate: Sales, new launches improve

The Centre’s increasing focus on the affordable housing segment and various relief measures announced by the Finance Minister have helped real-estate developers in the first half of FY20, albeit at a slow pace. Realty players with good leverage levels fared well with new residential project launches and an increase in new unit bookings.

Though about 6.65 lakh housing units still remain unsold, the number is lower than the 6.73 lakh unsold units towards the end of FY18, according to reports by ANAROCK, a property consultant. Also, demand in the commercial segment was robust, and all realty players with a presence in office, hospitality (hotels) and retail (malls) have given strong performance.

Consider Brigade Enterprises, a Bengaluru- based realty player. It registered 94 per cent y-o-y new sales (value) growth in H1FY20. This was mainly due to the robust Bengaluru market which has the highest office space absorption, drawing higher working population, leading to incremental residential demand. Also, the Bengaluru market has the lowest unsold stock (about 63,450 units), resulting in better residential demand than other cities including Mumbai and Delhi.

Brigade also launched six new projects between April and September this year. However, the company’s revenue declined 5 per cent y-o-y and profit fell 44 per cent during the same period, mainly on account of higher finance costs and depreciation.

Similarly, Prestige Estates Projects, another Bengaluru- based player, not only increased its new sales volume, by about 2 per cent, in H1FY20, but also registered a revenue growth of nearly 62 per cent y-o-y and a profit growth of 21 per cent y-o-y. Favourable locations, brand recognition and competitive pricing helped the company.

Strong demand for commercial spaces, competitive residential pricing, favourable locations and the Centre’s infrastructure push have aided the new sales bookings for these companies and improved new project launches.

Though other realty companies witnessed increase in new sales bookings, the inventory overhang in key cities have dampened the progress. For instance, consider Oberoi Realty, a Mumbai-based developer. The company saw low new sales bookings during the first half of FY20 due to low housing demand. Its revenue and profit fell 26 per cent and 44 per cent, respectively, during the same period.

But going ahead, the demand could improve with various relief measures put in place to revive the housing market. Buyers’ preference for organised developers would also aid the growth of realty companies.

Based on the future launch pipeline, lease rentals and valuation, Brigade Enterprises, Sobha and Oberoi Realty can be good bets for investors.

FMCG: Not all doom and gloom

Growth in the final private consumption expenditure component of the GDP came in at 7.2 per cent in Q1FY20, the slowest in the past five quarters. It is expected to be weak in the September 2019 quarter, too. But the silver lining is that consumer staples, or FMCG companies, which command a smaller share of the consumer wallet have not felt the heat as much as autos.

Unlike auto companies, frontline FMCG companies have not seen contraction in volumes. However, volume growth has slowed to single digits in comparison with the double-digit growth seen last year. Hindustan Unilever, for example, has managed to maintain a volume growth of 5 per cent in both the quarters of this fiscal. Britannia’s volume growth came down to 3 per cent in the last two quarters, compared with the 12 per cent growth seen a year ago.

Benign prices of many raw materials and corporate tax rate reduction amidst the slowdown also helped companies undertake price cuts to boost volumes.

Thus, despite the headwinds, FMCG companies managed to show an aggregate revenue growth of 5.6 per cent in the April-September 2019 period over the same period in 2018.

While companies such as Britannia saw operating margins take a hit from high milk prices, others such as Hindustan Unilever, Marico and Jyothy Laboratories saw operating margins expand.

Marico, for instance, benefited from low copra prices, the key ingredient for its flagship Parachute coconut oil. The company used this elbow room to push up advertising spends by 160 basis points year-on-year to 10.4 per cent of sales in April -September 2019. A 12 per cent fall in aggregate tax expenses year-on-year shored up profits for FMCG players. Adjusted profits for these companies grew 15.7 per cent in the first half of this fiscal.

Be it home care, personal care or foods, premium products with lower penetration and those with a natural/ayurvedic twist have been doing well amidst the slowdown. This is expected to continue.

A pick-up in rural income following the good monsoons, recovery in prices of some crops and the income transfer scheme from the Centre could bring higher demand in the months to come.

IT services: Global troubles

The first half of 2019-20 saw revenues and profits of companies that are part of the BSE IT Index grow at a fair clip. For the 37 companies that have reported numbers for the April-September period, the combined consolidated profit after tax grew 7.6 per cent y-o-yto ₹ 40,869 crore, while revenues grew 9.4 per cent to ₹2.41 lakh crore.

However, when viewed sequentially, the picture changes. The combined consolidated profits of the 37 companies grew at a tepid rate of 0.6 per cent on a sequential basis, while the combined consolidated revenues grew at 2 per cent during the period. This shows that there is an element of slowdown that is setting into the IT services business.

All the top tier IT companies — TCS, Infosys, HCL Technologies, Wipro and Tech Mahindra — reported good top- line growth on a y-o-ybasis in the first half. However, Wipro and Tech Mahindra’s revenues for the first half of FY20 fell compared with the previous six months between October 2018 and March 2019.

Tech Mahindra managed to make up for its weak revenue growth in the first quarter of FY20 by posting good numbers in the July-September quarter as deals signed in the past started coming on stream. Wipro was impacted by weakness in client spending in Europe that has been plaguing the Indian IT services space. Profits on a sequential basis for the six months ended September 30 grew only for Infosys.

Mid- and small- size IT services companies have seen some of the weakness in growth play out in this period, but it’s not the same across the board. L&T Group companies — Mindtree, L&T Technology Services and L&T Infotech — have posted robust revenue growth in both sequential and YoY terms. Infibeam Avenues and Cyient are seeing some sequential weakness in their revenues. Only L&T Infotech’s profits grew in the six months ended September 30, compared with the six months ended March 31.

The weakness in revenue growth is coming from clients based in Europe, especially in the banking and financial services space. A few capital markets-related clients in the US and a few retail customers are also contributing to the slowing growth. This is affecting most players, whether they are large, mid-sized or small IT services companies. Deals have been signed, but clients are holding back from executing those deals.

HCL Technologies and Infosys (despite its recent troubles) seem a good bet for investors as they have upgraded their revenue guidance for the financial year.

Published on November 16, 2019
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