Waiting for daybreak

It is always the darkest before dawn. Only if you subscribe to this view, do the results from Indian companies for the recent March quarter offer room for optimism. For, the numbers present a singularly gloomy picture of what is afoot in India Inc.

For 3,000 listed companies that unveiled their results, net profits fell by 13 per cent in the March quarter compared with a year ago. Raw material costs and interest payouts, the two key pressure points on corporate profit, showed no moderation. A depreciating rupee robbed companies of cost savings from falling commodity prices.

Operating profit margins, despite showing a slight sequential improvement, were a full two percentage points below last year's levels. But the most worrisome feature of this scorecard was undoubtedly the dwindling sales growth. Sales growth for these companies came in at just 13 per cent in the latest quarter, from 20 per cent plus levels in the preceding three.

Slowing sales

A breakdown of the numbers suggests that the slowing topline growth came from unexpected quarters. It was not just sectors such as construction, metals, capital goods and realty, beset with the now famous ‘policy paralysis', that lost momentum.

Even segments that were hitherto aided by strong domestic or export demand showed signs of giving way — consumer durables, software and realty for example. What is more, cost pressures took a toll on profit margins in sectors such as commodities, utilities and FMCGs in recent quarters a clear signal that manufacturers are running out of pricing power to effortlessly pass on cost increases to their consumers.

Some light?

But despite all the bad news, this may be an opportune time for investors to add to their equities portfolio for three reasons.

One , after the relentless profit downgrades of the past year, it is likely that much of the pessimism about earnings is already factored into stock prices. Sensex company earnings for the latest March quarter, in fact, beat consensus estimates by a thin margin. And the number of Sensex companies which bettered street estimates outnumbered the ones which missed estimates.

Two , the recent decline in crude oil prices (on concerns about demand destruction in China and Europe), if it lasts, may temper the risks to the economy as well as corporate earnings. The price decline in crude oil may cut energy and transport costs for companies across the spectrum. This is also likely to have a domino effect on linked industrial inputs such as packaging, chemicals, paints, palm oil and so on. Three , market valuations, hovering at about 12.5 times current year profits, seem reasonable enough for long-term investors to accumulate equities.

Watch out for…

Having said all this though, the sustainability of the recent fall in commodity prices and the stability of the rupee are still in doubt. This makes it early days yet to call a turnaround in India Inc's fortunes.

It is best, therefore, that investors remain quite selective with their stock market exposures. They can temper risks through the following:

Buy the bluechips : Larger companies have generally weathered the recent mayhem in the domestic and global markets better than their smaller and mid-sized peers. Apart from scale and pricing power, Sensex companies have benefited from a global leg to their operations which have bolstered their Rupee earnings. That is evident from the Sensex companies delivering profit growth and superior sales growth compared with the rest of the listed universe. This argues for investors to accumulate the Sensex basket through exchange traded funds.

Focus on the topline : While selecting stocks and sectors, look for companies that have managed to sustain strong sales growth in the March quarter. We say this because a correction in raw material prices or interest rates may bring about improvements in profits in sectors where demand drivers remain strong. But in sectors where demand drivers are weak, waning cost pressures are unlikely to provide a lift to earnings. In a market clouded by uncertainty, companies that offer visibility are likely to enjoy a premium.

Light on leverage : While there does seem to be light at the end of the tunnel on the input costs that are depressing corporate profits, there isn't any yet on interest costs. Even rate cuts by the central bank, if they do materialise, will make their impact felt on corporate profits only with a two-quarter lag. Therefore, it is best that you continue to give highly leveraged companies a wide berth while selecting stocks for your portfolio.

akrishnan@thehindu.co.in

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