Q1FY12 - Profits in the slow lane

The news of the US downgrade has certainly grabbed all eyeballs. Investors around the world would be keenly watching the developments on the global front, especially the US, to take cues for the way forward. Indian investors would be no different – most of them wouldn’t be bothered to focus on anything else, even forgetting to track the ongoing June quarter results, which is yet another significant event in its own right. While global events continue to unfold, and the dust of the US downgrade settles, investors would be back to tracking the fundamental story. Hence, it is imperative that we do a stock-taking of our own, and understand where we stand interms of earnings. This will help gauge what to expect both from India Inc. and from the markets in the coming quarters.

The last quarter of FY11 did surprise us, with better than expected numbers both at the topline as well as the bottomline. We did, however,anticipate a slower June quarter, more so on the bottomline, on account of rising input costs, the inability of companies to fully pass on costs, hardened interest rates and so on. This seems to have come true.

Of the total 1715 results that we have so far, India Inc. continues to post a stellar performance on the topline, with a 25% growth on a Yearon-Year (YoY) basis. However, it is the bottomline that looks stunted, with a YoY growth of just 10.50% during the same period. In fact, if we adjust the PSU refinery numbers and extraordinary items from the gross figures, we find that while topline growth continued to remain strong at 24% on a YoY basis, the net profit growth further shrunk to 8.5%. While it would be easy to conclude that the results are in line with the street expectations, there are a few points that we like to bring to your notice.

First and foremost is that, while the results have disappointed us on the bottomline front, the topline continues to deliver strong numbers. It should be noted that the 24% topline growth comes over an already higher base of 20% topline growth seen in the same quarter last year. Now, this is quite reassuring, as it confirms that the consumption-led demand continues to remain strong with every passing quarter, and hasn’t lost any steam.

Secondly, despite the fact that the input costs and the power and fuel costs have gone up by almost 24% and 19% respectively, the operating margins remained more or less flat, and slipped merely by 35 basis points. This indicates that topline growth has come not just through volumes, but realisations too have played a strong role. This can be seen from the manufacturing companies’ results, where sales and profits have gone up by 23% and 15% respectively. Producers still have pricing power in the market, though it must be accepted that they are not able to pass it on entirely to the end-customers. Thus, at one end, the volumes continue to come, which is a good sign. At the other end, realisations haven’t kept the same pace, as corporates have preferred to bear a part of the cost hit due to fear of dampening demand and increased competition – this is impacting profitability, which is now growing in single digits.

The other significant insight that these numbers have also thrown up is that India Inc., as a whole, seems to be slowly losing steam. While in the same quarter last year, the growth to decline ratio in sales stood at 3:1 (for every three companies whose sales grew, one company’s sales declined), the same ratio has slowed to 2.5:1 this quarter. Similar is the picture seen on the profit front, where companies’ profit growth to decline ratio was 1.6:1– the same has now slowed to 1.27:1. This indicates that India Inc.’s growth is indeed slowing, both on the topline and bottomline.

Besides, what has also hit the profit growth is the higher base of last year’s June quarter, when profits grew by 15%. In this quarter, overall interest cost and tax outgo was up by 44% and 17% respectively. When combined, these factors have only dented profitability further. However, having said that, the silver lining is that as expected, Sensex companies lead from the front, showing strong resilience with topline growth of almost 26% and double-digit profits growth at little over 13% during the same period.

Beyond the front runners, the BSE midcaps and smallcaps too have delivered strongly on the topline with 16% and 21% growth respectively. They have faltered on the bottomline, where profits of midcaps dipped by 1.4%, while profit for the smallcaps grew by 9%. Thus, it would be better for investors to stick to front-runners, as falling profitability in midcaps and smallcaps may not yield the anticipated returns. What lies ahead would be a strong test of India Inc.’s resilience, and every passing quarter would only make things tougher. Though the consumption-led demand continues to remain strong as yet, with inflation remaining firm, we expect the demand to taper off and volumes to shrink, going forward. To add fuel to the fire, input costs aren’t providing any respite, while the lag effect of the rate hikes could be felt from the September quarter onwards. All this could dent profits, impacting margins further.

At a time like this, when an economy needs liquidity to run its engines and sustain growth, RBI’s stringent policy is clearly a dampener for corporate and the economy at large, and isn’t yielding the intended result – instead of arresting inflation, it is actually arresting growth. Until and unless the government addresses the supply-side issue of inflation and RBI rolls back its rate hikes, life is certainly going to be tough for India Inc. and the consensus FY12 EPS estimate of Rs 1250 that everyone is talking about at which Sensex is available at 13.5x, may have to be downgraded further. Hence, it is time to apply caution before taking a leap of faith in the market, as it is surely not going to be an easy ride in the coming months.