First-quarter results review: Headline numbers up, but concerns remain

Earnings growth at three-year high; big divide between outperformers and laggards

Corporate earnings for the quarter ended June this year justified the jubilant mood on Dalal Street but not the way the bulls had expected. In the run-up to the results season, the bulls were betting on cyclicals and capex-heavy companies, but the actual numbers proved them wrong. The rupee's depreciation and the rural demand story once again came to India Inc's rescue, more than compensating for a continued poor show by others.

The net profit of 1,726 companies (excluding those in the financial and oil & gas sectors) rose 35.3 per cent on a year-on-year basis to Rs 99,527 crore, increasing the most in at least three years, thanks to a strong show by information technology (IT) services exporters, pharmaceutical companies, consumer goods makers and a handful of automobile makers such as Tata Motors and Maruti Suzuki. A low base contributed to the growth in profit - these companies had reported a decline of about 10 per cent in net profit in the quarter ended June 2013. The same set of companies had reported year-on-year growth of 26.6 per cent in earnings in the March quarter of this year.

The gap between actual numbers and market expectations was clearly visible in the case of revenue growth, which was only marginally better than in the previous quarter. Net sales (excluding financial and oil & gas companies) rose 11.8 per cent year-on-year to Rs 7,88,047 crore in the June quarter, against 5.4 per cent in the corresponding period last year and 11.3 per cent in the quarter ended March this year.

For the entire set of 2,106 companies, including those in the financial and oil & gas sectors, the net profit (adjusted for other income and exceptional items) rose 33.4 per cent year-on-year to Rs 1,54,741 crore, against 8.1 per cent in the previous quarter and a decline of 17.6 per cent a year ago. Net sales recorded annual growth of 12 per cent at Rs 13,36,619 crore, compared with 10.3 per cent in the previous quarter and 6.4 per cent a year ago.

The headline numbers were also impacted by the market-beating performance of mobile operators, especially Idea Cellular and Bharti Airtel, owing to higher data usage and an improvement in their pricing power. Bharti Airtel's net profit rose 61 per cent year-on-year, while Idea's earnings were up 57.4 per cent.

"Corporate earnings have been a mixed bag, with a big divide between outperformers and laggards. While the former more than compensated for a poor show by the latter, it seems a credible recovery in cyclical and capex-related sectors is still a few quarters away," says Devang Mehta, senior vice-president and head (equity sales), Anand Rathi Financial Services.

His fears aren't unfounded. If IT, pharmaceuticals and auto makers are excluded from the sample, the net profit growth (adjusted for exceptional items and one-offs) falls to 10.6 per cent, while revenue growth falls to 8.4 per cent year-on-year from 9.4 per cent in the previous quarter. In all, companies from these three sectors accounted for two-thirds of the incremental profit growth for all the companies in the sample.

Analysts say this explains why the stock market continues to move in a narrow band, despite high headline profit growth. "The current rally was built on expectations of a swift recovery in the investment cycle and a corresponding rebound in the profitability of capital- and interest rate-sensitive sectors. The results, however, suggest a continued salience of the exports and consumption story," says Dhananjay Sinha, head (institutional equity), Emkay Global Financial Services.

He attributes this to the positive multiplier effect of the rupee depreciation's on exporters and commodity manufacturers, who sell their goods at landed prices. Consumer goods companies benefited from a surge in pre-election spending by the United Progressive Alliance (UPA) government, various state governments and the current National Democratic Alliance government, which is continuing with the UPA's expansionary fiscal policy.

For companies in capital-intensive sectors, there was no respite; these saw a further slide in financial ratios. Interest coverage ratio (operating profit divided by interest expenses) declined to an all-time low of 1.8 from 2.5 in the previous quarter and 2.3 a year ago. In other words, the operating profit (including other income) is sufficient to cover interest expenses for less than two quarters. The case is similar for power companies, metal producers and capital goods makers. Typically, an interest coverage ratio of more than four is considered healthy.

Not surprisingly, analysts are keeping their fingers crossed. "The continued polarisation of earnings across sectors and companies is making its tough to make forward-looking assumptions. We will wait for at least two quarters before making any case for a secular earnings recovery," says Sinha.

Despite muted revenue growth, India Inc benefited from cost cutting and a resultant rise in operating margins. On a sequential basis, the core operating margin (excluding other income) rose by 90 basis points to a three-year high of 17.2 per cent of net sales. The margin stood at 16.3 per in the previous quarter and 15.6 per cent a year ago. The impact was most visible in the consumer goods space, with companies putting brakes on sales and marketing expenses.