Industrials' share of profit hits 10-year high amid commodity boom

This is on the back of a commodity cycle boom

The share of industrial companies in India Inc’s profit pool is approaching decadal highs, thanks to the commodity cycle boom. But it remains to be seen if the trend is sustainable or can be extrapolated into the increased contribution of the manufacturing sector to India’s gross domestic product (GDP).

According to an analysis done by ICICI Securities (ISec), the industrial sector accounted for 46 per cent of aggregate profits of Indian companies, up sharply from 36 per cent levels in 2016. It was slightly above 46 per cent in March 2012.

The trailing 12-month India Inc profit pool was Rs 11.3 trillion at the end of the March 2022 quarter. The brokerage has considered corporate profits of the top 1,000 listed companies by market cap, after excluding loss-makers.

Companies belonging to the industrial sector -- such as steel, cement, metals, mining, automobiles, power, and oil & gas -- contributed Rs 5.2 trillion to this pool. Financial services contributed Rs 3 trillion, while consumption, pharma, IT & other services put in nearly Rs 3.1 trillion.

“The above trend of the rising share of industrials and financials in the corporate profit pool is a positive sign for the nascent investment and credit cycles. However, commodity price-led expansion in profit base of industrials will recede as commodity prices show signs of stagnation,” said Vinod Karki and Niraj Karnani, Strategist at ISec in a note.

Industrials had the highest profit share of about 57 per cent between FY05 and FY06. Back then, the share of financials was less than 20 per cent, while the consumption, pharma, IT pack accounted for only a fourth of profits.

According to economists, back in 2005-06, the higher share of the industrial sector was demand-led, while currently it is price-led. “One cannot infer that India is becoming a manufacturing-driven economy. In the past two years, industrial firms’ profitability has been bolstered by twin tailwinds of higher commodity prices and low energy prices. The increase in profit share is driven mainly by metal, mining and energy companies. On the other hand, automobile, capital goods, power, and consumer durable companies have struggled,” said an economist.

Between 2005 and 2015, the share of industrials in the profit pool dropped from 57 per cent levels to just 36 per cent. On the other hand, the share of services, consumer goods and IT doubled from 20 per cent levels to 40 per cent levels.

The current earnings mix is a positive from a valuation point of view as stocks in the industrials and financials — whose share in the profit pool is increasing — trade at relatively reasonable valuations.

“Industrials-plus financials, which constitute 73 per cent of the aggregate profit pool, are reasonably valued at a trailing price-to-earnings (P/E) of 15x–16x, compared to historical levels while the remaining 27 per cent of the profit pool (services, consumption and healthcare) is still at a high trailing P/E of 33 times,” the analysts added.