Mid-sized companies expect demand, but margins likely to fall

A recent survey of 50 companies by JP Morgan shows that CEOs have become less optimistic on near term demand recovery

Indian mid-sized companies are expecting demand from consumers to fall, margins to shrink and prices to rise thus hitting their bottom line in the rest of the year, a recent survey of 50 companies by JP Morgan shows.

The survey cautions that CEOs have become less optimistic on near term demand recovery, particularly on the capex cycle recovery. This is in spite of Finance minister P Chidambaram giving a 15% investment allowance in the Budget announced on February 28. High interest rates, elections in many states across India and lack of any policy direction is making investors wary of the future.

CEOs say that margins in the December quarter came under pressure after showing an improving trend over prior few quarters. Consumer discretionary demand improved in Q3 along expected lines, aided by festive season rolling into the December quarter. But CEOs are not too optimistic on sustaining the seasonal pick up and most of the CEOs polled expect consumer sentiment to remain weak and inflationary pressures on food and fuel continue to eat into discretionary spends. On Tuesday, the consumer price index touched 11 per cent thus adding to negative sentiment of consumers.

What is worrying is that CEOs are expecting margins to get worse after showing improving trend over past few quarters. Margins will fall mainly due to high power and fuel costs. The margin pressure across most small and medium companies increased in third quarter after showing improving trend over previous few quarters. Lower volumes/order execution hurting operating leverage, rupee depreciation, hike in power tariffs and severe power shortages across certain states - which is driving usage of diesel based generators - were key reasons for margin decline in the third quarter.

CEOs say that working capital stress is building up further (more visible for capital goods sector), and managements are increasingly focused on capital preservation by curtailing capital expenditure and focusing on collections and liquidating inventories.  In spite of huge investments to be made by the big boys in the industry like Reliance Industries and ONGC, the order books for most small and mid cap capital goods players declined in the third quarter. The corporate leaders are now less hopeful than before on a near term capex cycle recovery and blame policy environment as the key impediment.

As the budget has given investment allowance to projects over Rs 100 crore, it will not help the small and medium companies. “The investment limit of Rs 100 crore is too high for the MSMEs sector to comply with and this limit should be abolished or replaced with the limit of 1 crore only,” Sharad Jaipuria, Senior Vice president, PHD Chamber of Commerce & Industry.