Past imperfect, future tense for India Inc

Q1 results indicate more pain ahead, as slowdown has spread to more sectors, pricing power has come down and rising interest cost is eating into profits

The pain has increased; and there’s little hope it will subside in the near future. That just about sums up the state of corporate India, after the results for the quarter ended June.

Though net sales of the 1,961 companies (excluding banking & financial and state-owned oil & gas ones) that had declared results till August 13 had risen 3.6 per cent from last year, the rise was the lowest in 13 quarters. The combined adjusted net profit (excluding extraordinary items) declined 5.4 per cent from that in the corresponding period last year, to Rs 61,186 crore. And, while operating margins, at 15.7 per cent, inched up marginally on a year-on-year basis, the aggregate interest burden surged 19 per cent.

Given the volatility in earnings of public-sector oil companies, most research houses exclude these to arrive at the true picture of broad earning trends. The June quarter has proved it again. If these firms were included in the sample, India Inc’s net profit would more than double. The reason: The combined net loss of six oil & gas companies — IndianOil, BPCL, HPCL, ONGC, Oil India and MRPL — declined 98 per cent to Rs 780 crore, from Rs 35,049 crore in the year-ago quarter. (THE STRESS IS SHOWING)

After adjusting for public-sector oil firms, according to experts, the results have not been encouraging; and the trend is likely to get worse in the coming quarters.

With the rate of inflation hovering between five per cent and six per cent, market participants say, the real demand growth (measured through sales growth) is in the negative territory. Also, unlike earlier, a large part of India Inc is facing pressure on various counts.

Prasad Koparkar, senior director (industry & customised research), CRISIL Research, says: “The malaise seems to be spreading. Now, it is not restricted to a few sectors. Earlier, it started with capital goods, infra-related and construction sectors. It has now spread to a much larger space — auto, chemicals, industrials and metals. So, barring three-four sectors, most are not doing well.”

Falling sales growth and rising interest cost have led to a decline in India Inc’s net profit. Worse, things are not expected to improve anytime soon. Industry believes correcting structural issues will take at least two years. If at all the rate-easing cycle begins again, that won’t be before March 2014. Given the macroeconomic challenges, such as weakening of the rupee against the dollar and an elevated current account deficit, the Reserve Bank of India has abruptly halted its easing cycle.

Essar Group CFO V Ashok says: “We don’t expect any cut in interest rate before March 2014; and, this might derail investment plans. We are looking at dollarising our debt, as we have a natural hedge of export earnings. The environment will remain challenging through this and next financial year, as interest costs for companies will remain high. Though RBI has cut rates since last year, the reduction has not been passed on to borrowers.”

It’s not only small- and mid-cap companies that are facing the heat. Larger ones are also under pressure.

Rajat Rajgarhia, managing director (institutional equities), Motilal Oswal Securities, says: “Excluding BPCL, the top line growth for Nifty companies is just three per cent, while their profit is down four per cent from that in the same period a year ago.”

He adds the Q1 numbers are quite disappointing as the top line growth is the lowest in a decade (excluding the year of global crisis) for Nifty companies. Also, pricing power has vanished across sectors. Given that Ebitda grew by just two per cent, interest costs clearly are an issue, But the bigger worry is a fall in demand which has been hurting companies’ pricing power.

After results, Motilal Oswal Securities has seen 400- to 500-basis-point downgrade in growth of Sensex firms’ earnings per share, which the research house now pegs at seven per cent in 2013-14.

A deeper look at the results suggests more than half the companies have reported lower profits or losses in the June quarter. Data compiled by the BS Research Bureau show 538 companies have reported a net loss, while 529 have seen profit decline. Of the firms that reported losses, nearly 177, including Jet Airways, Adani Enterprises, Ashok Leyland, Tata Power, Siemens and Torrent Power, had posted profits in the year-ago period.

Positively, about 115 firms, including Tata Communications, Madras Fertilisers, HCC, Punj Lloyd and TV18 Broadcast, have seen turnaround in earnings and have posted an aggregate net profit of Rs 342 crore (compared with loss of Rs 593 crore).

Information technology, pharmaceutical and fast-moving consumer goods companies, which reported an average 16 per cent net profit growth on the back of a 15 per cent jump in operational income, have saved the day for corporate India. Excluding these three sectors, compared with the year-ago period, the aggregate net profit would have declined 11.7 per cent, while net sales growth would have been 2.3 per cent in the June quarter.

Continued growth in US markets and depreciation of the rupee against the dollar helped the IT and pharma sectors report good numbers in the quarter. The telecom sector, too, saw an improvement.

The capital goods sector reported weak performance across the board due to a slowdown in orders flow. In fact, Motilal Oswal Securities’ Rajgarhia says capital goods firms showed a fall in revenues, something not seen in many quarters.

Cement companies’ earnings were also hurt due to low volume growth and margin pressure, while the metals sector performed poorly because of lower realisations.

So, what’s in store for India Inc?
“The government’s recent positive announcements are unlikely to result in a V-shaped recovery in the capital expenditure cycle. Rather, India first needs to address some structural issues (land acquisition, over-leveraged private sector, changes in contract terms, etc), which we expect will take at least 18 months,” says Espirito Santo Securities’ Aditya Bhartia in a July report.

Rajgarhia shares the view. He says: “First, one has to see where the earning downgrades stop. Recent RBI measures will have a negative impact and will reflect in the second- and third-quarter numbers. Now, banks are also raising base rates.”

Koparkar of CRISIL Research agrees. He says: “Overall, at least for some important sectors, earning downgrades still continue. There’s more downside in the near term.”

He makes a crucial point, saying: “The overall interest outgo has risen 20 per cent on a year-on-year basis. But you don’t get a break-up of how much of the increase is towards sustaining business and how much for growth investment. The worrisome part is that a large part of this is not growth-driven. It’s sustenance-driven. That is, for supporting stretched working capital (due to delayed payment). Just to remain above the water, companies are forced to borrow. This is not a good sign.”

In an environment of weakening demand and rising interest rates, further increase in interest costs could significantly hurt the companies that have high debt and low interest coverage ratio (operating profit as percentage of interest costs), possibly leading to problems in servicing debt and repayment obligations. And, this could further add to pressure on banks.