Third quarter - give and take

QUARTERLY RESULT ANALYSIS: December 2004

India Inc turned in impressive sales figures in the third quarter of FY05. For our sample of 1,000 firms, sales were up a splendid 26 per cent year-on-year.

Commodity makers Tata Steel and SAIL showed that they still command a premium for their products, notching up net profits of nearly 100 per cent. But pricing power continues to elude two-wheelers and consumer staples.

Increasing raw material costs caught up with most firms, denting their operating margins by about 70 basis points. However, the mood on the street is still upbeat.

"Despite the kind of cost pressures, most corporates have been able to contain the fall in margins" says Sandip Sabharwal, head (equities), SBI AMC. 
 

The big picture (top 1,000 by sales)
(In Rs crore)	Dec-04	Sep-04	Dec-03	% Chg  Dec 04 -Sep 04	% Chg   Dec 04 -Dec 03
Sales	307398	270304	242377	13.72	26.83
Other income	6124	6491	4386	-5.65	39.65
Interest	4463	4732	5155	-5.68	-13.42
Operating profit	44616	41914	36790	6.45	21.27
Net profit	25441	23559	18726	7.99	35.86
Total expenditure	262783	228390	205587	15.06	27.82
Raw material cost	130238	119692	99316	8.81	31.13
Staff cost	14825	14725	13186	0.68	12.43

Strong sales: The strong sales growth came on a high base last year - manufacturing grew at some 9 per cent in Q3FY04. The top 500 companies grew at nearly 28 per cent, signalling that demand in the economy is still buoyant.

However, competition is keen and therefore robust volumes don't always translate into higher realisations per unit, as in the case of two wheelers.

Nonetheless, purchasing power remains intact. Take Asian Paints: even though the topline growth of 32 per cent in Q3 is not quite comparable to the previous year - even after adjusting for the different timings of the festive season - the growth was still a good 20 per cent.

In some instances, the growth in sales appeared to be slowing. Britannia, for example, grew just 6 per cent in the quarter compared with a 14.6 per cent rise in H1.

Bharat Forge grew 29 per cent in H1 but slower at 26 per cent in Q3. Besides, Lupin saw sales up less than 10 per cent y-o-y and consequently the operating profit slipped from Rs 76.4 to Rs 41.4 crore.

The topline for BILT was flat at Rs 507. 77 crore compared with Rs 508.33 crore.

Raw material pressures: The inflation in commodities, however, took its toll on operating margins across sectors such as automobiles, engineering and pharmaceuticals.

That trend could continue for a couple of quarters - the full impact of commodity inflation will probably be felt in the current quarter. Consider: raw material costs as a percentage of sales for Asian Paints are up from 57.3 in Q3FY04 to 60.9 Q3FY05, resulting in lower EBITDA margins at 15.1 per cent, compared with 16.3 per in Q304.

For Bajaj Auto the drop in margins has been a steep 400 basis points with raw materials as a percentage of sales up from 67 per cent to 72.3 per cent.

"The fall in OPM on account of higher raw material and fuel costs, which was not really visible in the earlier quarters, is clearly being seen now," says Shyam Bhat, assistant vice-president (investments), Principal PNB AMC.

The pressure could remain for some more quarters though the impact might not be as severe.

Lower interest and other costs, boost net profit: That firms are borrowing cheaper was reflected in the 13 per cent fall in interest expenses for the top 1,000 companies.

At Tata Tea, for instance, margins were up 400 basis points thanks to lower expenses, interest and tax rate. At Britannia, staff costs were down by Rs 5 crore, barely allowing for an increase in net profit, saving it a few blushes.

A case of how other income has helped shore up profits is L&T where the other income was up 93 per cent at Rs 83 crore. That helped the PAT grow by 30 per cent Rs 132 crore. 

Costs and profits (As a percentage of sales)                              (In %)
	Dec-04	Sep-04	Dec-03
Raw material cost	42.37	44.28	40.98
Staff cost	4.82	5.45	5.44
Interest cost	1.45	1.75	2.13
Operating margins	14.51	15.51	15.18
Net profit margin	8.28	8.72	7.73
Other income*	24.07	27.55	23.42
*As a percentage of net profit

Industry in fine fettle
The growth in the Index of Industrial Production (IIP) slipped to 7.9 per cent in November 2004, from 9.8 per cent in October, the first time since June that industrial growth has slipped below 8 per cent.

That in itself is not too much of a worry, since the fall is on a higher base though there has been a slowdown in capital goods - the capital goods index rose 14.6 per cent in November 2003, it went up by just 10.3 per cent in 2004.

And the index for machinery and equipment other than transport equipment grew by 15 per cent in November compared with 21 per cent in October.

However, non-oil imports, a proxy for economic growth, rose by 44 per cent in December 2004. Besides, GDP numbers for 2004-05 are estimated at 7 per cent an indication that all is well.

Looking ahead economists are concerned that there could be some roadblocks in the absence of fresh capacities to match this galloping growth.

However, according to Paras Adenwala, investment advisor, the sales momentum should continue, thanks to the pump priming, the upturn in the asset creation cycle and a strong outsourcing story.

Adenwala believes profits could grow in the region of 20 per cent. Bhat observes that the pressure on OPMs, coupled with the higher base effect, would result in the earnings growth for 2005-06 being moderate.

To sustain margins companies will have to grow their topline because most firms have squeezed out all efficiencies from interest costs, wages and salaries.

These would only increase from now on though analysts believe, it would not eat into profit margins significantly. Neither would depreciation, they say, which again would only go up with capex plans being rolled out.

Sabharwal feels that pricing power is coming back. "With increasing capacity utilisation and strong order-books, some sectors are seeing pricing power," he says. If that is true, the markets need not worry.

Valuations in the aggregate today are at 12X FY06 earnings, which is not expensive. All that's needed is that India Inc keeps up the good work.