A turn in the tide

India Inc's Q2 results point to pain ahead

Global recessionary conditions, inflation, and interest rate hikes led to a disappointing quarter (July-September or Q2FY23) for India Inc. The results of a sample of 3,332 listed companies indicate widespread margin pressures and perhaps the end of the de-leveraging cycle, which started in the first half (April-September) of 2020-21.

Banks and non-banking financial companies (NBFCs) did well during the quarter because the rate hikes were not fully transmitted, leading to higher net-interest margins (NIMs). The NIM is likely to normalise in the second half of the current financial year because lenders have started hiking deposit rates.
 

The commodity cycle is weak. Steel-makers and producers of non-ferrous metals like aluminium saw drastic reductions in profitability, as did the upstream mining and mineral sectors. On the positive side, supply-chain issues have eased, with automobile companies able to increase production as chips are no longer in such short supply.

Banks and NBFCs had a 16 per cent year-on-year (YoY) rise in credit disbursement and services income, with 40 per cent improvement in net profits. Insurers saw strong recovery as premium income rose, while claims dropped. Crude oil and gas producers were hit by the cap on profits due to the windfall tax. Refiners were hurt by low refining margins, and elevated crude oil and gas costs. Gas distribution companies were also hurt by the rising cost of gas.

If banking, financial services, and insurance (BFSI) companies, and the oil sector are excluded, the rest of the sample (consisting of manufacturing and services) saw a 7 per cent YoY drop in profits, the first growth reversal since Q1 2020-21, which was hit by lockdowns. The operating margin for companies not in the oil and BFSI space dropped from 19.6 per cent in Q2 2021-22 to 15.8 per cent, a pullback of 380 basis points YoY. Raw material costs rose 43 per cent YoY while energy expenses increased 62 per cent, and interest costs went up 14 per cent.

Two key export-oriented industries saw margin pressures and delivered disappointing performances despite the weaker rupee. The software industry saw a 20.5 per cent rise in sales (rupee-denominated) translate into only 7.7 per cent rise in profit after tax (PAT) while the sector’s averaged operating margin dropped 250 basis points. The pharmaceuticals industry managed an 11 per cent rise in PAT on sales expansion of just 7 per cent. Both industries saw managements delivering cautious guidance.

Activity in the infrastructure and construction industry had a slowdown due to seasonal factors. Revenues were up 19 per cent YoY but PAT dropped by 31 per cent. The cement industry saw a drastic 87 per cent fall in PAT as energy and raw material costs jumped.

Consumption was reasonably strong under the circumstances, with a rebound in sales in gems and jewellery and auto. However, the profits were muted. The gems and jewellery segment saw a 73 per rise in revenues but only 38 per cent rise in PAT. The automobile industry generated a 34 per cent rise in revenues and PAT jumped 431 per cent, due to losses reducing by Rs 3,500 crore in Tata Motors. The fast-moving consumer goods segment saw sales revenue up by 17 per cent but PAT rose by only 12 per cent.

Inflation as measured by the wholesale price index was in double digits through Q2. So the results aren’t surprising. One must hope inflation eases and also that rising interest rates don’t impact consumption. A turnaround in global activity will unfortunately depend as much on geopolitics as on economics.