Base effect

Q3 headline profits look impressive but worries remain

India Inc registered strong gains in profit in the third quarter of 2019-20. While the conventional wisdom would point to the cut in corporate tax rates and low crude oil prices, a closer look at the data indicates that a lower base in the year-ago quarter had a more important role to play. An analysis of the results of 1,139 listed companies reveals a lopsided pattern. Overall, this sample registered a massive 43.9 per cent growth rate in pre-tax profit and 63.6 per cent year-on-year rise in profit after tax despite registering a mere 2.2 per cent rise in net sales. The difference between pre-tax profit and net profit is largely due to the tax cuts, which became effective in the September 2019 quarter, and that is visible in the aggregate tax payout, which remained at the same level despite the significant jump in profit.

Almost all the profitability gains were contributed by Tata Motors, banks, and refineries. Banks, especially the corporate lenders, had a subdued December 2018 quarter, which had resulted in losses or a drop in profit. In the December 2019 quarter, the situation improved as losses reduced and banks got the benefit of lower tax rates. Tata Motors was a big outlier. The company had reported a pre-tax loss of over Rs 29,000 crore, and turned around with a profit before tax of Rs 1,350 crore in the December 2019 quarter. If Tata Motors is removed from the sample, the rise in pre-tax profit and net profit is 16.2 per cent and 20.9 per cent, respectively. If banks are also excluded, pre-tax profit would decline by 0.6 per cent and net profit growth would be 5.6 per cent. Removing refineries from the sample leads to a pre-tax profit decline of 4.3 per cent and net profit growth of just 1.25 per cent. The operating margin for the sample excluding finance, refineries, and Tata Motors was flat at 20.8 per cent in the December 2019 quarter, compared to the year-ago period. 

The higher profitability of refineries is no surprise, given lower crude oil and natural gas prices. Lower fuel prices also helped InterGlobe Aviation (IndiGo) boost its pre-tax profit 2.9 times and those of fertiliser companies by 2.4 times. The improved performance of the banking sector is heartening, but concerns remain. The takeover of Essar Steel removed an overhang of Rs 42,000 crore in non-performing assets from the debtors’ balance sheets but this is a one-off. If more resolutions are completed in bankruptcy courts, banks would benefit. What was worrying is that consumption demand remained sluggish and companies didn’t seem to have adequate pricing power — the top line of FMCG (fast-moving consumer goods) companies grew 5.5 per cent while pre-tax profit was up 6.5 per cent, which was mainly due to lower expenditure. The story in automobiles and consumer durables was worse. The lack of a rebound in construction, cement, and steel indicates investment, including infrastructure investment, is also a dampener. The economy continues to remain stuck in second gear.