India Inc struggles

Another round of earnings downgrade possible

Corporate earnings for the June quarter are nothing to write home about. An insipid 0.3 per cent growth rate, year on year, in the net profit of companies, excluding those in finance and the oil and gas industries, along with the lowest revenue growth in six quarters at 4.4 per cent, is not inspiring. After considering banks and energy companies, the profit growth is worse; the adjusted net dips 0.8 per cent, the first decline after three quarters. India Inc is facing challenges on multiple fronts. For example, for the ex-banking and oil sample of 1,261 companies, raw material costs as a percentage of revenue went up by 40 basis points year on year, while energy costs were up 20 basis points. The core operating profit margin was down 90 basis points year on year. 

The consumer and automobile industries were affected by destocking at the dealer level and consumers postponing purchases in the run-up to the introduction of the goods and services (GST) tax. In the larger sample, which had 1,654 companies, public sector banks were hit once again; both asset quality and profits worsened. Two key sectors, information technology and pharmaceuticals, which contributed significantly to India Inc’s financial health in the past, were adversely affected by US regulators clamping down on Indian companies. The infotech industry had to additionally deal with a demand slump and telecom companies struggled because of the entry of Reliance Jio. On the other hand, metals and mining firms reported robust top line growth and turned profitable after a loss in the June 2016 quarter. Cement, construction and engineering companies also posted good growth.

At a broader level, there is a clear emergence of a trend. For the past three years, the Street has been beginning its annual forecast with projections of double-digit earnings growth but as the year progresses, this is trimmed to single digits. Analysts have estimated a 45 per cent increase in the combined net profits of the Nifty and Sensex companies between 2016-17 and 2018-19. This is a long shot given the current data. There are concerns that the disruption caused by demonetisation and the introduction of the GST is greater than what was initially anticipated, especially among second- and third-tier companies. Some analysts are already writing about earnings downgrades in 2017-18, specifically in sectors such as banking and pharmaceuticals. The current story on the Street is one of déjà vu. If 2017-18 is another wash-out year in terms of earnings growth, the only way current valuations can be justified is on the basis of 2018-19 earnings, which are what the market will start focusing on from the next quarter.