The analyses by this newspaper of corporate results for the fourth quarter of 2011-12 reveal that the trend of falling profit margins continues, allied to persistent inflation and a growth slowdown. This is the fifth successive quarter that margins have fallen and equity analysts have shaved forward estimates. Consensus earnings estimates of 2012-13 for the Nifty basket have been downgraded by two or three per cent since fourth-quarter results were received. Overall, quarter on quarter, across all 63 sectors, the net profit growth was an anaemic 2.7 per cent. However, there is significant heterogeneity in the results that is obscured by the overall number. For example, if five sectors – banking, cement, information technology (IT), pharmaceuticals and fast-moving consumer goods (FMCG) – are excluded, then profit has actually declined, by 9.6 per cent, for the other 58 sectors. The overall profit margin as a percentage of turnover was 10.4 per cent; and, again, if these five sectors are excluded, the margin drops to eight per cent.
These figures are, at first glance, mediocre — even poor. However, they are actually even worse than they appear. After all, these are nominal figures. Inflation through the period in question ran at seven per cent or more, and the yield on treasuries was above eight per cent. If that is taken into account, the picture is grimmer. An examination of operating margins and returns on capital suggests that less than one-third of the sample beat inflation by a meaningful amount and even fewer companies logged premiums over the treasury yield. Of the top five sectors, FMCG put in an outstanding counter-cyclical performance. Sector profits rose 27 per cent at a healthy net margin of nearly 12 per cent, suggesting some pricing power. Cement, too, appeared to have improved margins and realisations. IT and pharma saw windfall gains from the falling rupee. FY13 advisories in IT are mostly downbeat. Banks saw lower net interest margins and profits were, at least to some extent, boosted by lower provisioning. Public sector banks suffered declining asset quality.
Corporate results correlate to the macro-economy and vice versa, since a substantial portion of GDP and a larger proportion of tax revenue come from India Inc. One way of checking the credibility of top-down budgetary estimates is by aligning these to bottom-up company-by-company earnings estimates. Bottom-up earnings estimates for 2012-13 now suggest the deceleration is likely to continue for at least a couple of quarters. That mismatch makes it somewhat more likely that the Union Budget’s estimates for this financial year will be missed. High costs and high interest rates may often be cyclical but there are obvious structural problems here. Funding a large and rising fiscal deficit has meant crowding out corporate borrowing. Overseas borrowing is also fraught with currency risk, given a ballooning current account deficit. The mercantilist advantage of a weak currency is being offset by a global slowdown. The government could, in theory, cut deficits and institute vigorous reforms to deal with supply-side issues. It could also raise interest rates to a point where recession is triggered and inflation beaten into the ground. If it lets matters drift, as appears most likely to occur in practice, it will be difficult to set a timeline for recovery.