Beating the street

BS Compass

Polaris margins' drop is less than expected

Polaris Software's performance last quarter wasn't much better than its peers in the industry, but the markets seemed rather impressed, what with the stock rising by over five per cent in Tuesday's trading session.

In fact, Polaris's revenues fell 1.4 per cent sequentially and profits (before taxes and exceptionals) dropped 20.2 per cent, which is clearly an inferior performance compared with peers. So why has the market rewarded Polaris?

It turns out that they were expecting a sharp fall in the company's operating margin, what with the company having taken salary hikes, besides having to deal with lower billing rates.

Onsite billing rates were 1.64 per cent lower, while offshore rates were 2.23 per cent lower, which in fact led to a 240 basis points decline in gross margin.

But SG&A (selling, general and administration) expenses were much lower, thanks to which the company could maintain operating margins close to the March quarter level 21.3 per cent. There was some element (around Rs 1.4 crore) of genuine saving in general & administration expenses on account of "benefits of the merger integration".

It's interesting to note, however, that much of the drop in general & administration expenses was because the March quarter included a non-recurring expense worth Rs 3.3 crore.

Strangely, when the company had reported its March quarter results, it hadn't mentioned this amount of Rs 3.3 crore separately as a non-recurring item.

Anyway, adjusting for this, there is a 180 basis points drop even in the operating margin. But going by the jump in the stock price, it looks like the markets were expecting margins to drop further.

Besides, the company management has also pointed out that, going forward, margins would improve from the June quarter levels. But like some analysts point out, going by past experience, it doesn't make much sense to take Polaris's forward looking statements at face value.

On the revenues front, the company recorded a 1.5 per cent sequential growth in dollar terms, which came down to a -1.4 per cent growth in rupee terms because of the appreciation in the rupee.

Revenues from Citigroup fell 4.75 per cent sequentially and now account for 63.3 per cent of total revenues. Non-Citi clients, on the other hand, increased revenues 4.85 per cent sequentially.

Going forward, the direction of the stock depends on when the synergies of the merger kick in, thereby leading to an improvement in margins, which have fallen considerably since last year's levels.

Gujarat Gas

Gujarat Gas's June 2003 quarter results show that the company is still to find a floor for its operating margins, although much of the expected decline in margins has been reflected.

Operating margins declined by around 90 basis points compared to the corresponding quarter. The decline has to do with an ever increasing share of bulk gas sales instead of retail gas sales.

For instance, the company added Kribhco as a client in the March quarter this year. (It now has Searchchem and Kribhco on fixed supply and price contracts while supply to Essar is on a spot contract.) The increase in volumes have led to a 161 basis points improvement in operating margins compared to the March quarter.

The threat of an increase in natural gas prices looms large over the company, with the government recommending a 12 per cent increase in gas prices to Rs 3,200 per thousand cubic metres.

Since Gas Authority of India is the primary supplier of gas, this should impact the performance in the current quarter. The risk has been mitigated a bit due to offtake of gas from Cairn Energy at Brent-linked prices.

Therefore, with a fall in price of crude, it will benefit the company. But not for long, since the benefit will have to be passed on to the consumer as prices of competing fuels like naphtha will also decline.

Correspondingly, as the supply of gas increases, prices will be influenced more by the supply-demand scenario instead of crude. Under these circumstances, there is still a risk to margins when the gas prices are completely deregulated.

With contributions by Mobis Philipose and Sameer Ranade