Calming numbers

Corporate performance in any period is inevitably going to be judged in relation to the achievements, or lack of them, in previous periods. Thus, it is that, when a sample of over 1,400 companies analysed by the Business Standard Research Bureau, shows growth in net profits of around 26 per cent, red flags shoot up. Under any reasonable circumstances, 26 per cent growth would be considered quite an achievement, but when the previous three years have yielded profit growth rates of 36, 29 and 40 per cent, respectively, it falls short by comparison. Coming at a time when the stock market appears to be highly sensitive to bad news, the fact that aggregate growth in profits of the corporate sector is showing signs of slowing down can only add to the downward pressure. It is, therefore, imperative that such news be interpreted reasonably.

Looking beneath the surface of the numbers reveals several shades of grey. Net profits have grown by 26 per cent on the back of sales growth of 19.4 per cent. Profits growing faster than sales reflect an increasing efficiency of input usage or falling input prices or a combination of the two. In the current scenario, the predominant tendency as far as input prices are concerned is upward. Some inputs may have seen declines, of course, but energy and capital costs have unquestionably increased. The government may be resisting price increases on four key petroleum products, but other important inputs into industry like furnace oil have seen their prices fully reflect the global scenario. On the back of rising interest rates as well as heavier borrowing, this sample of firms has seen its interest costs rise by about 5 per cent over the previous year. Productivity increases, therefore, seem to offer the best explanation for the gap between sales and profit growth. This is obviously a good sign; the persistence of this factor in determining corporate performance should preserve the incentives for firms to continue to invest in new capacity, which has contributed significantly to growth over the last couple of years.

Beyond this aggregate perspective, the variation in performance across sectors as reflected in the sample also provides no compelling evidence of an across-the-board slowdown, which should give the markets something to cheer about. The performance of the oil-marketing companies, which are adversely affected by the government's rigidity on prices, is a significant contributor to the slowdown in profit growth. Some other sectors, like packaging and entertainment, have also performed poorly, somewhat at odds with the perception that consumer spending is still a powerful growth driver. But, sectors like construction and those related to it, cement and steel, have done extremely well, with over 100 per cent growth in net profits, while a number of sectors, notably power, pharmaceuticals and food processing, have achieved profit growth in the 50-100 per cent range. This wide range of sectors doing relatively well suggest that the twin engines of growth over the last couple of years, consumption and investment, are still generating adequate momentum. Higher prices of petroleum products and rising interest rates will, of course, take their toll, but may not be enough to completely neutralise their positive impact. In short, as investors in the stock market scramble to protect themselves against more bad news, a considered reading of recent corporate performance should provide a much-needed dose of stabilisation.