Next turn in the cycle

The corporate results season is almost over, and there are more than enough clues to detect the winds of change blowing across India Inc. The interest rate cycle has turned, with the result that savings on interest costs are no longer available.

Simultaneously, the upturn in global commodity prices has impacted raw material costs in several industries, while boosting profits for commodity producers. Rising raw material and interest costs are impacting margins.

Record crude prices and the policy of forcing oil refining and marketing companies to share the burden of the oil subsidy have led to lower margins in these companies, although very high refining margins have compensated.

Banks have been hit hard by higher bond yields and lower bond prices. On the other hand, the pick-up in investment demand has led to fat order books for engineering companies, and good profits.

The structural change in the global economy, resulting in the continuing growth of outsourcing, has been very favourable for the software and BPO businesses, and most of these companies have not only been able to show higher profits and beaten expectations, but also raised their revenue and earnings guidance for the full year.

With the supply-demand balance turning favourable for cement companies, realisations and profits have improved. The shipping industry continues to do excellently, riding on the back of global trends.

As these examples illustrate, the turn of the business cycle has led to earlier leaders ceding ground, while other industries have emerged as leaders.

And finally, earnings momentum is slowing due to the effect of a higher base""the auto sector being a case in point.

These trends are reflected in an analysis of 618 second quarterly results of manufacturing companies, done by the BS Research Bureau. While year-on-year sales of these companies have risen by 21.5 per cent and net profits by 28.9 per cent, a comparison of the second quarter results with those of the first quarter shows that, sequentially, sales are down 1 per cent, although net profit growth is robust at 16.7 per cent.

Year-on-year, interest costs have gone up by 2.3 per cent, a marked change from the declining trend in interest payout in earlier quarters. The consequence of rising interest and raw material costs has been that operating, gross as well as net profit margins are all lower than a year ago.

Going forward, the main theme for companies will be investment growth. With capacity utilisation in many industries at high levels, there is no alternative to capital spending. Until the new capacities add to revenues, companies will have to bear the burden of higher interest costs.

This could be accentuated if interest rates move up further. The less-than-favourable monsoon will also impact demand. In textiles and pharmaceuticals, policy shifts will usher in major changes.

The corporate restructuring story, which led to a slashing of costs and greater profitability, appears to be over, although opportunities remain for reducing interest costs by borrowing abroad. But the key feature of the second quarter results is that they mark the turn of the business cycle.