T N Ninan: Good times roll

WEEKEND RUMINATIONS

At the start of this results season, many corporate observers were nervous about what was in store. Would the good news run out, was the question""given the slight slowdown in GDP numbers reported for the October-December quarter, the high oil prices, the downtrend in commodity prices other than metals, and the troubles surfacing in such previously fancied areas as pharmaceuticals, not to mention information technology.

The early shocks provided by TCS and the Infosys guidance seemed to confirm that the run of good news may have come to an end. But though it is still early days, since barely 400 companies have announced their results (and we know that the early birds are usually the best-performing), it seems that all worries can be laid to rest.

The corporate results announced this past week have beaten all expectations. The Business Standard Research Bureau calculates that 421 companies which have so far reported their January-March results enjoyed 44 per cent growth in net profits, on 21per cent growth in sales.

This caps a great run in the previous three quarters of the financial year. Profit growth in the previous three quarters (for more than 2,400 companies this time) was 45 per cent, 27 per cent and 42 per cent. Sales growth in the same quarters was 25 per cent, 23 per cent and 26 per cent. So it is a fairly consistent story of sales growth in the 20 plus per cent range, and profit growth of 40 plus per cent.

This is the third successive year to bring such good news. Last year, the 1,000 largest companies in the country reported net profit growth of 40 per cent, on sales growth of 16 per cent""which tells us that sales growth has accelerated this year. The year before (2002-03), sales growth was only 13 per cent, but profit growth was a whopping 54 per cent.

These numbers suggest that the strong uptrend is holding. Indeed, because the earlier periods saw profits boosted by falling interest rates and then by falling debt levels, the latest numbers should give extra satisfaction. Top line performance has been better this past year, and the growth in profits is because operating margins have improved. It is no wonder that companies today are both borrowing and investing more.

The cumulative effect of three years of rapid profit growth is that net profits earned by the largest companies have tripled, to about Rs 100,000 crore, from barely 33,000 crore in 2001-02.

Corporate India has never had it so good, not even in the dotcom years of 1999-2001, when companies didn't really do very well; profits were stuck in the Rs 30,000-35,000 crore range. It is no wonder, therefore, that Crisil should now report the highest ever upgrades-to-downgrades ratio and a best ever rating picture for the entire corporate sector.

Can this be sustained? It is foolhardy to predict 40 per cent profit growth for a fourth year in a row, because the effect of a high base will kick in at some point, and today net operating margins are running at a healthy 11.4 per cent. If margins level off, then profit growth will track sales growth.

But even that is not a bad story, if sales continue to grow at over 20 per cent. If the forecast of a normal monsoon is borne out and the global economy does not impart any shocks (remember that exports are now an important part of the growth story), there is no reason to disbelieve the RBI's growth forecast of 7 per cent for the new year. An economy growing at that speed will certainly see the corporate sector doing well. The constraint will be infrastructure, specifically power and transport.

The mystery, if there is one, concerns the stock market""which remains decidedly nervous despite the excellent corporate performance. A trailing price-earnings ratio of 14.2 in the face of buoyant results suggests very reasonable, even modest, valuations. For all that, fund managers seem to believe that picking the winners has become difficult.

The skittishness could be explained by the bearish influence of international markets, domestic nervousness about interest rates (which have hit bank stocks), and worry about oil and the dollar. Whatever the reason, the story today is performance and not valuation.