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India Inc feels the chill in Q3

India Inc’s earnings have disappointed yet again. For the three month period ended December 2014, profit growth has been the worst in five quarters, with the aggregate net profit of 2,941 companies declining 16.9%.

Even after adjusting for one-offs (or extra-ordinary transactions), it is down 6.3% over the year-ago period.

That’s not all. Sales growth is also the weakest in at least 12 quarters.

For the Sensex companies, the reported net profit is down 6.5% year-on-year, its weakest show in six quarters, on a 2.2% decline in sales. What’s more, 17 Sensex companies reported profits that were short of Bloomberg consensus estimates. On aggregate basis, Sensex profit was 7.5% lower than estimates.

“Earnings were a drag. Most of the earnings have not been good. It’s been a polarised market,” says Devang Mehta, Head Equity Advisory, Anand Rathi Financial Services.

Pankaj Pandey, Head Retail Research, ICICI Securities, however, says the numbers largely were a shade below expectations and very few companies were able to surprise positively.

There are many reasons that led to the weak performance, the key being currency and subdued demand.

Dhananjay Sinha, Co-Head Institutional Research (Economist & Strategist), Emkay Global, says, aggregate demand has been weak as weakness in the global markets such as Europe and China affected export oriented companies. Another variable, he says, was currency. The rupee depreciated from May 2013 and so, there was year-on-year effect till the June 2014 quarter. “The base effect has started to kick in. Q2 and Q3 of FY15 have seen this base effect of rupee depreciation fading out,” Sinha says.

The weak demand is visible in volume growth of companies. For the December quarter, many fast moving consumer durables companies as well two-wheeler players saw slower increase in volumes. Also, pricing power for many sectors was weak. Though cement sector saw healthy volumes of 7-8%, realisations were weak.

Pandey says FMCG companies witnessed a dismal volume growth of 3-7% due to delay in recovery of urban discretionary demand. Also, the high base effect came into play as festive season demand advanced this year to Q2 compared to Q3 last year.

Operating profit margins of 1,992 manufacturing companies in the sample were down 100 basis points year-on-year and 140 basis points sequentially, largely due to decline in sales and a rise in employee and power & fuel expenses.

The government has also tightened its purse strings to meet fiscal targets, which impacted top line growth of companies. Likewise, the sharp decline in commodity prices (steel, oil, coal) put pressure on top line and bottomline of producers.

Not surprisingly, companies across sectors like metals, capital goods, infrastructure, auto and even consumer goods disappointed. Experts also put part of the blame of results falling short of expectations on markets, which had built up high hopes consequent to falling input prices.

It’s not that companies did not benefit from lower input prices, but the gains were lower than expected. For the 1,992 manufacturing companies, aggregate cost of goods sold fell eight% year-on-year and 3.7% sequentially, much more than the decline in sales of 3.3% and 2.5%, respectively.

But the full benefits of the price decline did not transpire in the December quarter, which experts believe could be more visible from the current quarter onwards. But, even as sales and PBIDT of the manufacturing companies was down, interest costs and depreciation increased by 7-8% each.

Says Mehta, “To an extent, people got more optimistic about the fall in crude oil prices and its positive impact on corporate profitability. The decline in cost of inputs isn’t that visible. Inventory losses, especially in case of oil companies, are another reason for the weak results.”

The decline in crude oil prices led to inventory losses of nearly Rs 14,000 crore for public sector oil marketing companies, which in turn suppressed their profitability. While BPCL swung into profit at the net level due to subsidy compensation from government, it reported an inventory loss of Rs 1,600 crore. IOC reported an inventory loss of over Rs 12,000 crore leading to a 175% rise in net loss to Rs 2,637 crore for the quarter.

In banking, too, many public sector banks saw pressure on their profit in the December quarter due to increase in provisions as asset quality worsened, and thus proved a drag on the sector. However, the sector still managed to post a respectable 11.8% increase in aggregate profit because of a much better performance by private banks. Since banking accounted for a fifth of aggregate profits, it supported overall profits of India Inc.

Capital goods and engineering companies disappointed the street. While aggregate sales and profit of metal –steel and non-ferrous –companies (16% of aggregate reported net profit) was down 1% and 53% respectively, the automobile sector’s aggregate profit was down 10% mainly due to a 25% fall in Tata Motors profit. Excluding Tata Motors, the sector’s aggregate profit would have been up 14%.

Although the pharma sector aggregates paint a grim picture, it is largely due to two companies — Ranbaxy which saw losses jump six-fold to Rs 1,030 crore while Strides Arcolab’s profit fell from Rs 3,525 crore in the year-ago quarter to Rs 97 crore. Adjusted for these, sector profits are down 3%.

On the positive side, Sensex companies that beat estimates include Maruti, NTPC, Bajaj Auto, Bharti Airtel, M&M, Tata Power, Infosys and Sesa Sterlite. HUL also beat estimates, but largely due to exceptional income.

Among sectors, IT did relatively better with topline growing 10% and profit by 4%. The growth was partly impacted by cross-currency headwinds, while demand environment remains stable. So did private banks.

The outlook for FY15 is far from rosy. “For the first nine months of FY15, Sensex companies reported PAT growth of 7.4%, Nifty 5.2% and BSE 500’s is at 10%. Sensex average quarterly earnings growth since Q1’FY09 has been 8-10%. So, earnings growth will be lower than estimated for FY15,” says Sinha.

Given the trend, experts believe that expectations will have to be toned down for FY15 and FY16.   

Nevertheless, expect FY16 earnings growth to be around mid-teens. Pandey says the benefit of commodities price decline will be visible in March quarter onwards which should provide a leg up to earnings going forward.

But till growth momentum picks up, sectors that are doing well in terms of earnings and volume growth will continue to command premium, and the polarisation in markets and premium for good earnings should continue.


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