Long road to full recovery for India Inc

India Inc seems to have lived up to the current exuberance on Dalal Street, with net profit of 2,178 companies that have announced their earnings for the quarter (excluding financial and oil & gas ones) increasing 25.4 per cent on a year-on-year basis.

That’s where the good news ends.

A good bottom-line growth is largely on account of one-time factors like a sharp decline in direct tax outgo, cost-cutting measures and other exceptional gains.

Effective tax rate for this sample of companies declined to 21.8 per cent in the March quarter from 26.4 per cent in the previous three-month period and 29.3 per cent in the year-ago quarter.

In last four years, companies paid an average 26.6 per cent of their pre-tax profit as direct taxes.

Adjusted for exceptional gains, net profit in the March quarter grew only 16.8 per cent, lower than the 44.7 per cent growth seen by the same set of companies in the December quarter.

There also was an element of base effect, as these firms had reported a 5.6 per cent decline in net profit during the same quarter last year.

A tight leash on overheads and sales & marketing expenses helped companies improve their margins, leading to a 140-basis-point increase in core operating margins in the March quarter.

Margins, however, declined on a sequential basis, as consumer goods firms stepped up their advertising spend to boost growth.

Volume growth, however, continues to dodge India Inc: Net sales grew 10.2 per cent on year-on-year basis for companies in the real sector.

Adjusted for double-digit retail inflation and rupee depreciation (on a year-on-year basis), this translates into near-flat to negative volume growth for manufacturing companies.

Revenue growth in the March quarter was even lower, at 8.5 per cent, if information technology and pharmacheutical companies are excluded — a seventh straight quarter of single-digit growth.

For the entire sample of 2,622 companies (including financial and oil & gas ones), adjusted net profit was up 3.8 per cent in the March quarter a year-on-year basis, while net sales grew 10.1 per cent.

There was no sign of an improvement in India Inc’s balance sheet ratios, either.

Excluding IT and pharma companies, interest payments for companies in the sample rose 15.1 per cent on an annual basis, up from 10 per cent growth in December quarter and 13.9 per cent growth in the March quarter of last year.

As a result, the ratio of operating profit to interest payments (interest coverage ratio) remained unchanged at 4.0, compared to 4.1 in the year-ago quarter.

Results, however, show the beneficial impact of higher agricultural growth and pre-poll spending by the government, with net sales of fast-moving consumer goods (FMCG) companies growing at their fastest pace in five quarters.

The farm sector grew at 6.3 per cent in the March 2014 quarter, according to the Central Statistics Office.

The government’s final consumption expenditure remained stable in the March 2014 quarter, despite a fall in the share of private final consumption expenditure in GDP during the financial year.

With a new government taking office and the likelihood of a below-average monsoon, consumer goods companies are likely to face headwinds in 2014-15.

Another worry, analysts say, is the negative impact of the rupee’s recent appreciation on corporate earnings.

The impact was already visible in the March quarter in the earnings of IT and pharma companies, which together account for around a fourth of all earnings.

The combined net profit for IT exporters like Tata Consultancy Services, Infosys, Wipro and HCL Tech grew 36.5 per cent on an annual basis, down from 39.3 per cent growth in the December quarter.

A similar trend was seen in the case of leading drug exporters like Sun Pharma, Lupin, Divi’s Labs, Dr Reddy’s and Cipla.

“With rising importance of export-dependent companies, corporate earnings now show a strong co-relation with currency depreciation.

If the recent trend of rupee appreciation continues, it will pull down corporate earnings in 2014-15, unless domestic demand and capital-expenditure-driven companies pick up the slack.

This looks unlikely, given the odds against a quick recovery in GDP growth,” says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.

Others, however, are more optimistic, given good show by some leading capex-driven companies like Larsen & Toubro and Siemens.

“Better-than-expected revenues and profits by L&T and Siemens hint at the possibility of a growth revival in 2014-15.

"This will support corporate earnings, especially in the capex-related sectors like capital goods, metals & mining and cement,” says Devang Mehta, senior vice-president and head of equity sales & advisory at Anand Rathi Financial Services.

Nitin Jain of Edelweiss Securities also expects a positive surprise in earnings during the current financial year.

“Corporate earnings are likely to surprise on the positive side from the first quarter of 2014-15,” he adds.

During the year ended March, adjusted net profit (excluding financial and oil & gas companies’) was up 11.6 per cent on an annual basis, while net sales rose 9.1 per cent.

Earnings growth was led by higher operating margins and a decline in effective direct tax rate.

Excluding IT and pharma companies, adjusted net profit for the sample grew 5.6 per cent annually, while net sales rose 7.4 per cent in 2013-14.

Net profit would have been near-flat if it was not for a 4.4 decline in tax outgo, which more than compensated for a double-digit growth in interest payments (up 18.3 per cent) and depreciation (up 14.8 per cent).