Will the fall get arrested?

If you look at the numbers in the table Saga of a slowdown,what we see is income and profit growth slowing from one quarter to the next as the crisis that crippled the financial system in advanced countries caused distress to Indian corporates as well.

Q1FY09: Decent start

April-June quarter saw the Wholesale Price Index WPI soar from single digit to as high as around 12 per cent. Commodity and fuel prices were the chief contributors to the high inflation of this period. To contain inflation,the Reserve Bank of India RBI raised key lending rates.

Sensex companies saw a healthy year-on-year y-o-y increase of 27.1 per cent in income. At 11.8 per cent the y-o-y growth in net profit was also respectable. However,in what was a precursor of things to follow,operating profit margin OPM and net profit margin NPM shrank between June 2007 and June 2008 See table: Margins getting compressed.

Q2FY09: Crisis deepens

The crisis intensified during this quarter. As Lehman Brothers collapsed in September,causing liquidity flows in the West to come to a virtual standstill,the full impact of the crisis hit home. Interest costs rose. The tightening of monetary policy in the first half of FY09 with the aim of reining in inflation led to a sharp rise in interest rates. It adversely affected the spending power of consumers and also strained the balance sheets of corporates, says Hitesh Agrawal,head of research,Angel Broking.

During most of this quarter WPI inflation hovered at above 12 per cent. In July crude oil price touched its zenith of 145 per barrel. With foreign institutional investors FIIs pulling out money and banks reluctant to lend,corporates faced a liquidity crunch. After touching peak levels,commodity prices started cooling. But corporates could not enjoy the benefit of this fall as most of them tend to lock themselves into long-term contracts.

Till this quarter,the growth in income sustained. For Sensex companies y-o-y growth in income remained at a healthy 25.4 per cent. But rising fuel,raw material and transportation costs resulted in OPM and NPM getting compressed See table: Margins8230;.

Net profit growth took a hit: y-o-y growth slid to 5.3 per cent,while quarter-on-quarter q-o-q it declined by almost 650 basis points bps.

The stress due to high interest expense was clearly visible on profit margins and profit-after-tax growth of companies, says Yashika Singh,head-economic analysis,Dun amp; Bradstreet India.

Q3FY09: Full-blown impact

This was the quarter when Indian corporates took the worst battering. The impact of the global slowdown reached Indian shores and demand began to shrink here as well. While in earlier quarters India Inc. had worried about falling margins,in this quarter the trend reversed and slowdown in topline growth became the major concern.

The revenue of Sensex companies rose a meagre 6.1 per cent y-o-y a drastic decline of nearly 19.4 percentage points compared to the previous quarter. Net profit growth was a negative 10.4 per cent y-o-y.

The only respite came from moderation in total expenses. Expenses fell due to softening commodity prices,which lowered raw material costs as prices of crude oil,coal and base metals fell. Hence OPM increased 205 bps q-on-q from Q2 to Q3. However,NPM declined by 117 bps q-o-q for the same period.

According to Agrawal,With the topline of India Inc. coming under pressure and the existence of high-cost inventory,Q2 and Q3 profitability of Indian corporates was severely dented. What added to their woes was the high debt on the books of many companies and also the increased cost of debt due to higher interest rates.

On the macro-economic front,during October-December,inflation,which hovered in double digits in the last two quarters,started declining sharply and dropped to single-digit. With inflationary pressure easing,the RBI reduced key rates such as the cash reserve ratio CRR,repo and reverse repo rate beginning October in a bid to infuse liquidity and lower borrowing cost.

Nine-month: Measly growth

If we look at the nine-month aggregate of Sensex companies,income has registered y-o-y growth of 18.9 per cent while net profits have grown by a meagre 2 per cent. OPM and NPM have fallen by 244 bps and 235 bps respectively y-on-y. Says Singh: During Q1,Q2 and Q3,interest expense reported significant y-o-y increase of approximately 23,31 and 34 per cent respectively,which eroded the bottom line significantly. Employee cost during all the three quarters grew by more than 20 per cent y-o-y.

During the second half of CY09,the central bank reduced interest rates to multi-year lows while the government came out with stimulus packages. What remains to be seen is whether these measures will have the desired impact on Q4FY09 results.

Q4FY09: No turnaround likely

Most market experts dont expect any major positive surprises from Q4 results. According to Ambarish Baliga,head of research,Karvy Stock Broking,Q4 results will more or less be in line with Q3 results as there has been no major improvement in the economy. Q1FY10 may see a turnaround.

Singh too believes that top line growth is likely to remain moderate. On the expense front,she says,the pressure of high raw material prices felt in the previous quarters may get mitigated with the fall in commodity and crude oil prices,thereby cushioning operating profit margins. However,depreciation expense is set to rise on account of massive capital expenditure undertaken by companies. In addition,high interest expense is likely to contribute to subdued profitability.

According to Agrawal,We expect another bad quarter of earnings for India Inc. We expect Sensex companies to report about 5 per cent y-o-y growth in top line. Operating profit margin is likely to decline by about 80-100 basis points y-o-y. Net profit is likely to grow by a negative 7 per cent y-o-y. Net profits will face pressure on account of higher interest burden and higher depreciation charges,while demand will take some time to get restored.

Those hoping for a quick turnaround in corporate performance are likely to be disappointed. But as is apparent from the comments of market experts,most of them have tempered their expectations. The best one can hope for is that the results are at par with those witnessed in Q3 and that the negative spiral gets arrested. u

Sector watch

Leaders…

FMCG. The sector is poised for stable growth. Profit margins are expected to remain high due to fall in raw material costs.

Pharma. Pharma companies are expected to report robust results aided by business growth and rupee depreciation.

Power. This sector is less vulnerable because domestic consumption is strong and the country faces a power deficit. Operating margins may rise because prices of coal and other fuels have decreased while pricing power remains high. High interest outgo may put pressure on NPM.

Cement. Increase in cement prices together with excise duty cuts and decrease in costs could enable cement companies to report y-o-y increase in profits. 8220;We expect cement companies in our universe to report EBITDA margin expansion of 100-200 basis points y-o-y and 500-1,000 basis points q-o-q,8221; says Nemkumar,analyst at IIFL,the institutional research arm of India Infoline.

Infrastructure. Topline growth may moderate due to slowdown. Infrastructure projects undertaken by the government could mitigate impact.

Automobiles. The sector is expected to report a sequential spurt in revenue growth on better volumes and stable pricing in Q4FY09. The growth could also be attributed to Sixth Pay Commission payouts and excise duty cuts.

…and laggards

Banks amp; Financials. A sharp deceleration in earnings growth from Q4FY09 till FY10 is expected on account of slowing loan growth,margin pressure,and possibly,treasury losses.

Realty. The sector is expected to decline further in revenues due to slow-paced construction activity which is slowing project completion and revenue recognition.

IT. Volumes are expected to decline on account of worsening global economic environment and poor health of major clients.

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