Push for a Rebound

Corporate India is back with a bang!

In signs of economic recovery and indication of businesses returning back to normalcy, listed companies in India posted a combined net profit of Rs 1.5 lakh crore during the July-September quarter - an all-time high and up nearly three times from the year-ago period. Excluding the contribution of extraordinary transactions, net profit of these 4,000 companies registered a 38.2 per cent year-on-year (y-o-y) growth after four quarters of double-digit contraction that also included a steep 40 per cent fall in the June quarter due to the nationwide lockdown.

However, even though profit growth is back after a year, top line still continues to slacken. Year-on-year revenue growth of the sample companies declined 6.9 per cent in Q2FY21 and 27 per cent in Q1FY21.

The trend is expected to continue in the next quarter due to further push in pent-up demand from the festive season and re-opening of the economy, says Vinod Nair, Head of Research at Geojit Financial Services. "Better profitability is also due to increasing selling prices of products and lower discounts. Demand has also increased for segments such as electronics, telecom and household items due to most people working from home," he adds.

The Fiscal So far

The first-half fiscal numbers, however, paint a very different picture. Corporate earnings remained weak in the first six months with a 1.2 per cent fall in net profit compared to the year-ago period. Total income from operations plunged by 17.1 per cent, year-on-year.

The June quarter bore the brunt of the lockdown wherein profits plunged by a massive 75 per cent, year-on-year, which left perceptible traces on the first half of FY21. Though, going forward, it may not be a drag on the entire fiscal, according to analysts.

"While Q1FY21 was disastrous given the lockdown, subsequent quarters are expected to show significant recovery and eventually lead to positive earnings growth in FY21," says Gautam Duggad, Head of Research, Motilal Oswal Institutional Equities. For the Nifty50 companies, Q2FY21 profits have grown 17 per cent after declining 31 per cent in Q1FY21. Duggad expects earnings to recover in H2FY21 and estimates FY21 Nifty earnings per share (EPS) growth at 7 per cent.

Cost Reductions

Companies managed to post these extraordinary profits in the middle of a partial lockdown primarily due to sharp cost-cutting measures.

"It clearly demonstrates the ability of corporate India to do belt-tightening in challenging times," says Duggad. On a sequential basis, overall expenses as a percentage of net sales of the sample has come down considerably - from 103.7 per cent in April-June to 96.6 per cent during the July-September period. Employee costs (as a percentage of net sales) reduced by nearly 240 basis points in the past two quarters. Continued cost-control measures were visible in other expenses as well, which fell 9.6 per cent, year-on-year, in Q2FY21, compared to a 24.2 per cent decline in the previous quarter. "Some elements of these cost reductions can stay in the profit & loss statements while some will return as economy and businesses resume normalcy. However, we believe that not all costs will return," adds Duggad.

Focus on cost-cutting measures also boosted companies' efficiency in generating profits from sales, or drove their margins. The sample's operating profit and net profit margins have expanded by over 600 basis points, sequentially. "It is largely done by lowering marketing, sales and other expenditure, including selling price, given the low demand. Cost control and high-pricing strategies are likely to stay till the economy normalises, which can take another 12 months based on the availability of vaccine," says Nair.

The Winners

Companies in the manufacturing space emerged as the show stealer with the sharpest fall in operating costs. Almost 71 per cent of the profits made in the September quarter came from non-financial firms, of which, manufacturing had around 50 per cent share. The combined operating profit of the entities within this segment grew by Rs 58,366 crore, quarter-on-quarter, and Rs 20,382 crore year-on-year. Total income shrunk by Rs 1.05 lakh crore, or 10.6 per cent, year-on-year, after operating expenses fell by almost 16 per cent. The decline was mostly due to lower raw material and finished goods spend, which saw a decline of 54.2 per cent and 22 per cent, respectively, in the past two quarters.

Banks, too, saw strong earnings led by lower provisioning requirements that declined by 3.2 per cent during the quarter. Both income from operations and other income grew by 10.7 per cent and 10 per cent, respectively, on a yearly basis. Their major expense head, interest expenses, grew marginally by 1.8 per cent during the period. The segment reported a 28.6 per cent growth in its profit before provision and taxes in Q2FY21, after recording a similar 26.5 per cent increase in Q1FY21.

Big Relief

The recovery in earnings coupled with declining interest cost augur well for companies to meet their debt obligations. The combined interest coverage ratio of the sample of 3,147 companies (excluding banking and financial services companies) improved to 5.7 during July-September, the highest since the March 2012 quarter, compared to 2.7 in April-June. It was 3.1 times in the year-ago period.

"A higher coverage ratio is considered healthy and may vary from industry to industry depending on the nature of business. Last two quarters have been abnormal and not worth considering as business were hit due to Covid-19," says Rusmik Oza, Executive Vice President and Head of Fundamental Research-PCG, Kotak Securities Ltd. Interest coverage ratio measures the margin of safety a company has for paying interest on its debt.

"The fall in coverage ratio in the June quarter was mainly due to lower business activity on account of the lockdown and hence a lower numerator (i.e. EBIT). Interest expense had also gone down, but the EBIT fall in June quarter was disproportionally higher. As activity normalises, the interest coverage ratio is likely to go back to FY20 levels."

During the July-September period, the aggregate EBDIT (earnings before depreciation, interest and tax) registered a yearly growth of 39.4 per cent compared to a 47 per cent decline in April-June. Interest expenses declined 3.73 per cent vis-a-vis a 5.8 per cent growth. According to Oza, "The moratorium and deferment of interest payment is the reason for fall in interest cost in Q2 vesus Q1. In Q1, activity was normal till first week of May and lockdown impact is visible for two out of three months. The renewed pick-up in businesses led to sharp improvement in EBITDA on a quarter-on-quarter basis in Q2, but many corporates who opted for moratorium have been able to postpone their interest payment obligations."

Interest cost is expected to rise again from Q3 onwards, once the moratorium period ends. However, if business activity remains sub-optimal compared to last year, the requirement for working capital loans will be lower, and the rise in interest cost could also be slightly lower, he adds.

Recently, economic indicators such as manufacturing PMI, GST collections and industrial output have managed to regain lost ground. Duggad expects demand to improve gradually going forward, and this coupled with inflation will help drive revenue growth ahead.

@nitikiran