The great earnings slowdown

For 22 Quarters, India inc.’s earnings juggernaut rolled on without a pause, turning out double-digit growth four times a year for the past five years. But the 23rd quarter has proved different. Last fortnight, when the first flush of report cards for the second quarter of 2008-09 emerged, the much-anticipated slowdown in corporate earnings was finally out in open. A sample of 531 companies considered by Business Today (which is the number of companies that had reported results at the time BT went to press) shows profit growth of 9.11 per cent for the quarter ended September 2008.

That’s the first time it’s fallen into single digits since 2003 when the bull run began on Dalal Street. The topline hasn’t been impacted, growing 31 per cent (as against 33.3 per cent in the first quarter of 2008-09). Operating profits are up 18.5 per cent (16.1 per cent in the first quarter).

The slowdown in earnings can be attributed mainly to rising commodities prices, especially crude, which hit a record high of $147 (Rs 7,056) a barrel in July. Interest costs, up almost 41 per cent year on year, and a falling rupee are the other culprits that took their toll of bottom lines. The worstaffected sector is cement, even as construction and engineering succeeded in weathering the storm.

Though oil prices have crashed—along with stock prices—by more than half in less than four months, the investment community is still sceptical about the future growth of corporate earnings. That’s because the global economy has taken a knock, and India, too, is impacted. “Corporate profits will be bad for the next 2-3 quarters,” says Manish Chokhani, Director, Enam Securities. He adds that the tightening of the monetary policy has also impacted corporate profits. The impact of the recent measures by the Central bank to restore liquidity and confidence will be felt, but only after a lag effect. Some of the recent measures announced by the Central bank include a reduction in the cash reserve ratio by 2.5 per cent, and a cut in the repo rate by 1 per cent.

The downward revision of the projected economic growth for 2008-09, to 7.5-8 per cent from the earlier estimated 8.5-9 per cent, has also made analysts apprehensive. “Going forward, no doubt, raw material costs will come down, but a shrinking economy will lead to slower sales,” says Ajay Parmar, Head of Research, Emkay Global Financial Services. He adds that corporate profitability will be affected by rising interest rates in the third and fourth quarter.

It is not just the investment community that is wary about profitability in the quarters ahead; the corporate sector, too, is accepting the reality, despite a sharp fall in commodity prices. What’s more, companies in the commodities sector will get hit by prices globally; margins will be under pressure as cement prices will also be under pressure,” says D.D. Rathi, Director & Chief Financial Officer, Grasim Industries, a maker of cement and viscose staple fibre (VSF). Grasim, to be sure, has been hit by double whammy, as VSF consumption has been hit, courtesy a downturn in the textiles sector.

But there are others within the commodities space who still believe they can weather the storm. “Steel prices are likely to drop by Rs 3,000-4,000 per tonne, but the company will be able to ward off most of the margin pressure through cost cutting,” says Hemant Nerurkar, Chief Operating Officer, Tata Steel.

The confidence in that statement isn’t unwarranted as Tata Steel reported a net profit jump of 50 per cent for the second quarter (excluding Corus of the UK, which it had acquired last year). Even in the midst of the liquidity crisis, the company is financially strong. “We are sitting on around Rs 1,500 crore cash. We also have our credit lines intact,” says Koushik Chatterjee, Chief Financial Officer, Tata Steel. He adds that the company has paid back around £300 million (Rs 2,460 crore) of the loans taken for the Corus acquisition; the next lot of payment is due only in December 2009.

Another company from the same stable, Tata Consultancy Services (TCS), despite a decline in net profits, showed good growth (around 18 per cent) on the topline. “Our revenues across geographies have grown during the last quarter with the exception of India. In India, contracts are project-based and not annuity-based and, as a result, there is volatility in revenues,” says N. Chandrasekaran, Chief Operating Officer, TCS.

Some leading players that have not been affected by the slowdown include Hero Honda, Larsen & Toubro, Hindustan Unilever, Bank of India and Punj Lloyd. However, by the time all the results are in (by October 31), there will be more bad news. At the time of going to press, none of the leading real estate companies had announced their results. This sector threatens to spoil the entire report card for India Inc.
 
The reason: if the real estate sector slows down further, the demand for cement and steel could be affected. This could also lead to a slowdown in demand for housing loans. Meanwhile, there are murmurs of leading automobiles producers resorting to production cuts; this will lead to a further decline in profitability and also a slower growth of the topline.

With so many dark clouds hovering, the only silver linings for India Inc. are the prospects of a decline in interest rates and inflation. But for a turnaround in earnings growth to take place, the global financial system has to stabilise first. That’s going to take some time.

—Additional reporting by Suman Layak and T.V. Mahalingam