Mumbai: Global economic uncertainty, high interest rates and a weak rupee are likely to dent the July-September earnings of Indian companies, which are expected to post among the worst quarterly results in at least two years.
Announcements of the earnings for the three months to 30 September will begin next week; Infosys Ltd is the first major company scheduled to do so, on 12 October.
In the first quarter of fiscal 2011-12, although revenue continued to grow at a healthy rate, Indian firms earned the least per-rupee worth of goods sold in at least 24 quarters as higher commodity prices and interest rates played spoilsport. This time around, though commodity prices have cooled off a bit, slowing demand from the West may exacerbate the effects of the weakening local currency and the tight monetary policy of the Reserve Bank of India (RBI).
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“Even though the top line and operating profits will register positive growth rates, profitability will come under pressure due to the unabated hike in key policy rates by the RBI,” ICICI Securities said in its consolidated results preview report. The broking firm expects broader market earnings to grow at a compounded annual growth rate of 11% over the 2011-2013 financial years.
“After the numbers (of all companies) are out, there will be some disappointments and further earnings downgrades,” said Amar Ambani, head of research, India Private Clients, India Infoline Ltd. “Our earnings per share (EPS) estimate for Sensex companies is Rs1,125-1,150, which may be conservative but realistic. Those who have a higher EPS target will have to scale down after results.”
For the quarter ended June, though revenue in 27 of the 30 companies that constitute the BSE Sensex rose 23.66% from the year-ago period, net profit rose only 8.03%, the second slowest rate of growth in the past four quarters. Total expenses for these 27 firms was at its second highest in 24 quarters, as was interest expenditure, or the cost incurred by them in servicing loans.
One of the main reasons for the muted profit growth for the June quarter was higher interest expenses as RBI raised its key policy rate for the 11th time since March 2010, to fight ballooning inflation.
In September, RBI raised its key rates again by another 25 basis points to 8.25%, but it has done little to contain inflation. Wholesale inflation has increased from 8.23% in January to 9.78% in August. One basis point is one-hundredth of a percentage point.
“There will be pressure on the margin front because of high interest rates. Profit and sales are expected to be more or less flat for the second quarter,” said Rakesh Mehta, chairman, Mehta Equities.
In the first quarter, the interest coverage ratio, a measure of the debt burden on companies, stood at a six-year low of 16.84 for 44 of the 50 firms that comprise the Nifty index; data was available on these firms for at least the past six years. The ratio is calculated by dividing a company’s earnings before interest and taxes by interest expenses. A lower ratio means higher leverage.
Thus, profits of capital intensive and rate-sensitive sectors could take a hit in the second quarter as such companies pay more to service loans, while demand for goods that are mostly bought on borrowed money slows further.
“Sectors like auto, capital goods, infrastructure, metals and telecom will report revenue growth, but the same will not reflect on their profitability as high capex, working capital, high interest rates, and one-offs will spoil the show,” the ICICI Securities report said.
However, according to the brokerage, a “highly crucial” factor to watch out for after second-quarter results is whether there will be more earnings downgrades. Several brokerages have already downgraded their earnings estimates for the Sensex in the current year.
According to Motilal Oswal Financial Services Ltd, since the second quarter of financial year 2011, the Sensex EPS has been downgraded by 9% and for financial year 2013 by 10%.
“The earnings downgrade cycle has continued in the second quarter of financial year 2012 as well, with financial year 2012 earnings down 1% and financial year 2013 earnings down 2.8%,” the brokerage said in its second-quarter preview report.
The key contributors, according to the brokerage, to the financial year 2012 earnings downgrades are State Bank of India, Oil and Natural Gas Corp. Ltd, NTPC Ltd and Bharti Airtel Ltd. The broking firm expects second-quarter earnings growth to be slow. “Earnings will be reported amidst an adverse macro backdrop. Interest rates are up further 50-75 basis points during the quarter, demand continues to weaken in the domestic economy and the rupee depreciated by around 10% against the dollar.”
Starting the year at 44.72 against the dollar, the rupee was valued at 49.14 as per the latest data available on the RBI website. A weak rupee usually helps exporters, including information technology (IT) companies, as they earn in dollars. However, that may not be the case this time around.
“The notion that a weaker rupee may help IT companies could be wrong because there may be hedging positions open that will show some mark-to-market losses,” Ambani said.
The only good news in the ongoing economic slowdown is the correction in commodity prices. The Thomson Reuters/Jefferies CRB Index was at 303.52 on 7 October, off from a high of 370.56 on 29 April. However, a weaker rupee will offset the benefits of lower prices as the country will need to pay more for its imports.
“Commodities like steel, aluminium and rubber have declined about 2-8% y-o-y (year-on-year). However, currencies have played havoc in the market with INR (Indian rupee) depreciating about 10% in September,” ICICI Securities said.
While signs of a slowdown across sectors are evident, some companies face the risk of posting losses as well. According to the Emkay Global Financial Services Ltd’s results preview, 52 out of 124 companies in its coverage universe are expected to post “negative profit after tax growth”. The brokerage expects cement, auto ancillaries, IT, consumers and pharmaceuticals to post y-o-y earnings. Print media and offshore oil field services are likely to post a decline in earnings, according to it.
According to Motilal Oswal, fast-moving consumer goods, private banks and retail are the only sectors in which all firms will show earnings growth, while sectors with muted growth will be public sector banks, telecom and auto.
However, there may be an upturn from the next quarter as interest rates peak and inflation slows as the festival season gets under way and consumers start spending. That depends on whether consumers feel confident enough to spend at Diwali.
“Things should improve from now as the festival season begins and we expect the third and fourth quarters to be better,” said Mehta.
Graphic by Sandeep Bhatnagar/Mint