Higher costs to crimp profit growth in Q1, but worse is yet to come

Higher costs to crimp profit growth in Q1, but worse is yet to come
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First Published: Thu, Jul 10 2008. 01 06 AM IST

Updated: Thu, Jul 10 2008. 01 06 AM IST
Mumbai: Brokerages expect to see a sharp decline in the profit growth of companies in the first quarter of 2008-09 compared with the same quarter last year, despite a healthy growth in sales largely because of higher costs of raw materials and credit. And they also expect things to get worse in subsequent quarters.
Earnings season, or the period when companies declare their results, begins Friday when Infosys Technologies Ltd, one of India’s biggest software services firms, declares results for the April-June quarter, the first for most Indian firms that typically follow an April-March accounting period.
The low expectations of brokerages come even as the Bombay Stock Exchange’s benchmark index, the Sensex, has fallen 32% this year, largely on concerns related to the global and Indian economy. The brokerages expect earnings growth in subsequent quarters to fall further.
To be sure, the brokerages expect Indian firms to make more profit in the June quarter than they did in the corresponding quarter last year but the rate of increase this year (over April-June 2007) will likely be a lot less than last year’s rate of increase (over April-June 2006).
SLOWDOWN AHEAD? (Graphic)
At least half a dozen domestic brokerages have, in the past two days, released reports on the expected performance of Indian firms in the first quarter of 2008-09, and the consensus seems to be that there will be pressure on Ebitda margins or operating profit margins.
Earnings before interest, taxes, depreciation and amortization, or Ebitda, is a metric to evaluate the profitability of a company’s core operations, and is calculated by substracting its expenses excluding interest, taxes, depreciation and amortization from revenue.
According to Motilal Oswal Financial Services Ltd, Ebitda margin will hit a 10-quarter low in the first quarter of fiscal 2009. Nemkumar and Ashutosh Datar of India Infoline’s institutional research desk say the quarter will be marked by “continued Ebitda margin compression, reflecting the impact of rising commodity prices”.
The pain on margins, according to brokerages, will be compounded by higher interest rates, depreciation costs and a drag on non-operating income or other income.
In several cases, “we will also see negative mark-to-market losses, on account of currency hedges and also on account of forex liabilities such as foreign currency convertible bonds and external commercial borrowings”, said another domestic brokerage, Prabhudas Lilladher Pvt. Ltd. Mark to market is an accounting practice of valuing a financial asset at its current price.
Even while almost all of them agree that the April-June quarter will be bad for Indian companies, the brokerages say this quarter may not be an accurate indicator of larger macroeconomic concerns that have made the business environment more challenging.
The real impact, according to the brokerages, will be witnessed only from the second quarter of this fiscal.
In sync with this, global advisory firm Dun and Bradstreet on Wednesday said the optimism level of Indian corporations for the third quarter of 2008 is at its lowest since the fourth quarter of 2004.
The firm’s Business Optimism Index, a composite index that considers six parameters—sales, net profit, selling prices, new orders, inventories and employees—to assess business outlook is at 136.5 points, a fall of 11.2% over the last quarter and a decline of 18% year-on year.
The Motilal Oswal report projects at least a 30% sales growth for the Sensex firms (the 30 companies that are part of the index) and a 15.6% growth in their net profit.
The net profit growth for firms represented in the country’s two main equity indices— the Sensex and 50-stock Nifty—plunged to an eight-quarter low in the March quarter, the last of fiscal year 2007-08.
Collectively, the Sensex companies managed to keep their year-on-year net profit growth in that quarter in the double digits, at 12.89%, but for the Nifty firms, net profit growth fell to 9.31%.
The growth in net profit for both the Sensex and Nifty firms has been progressively reducing in the last four quarters even though the growth in their operating profit and net sales does not show any definite trend.
“Real pain of ballooning inflation and hardening interest rates” can be “experienced from (the) third quarter (of 2008-09),” said Religare Securities Ltd, which has titled its quarterly preview report “Visible signs of a slowdown”. According to the Religare results preview report, there is “likelihood of further 10 to 12% downside in profit growth estimate for fiscal 2009.”
But analysts said that despite these estimates, there is little scope to de-rate Indian stocks. At current valuations, “we believe that the markets have factored in majority of the concerns—high crude prices, inflation and rising interest rates,” said Angel Securities Ltd’s earnings preview note.
The valuation of several key stocks, in terms of the (share) price-earnings (per share) multiple, has corrected from 25 times forward earnings (or future earnings) in January to 14 times now.
“Analysis of past bear phases indicates that markets are in a consolidation phase and scope for a further price and valuation downside is restricted to 10–15%,” said Motilal Oswal’s report.
The Sensex gained 4.6% or 614 points in Wednesday’s trade, supported by strong cues from global equity markets, a drop in crude oil prices from record levels and hopes of a better political climate emerging in the country after the Left Front withdrew its support for the ruling coalition government at the Centre that found a new ally which may not be opposed to key economic reforms. “With the Left out...the government besides focusing on inflation will probably try to get some reforms done to improve its scorecard ahead of the elections,” said Rohini Malkani, India economist for Citigroup.
The benchmark index has recovered around 7.8% in six trade sessions, after dropping to 12,961.68 on 1 July, the lowest this year. The Sensex and Nifty were among the best performing indices across key Asian markets on Wednesday. China’s benchmark index gained 3.7% and Hong Kong’s Hang Seng index added 2.76%.
“If all goes well, we could expect a speeding up of reforms or bills pending in parliament, such as FDI (foreign direct investment) in retail, pensions, divestments and banking or finance related amendments. This in turn would have a positive impact,” Malkani added.
Anup Roy contributed to this story.
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First Published: Thu, Jul 10 2008. 01 06 AM IST
More Topics: Profit | Growth | Tax | Interest | Sensex |