Mumbai: The US recession is real, inflation is at a three-year high in India, and those who expect the stock market to recoup losses arising from these two reasons from positive news flow in the coming earnings season better brace themselves for a shock: analysts expect profits for the quarter ended March, the fourth quarter of 2007-08 for most Indian firms, to grow at the lowest rate in the past two years. But they will still be better than the profits Indian firms registered in the quarter ended December.
Meanwhile, some analysts expect profit margins for the March quarter to decline and others predict an absolute fall in profits. It is evident that rising cost of inputs or raw materials, a slowdown in overall industrial production, and losses from derivatives deals have taken their toll.
In its India Strategy report released Saturday, retail brokerage Motilal Oswal Financial Services Ltd (MOFSL) predicted that net profit for the March quarter would grow 18% over the corresponding quarter last year, better than the 14% growth in the quarter ended December as compared with a year ago, but still the second lowest in nine quarters.
And Motilal Oswal’s estimates are optimistic.
Mumbai-based First Global Securities Ltd has a gloomier outlook. “Given the slowdown in industrial production in January 2008, it would be unwise to expect the fourth quarter to be any better (than the third),” the firm said in its earnings report.
Partha Ghosh, partner and head of banking and capital markets at audit and consulting firm PricewaterhouseCoopers Pvt. Ltd (PwC), said he expects “the (fourth-quarter) results to be negative.”
Apart from rising input costs and a fall in demand, analysts blame the mark-to-market losses being booked by Indian companies on their derivatives positions as one of the main reasons for the drop in profits.
The Institute of Chartered Accountants of India (ICAI), the body that oversees the audit profession in India, has suggested early adjustment of mark-to-market losses on quarterly results, after some companies revealed losses from their exposure to foreign exchange derivatives products which were originally meant to hedge against sharp movements in the Indian rupee as compared to other currencies.
Marking to market is an accounting practice that values investments according to the prevailing market prices.
“There could be 15-20% dip in the profits of all these companies (with derivatives exposure),” said Ghosh.
Vineet Bhatnagar, managing director of MF Global (India) Pvt. Ltd, the domestic brokerage arm of UK-based Man Group Plc., added that losses on “currency derivatives will affect corporate earnings.”
Growth in net profits, or profits after tax, has gradually but steadily declined over the past financial year, slipping from 33.02% in the first quarter ending June 2007, to 24.48% and 14.49% in the second and third quarters, respectively. Growth in revenues has fallen from 21.10% in the first quarter to 16.22% and 15.85% in the second and third quarters.
The earnings season will effectively begin with the 15 April results announcement of Infosys Technologies Ltd, a bellwether for the Sensex, the benchmark index of the Bombay Stock Exchange, as well as for the tech sector.
Meanwhile, some brokerages have already downgraded their fourth-quarter or annual earnings estimates.
Motilal Oswal lowered its 2007-08 earnings growth estimates for Indian companies by about 5.8 percentage points and for companies that are part of the 30-stock benchmark Sensex index to 20.1% from 20.5%, blaming an “increase in commodity prices and the adverse impact of currency fluctuations.” India’s inflation rate, as measured by a rise in wholesale prices, touched a three-year high of 7% last week.
The earnings downgrade in the metal, technology, telecom, cement and auto sectors will have an impact on overall growth figures, the firm said.
Motilal Oswal also expects a wide drop in margins. It said that the operating margins (the ratio of operating profit or earnings before interest taxes depreciation and amortization to revenue) of the 146 companies it tracks could drop by at least 1.9% and the real estate sector could be the worst hit with margins likely to fall 18.5% to 41.6%.
Prabhudas Lilladhar Pvt. Ltd, another domestic brokerage, said it plans to downgrade earnings estimates for its universe of 125-150 companies. Excluding those in the oil and gas business, these companies are likely to show an average net profit growth of 17% in the fourth quarter, down from a 22.3% growth in the third quarter. However, the firm added that these expectations had already been factored in by the markets.
However, the Motilal Oswal report said that the valuations of Indian companies are reasonable. It added that the Sensex is trading at price-earnings multiple of 15.6 times 2008-09 earnings, lower than the 15-year average multiple of 17.5 times. “In the near term, the headwinds (inflation, interest rate, oil prices, etc.) may become stronger, but we see limited downside from current levels. The risk-reward equation has turned favourable” it said.