Mumbai: Earnings of Indian companies grew in double digits for the quarter ended September over a year ago, driven mainly by sales gains, but rising costs crimped profit growth.
The increases have mostly been in line with Street expectations, but a prior run-up in stock prices has made analysts and fund managers cautious about the near-term outlook.
While stand-alone profit growth of 28 Sensex firms, at 10.3% in the September quarter over a year ago, is in line with expectations, it is unlikely to trigger any rise in stock prices as these gains were largely priced in.
The profit growth for the same set of firms was 1.63% in the June quarter over the year-ago period.
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The consensus estimate of consolidated earnings per share for Sensex companies in the fiscal ending March has remained unchanged in the Rs 1,040-1,050 range.
“While sales growth has been above expectations, margins have been slightly on the lower side owing to cost inflation,” said Apurva Shah, head of research at Prabhudas Lilladher Pvt. Ltd.
Sales of the 28 Sensex firms grew by 20% and the trend is similar in the broader market, reflecting robust demand in the domestic economy.
Profit of 40 Nifty firms rose by 7.17% driven by a sales growth of 17.8%.
Although recent factory output numbers have disappointed—the index of industrial production (IIP) rose by a less-than-expected 4.4% in September—market experts are not reading too much into them.
“The IIP numbers do not reflect the state of the entire Indian industry today as growth in the small and medium enterprises are not measured well,” said Satish Ramanathan, head of equities at Sundaram Asset Management Co. Ltd, which manages Rs 14,241 crore worth of assets.
A Mint analysis of 375 firms in the BSE 500 universe for which data is available shows that sales grew by 20.7% for these firms. Profit rose by 17.5% over the same period last year, against a decline of 14.4% in the June quarter.
Much of the growth in profits is, however, because of volatility in the earnings of oil and gas companies, the fortunes of which depend on international crude oil prices as well as government subsidy burden.
Excluding these firms, earnings for 358 firms rose by 7.9% in the second quarter after registering growth of 6.54% in the previous three months.
The Mint earnings analysis counted net interest income (interest earned on loans minus the cost of deposits) and non-interest income as net sales of banks. The BSE 500 constitutes 93.5% of market capitalization on the Bombay Stock Exchange.
Cost pressures have limited the margin growth of most companies, as in the June quarter, and analysts fear that unabated inflation may take a toll on earnings by inducing interest rate hikes.
The Wholesale Price Index rose by 8.6% in October and prompted the Reserve Bank of India to hike the repo and reverse repo rates by 25 basis points each on 2 November.
“Inflation poses the biggest downside risk to earnings,” said Roopesh Patel, head of research at HSBC Securities and Capital Markets (India) Pvt. Ltd.
“Rising inflation would lead to further rise in interest rates impacting operating leverage and valuations adversely,” he added.
Rising prices of commodities have not helped matters and the quantitative easing in the US could make it worse, as a fresh surge of liquidity finds its way into global commodity markets leading to a rise in commodity prices.
In the past three months, crude oil, aluminium and copper prices have registered double-digit growth and rubber prices have moved up 28%.
Although most firms hedge against the rise in commodity prices using forward contracts, the numbers seem to suggest that they have not been able to limit cost pressures.
Both raw material costs and employee expenses among 291 manufacturing firms in the BSE 500 universe rose at a rate faster than sales. Raw materials as a proportion of net sales have risen to their highest level in six quarters at 38.3%.
Profit growth for this set of firms was 1.45% even as sales growth touched 19% over the year-ago period.
Unlike in the June quarter, when banking and auto firms sprang a positive surprise, there’s no clear favourite in the September quarter.
ICICI Bank Ltd, with profit growth of 19%, beat Street expectations, but a few public sector banks, including State Bank of India (SBI), the nation’s largest lender, delivered results that were slightly below expectations. SBI posted a profit growth of 0.5%.
In information technology, Wipro Ltd, which saw a 4% fall in profit, disappointed, while rival Infosys Technologies Ltd delivered higher-than-expected earnings growth of 14%.
The market, though, seems to be watching global factors more carefully. A liquidity-driven rally that has taken valuations to high levels means that the market is more vulnerable to a correction in case of disappointments, Shah commented.
The Sensex currently trades at over 19 times its forward earnings against its historical average of 17 over the past five years, Bloomberg data show. The index has risen 11.5% in the past three months.
Record foreign institutional investor (FII) inflows of $28 billion have helped the Indian benchmark outperform its Bric (Brazil, Russia, India, China) peers this year. So far, the Sensex has beaten the MSCI Emerging Markets Index by 7% to generate returns of 23% in dollar terms.
Still, any rise in risk aversion could hurt investor sentiment, as seems to be currently happening on fresh signs of sovereign debt problems in Europe and fears that China might raise interest rates to cool its economy. The Sensex has already fallen by over 3% over the last two trading sessions.
“There is a risk that interest costs move up, wage inflation rises and growth disappoints slightly,” Ramanathan said. “That could lead to a moderate correction in the coming months.”
To be sure, the consensus view on growth remains optimistic and that alone could ensure that India continues to be a beneficiary of the liquidity flow unleashed by the US Federal Reserve.
In a 4 November note, Geoffrey Dennis and Jason Press of Citigroup Global Markets estimated that emerging market returns could go as high as 35% in dollar terms by the end of 2011 on the back of strong flow of funds and attractive economic fundamentals.
“Near-term risks are a US double dip, aggressive Chinese rate hikes and a strong dollar rebound. Long-term, we must watch for high valuations,” the note added.