Has the recent rally in the stock market been based on “fundamentals”? A Mint study of 833 non-bank, non-oil companies that have declared results for the March quarter appears to suggest so. (These are companies that have quarterly net revenues of Rs1 crore and above). Growth in aggregate operating profit in the quarter for these companies has been the highest in the year. Operating profits rose by a mere 4.87% year-on-year in the June quarter and 15.09% in the September quarter, then slumped to an annual growth rate of 1.83% for the December quarter. Operating profit growth (year-on-year) for the March quarter, however, is a high 20.39%. It’s early days yet, but the initial results do show that the market may have overreacted to the bad news, before the recent rally, about a slowdown in the economy and a rise in input prices.
Even at the net profit level (net profit adjusted for extraordinary items), year-on-year growth in the March quarter for these companies has been a high 21.51%, well above the 10.84% and 19.46% growth notched up during the previous two quarters, but lower than the June quarter’s growth rate of 28.06% for profit after tax.
Growth in net revenues in the March quarter for these companies has been 17.13%, compared with 13.92% in the December quarter, 16.58% in the September quarter and 21.93% in the June quarter. The prediction of doomsayers of a sequential deceleration in the quarterly growth rates hasn’t proved to be correct, at least so far. Also, with operating profit growth rates being well above the growth rate of net revenue, companies have been able to expand margins in a difficult environment. In short, the data show that companies have been able to combat the headwinds they are facing.
But perhaps the higher growth rate in March is the result of a base effect, with growth in the March quarter of 2007 being lower than in previous quarters. Not really. True, operating profit growth in the March 2007 quarter was lower than in the December quarter, but that can’t account for such a massive difference in operating profit growth rates.
In the last quarter, while growth in “other income” was lower, growth in interest and depreciation costs was lower than in the December quarter. The growth in tax provisions too was lower in the March quarter compared with the December quarter.
Moreover, the improvement in operating profits was across the board, extending to small, medium as well as large companies. For instance, among the companies with a net quarterly turnover Rs1,000 crore and above, year-on-year growth in operating profits was 3.41% in the June quarter, 10.43% in the September quarter, -0.57% in the December quarter and 15.44% in the March quarter. But part of the reason for the bounce could be the fact that growth in the year-ago period (March 2007 quarter) was a comparatively low 25.34%, much lower than the December 2006 quarter’s growth of 61.64%.
However, for small companies too with a net quarterly turnover of Rs1-500 crore, the same trend of the March 2008 quarter having the highest growth rate in operating profit holds, but there’s no base effect involved in this sample.
I-flex’s premium looks unjustifed
I-flex Solutions Ltd, majority owned by Oracle Corp., reported decent March quarter results, especially for its core products business. Revenues of the company grew by 11.7% over the December quarter, while operating profit jumped by 35% sequentially. As a result, its stock held firm at the Rs1,360 levels. I-flex shares have risen nearly 45% since April, compared with a much smaller 22% increase in the National Stock Exchange’s CNX IT index. But note that the March quarter has traditionally been a strong one for the company, and so a sequential comparison doesn’t make much sense. In fact, looking at quarterly results even on a year-on-year basis doesn’t make much sense because of the lumpy nature of the products business, where large deals can skew the picture.
Looking at annual results is a better idea. The year till March hasn’t been great for the company, with revenues growing by a mere 15.5% and operating profit increasing by just 5.2%. As far as the company’s operating profit growth is concerned, performance has varied substantially every alternate year. In the year till March 2007, profit grew by an impressive 37.5%, but in the previous year (FY06), growth was just 1.9% and in FY05 it had been steady at 23.7%. The compounded average growth in profit has been mediocre at about 16%, especially since other large Indian IT players have grown profits by more than 30% year-on-year, except in FY08 when growth slipped owing to the appreciating rupee. The company’s large exposure to the banking and financial sector could mean that growth will be increasingly difficult to come in the near future.
Still, i-flex commands a premium valuation of about 27 times trailing earnings, a substantial premium to even Infosys Technologies Ltd, which trades at 22 times its trailing earnings. One reason could be that minority shareholders, who now own 20% of the company’s float, are hopeful that Oracle will make another open offer to buy them out. But it’s also important to note that i-flex traded at premium valuations even before Oracle came into the picture, because of an impression that the company’s successful products portfolio for the banking and financial services industry deserved a premium valuation. But almost every other year (as it did in FY08), the company has disappointed with profit grow-th, and unless investors have bought in expecting an open offer from Oracle at a substantial premium, there are better and cheaper alternatives in the IT space.
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