Alarge part of India Inc.’s growth in profits during the first quarter of FY08 is the result of growth in ‘other income’ or income from sources other than operations. A Mint analysis of the earnings growth of 25 non-financial companies that constitute the Sensex shows that ‘other income’ increased by 109.76% in the June quarter, compared with the year-ago period. During the first quarter of FY07, growth in ‘other income’ at these companies was a much lower 29.47%.
A similar result was obtained by comparing the companies that make up the Nifty, the broader index of the National Stock Exchange. Of the 50 Nifty companies, eight have not been considered for this study as they are banks and financial institutions. Besides, Reliance Communications Ltd and Reliance Petroleum Ltd have not been considered because they are relatively new entrants in the Nifty basket and there were no previous year’s figures to compare. HCL Technologies Ltd wasn’t included as it has not yet announced its results for the April-June quarter. Excluding these companies, ‘other income’ growth of 42 Nifty stocks was 129.3% in the June quarter, a very big jump from the 30.69% growth in ‘other income’ notched up by the same companies in the June quarter last year.
More significantly, the proportion of ‘other income’ to profits before tax (PBT) has been increasing. This indicates a deterioration in the quality of earnings. For the 25 of the 30 Sensex companies, ‘other income’ constituted 19.74% of profits before tax, much higher than the year-ago period’s percentage of 12.08%. Similarly, for the 42 Nifty companies, ‘other income’ amounted to 21.04% of PBT, up from 11.67% in the first quarter of FY07. This percentage has increased not only because ‘other income’ has gone up, but also because growth in PBT has decelerated. For instance, for the 42 Nifty companies analysed, the rate of growth of PBT went down from 33.40% in the first quarter of FY07 to 27.24%.
While ‘other income’ includes items such as profits on sales of assets, treasury income, dividends and other non-operational income, most of the gains in the June quarter have been the result of foreign exchange gains. A recent Merrill Lynch report points out that while Sensex companies’ earnings growth in the June quarter has come in well above expectations at 31.2%, the earnings surprise was largely on account of forex gains.
Shorn of such gains, earnings growth would have been lower than 20%. For some of these companies, Tata Steel Ltd being an example, the forex gains have been booked as ‘extraordinary income’ rather then ‘other income’. Companies with large foreign curreny translation gains in the June quarter include Tata Steel (Rs530 crore), NTPC Ltd (Rs382 crore), Tata Motors Ltd (Rs206 crore), Larsen & Toubro Ltd (Rs133 crore) and Ranbaxy Laboratories Ltd (Rs106 crore).
Interestingly, among a sample of 1,751 companies with market capitalization less than Rs1,000 crore, ‘other income’ growth has actually been negative in the June quarter. That’s probably because the lion’s share of the foreign currency loans have gone to large companies which find a place in the Sensex or the Nifty.
Merrill Lynch believes that shorn of the one-time gains, earnings growth is likely to slow down around 17% this fiscal.