Indian companies will likely announce good results for the first quarter of the new financial year. This is in pleasant contrast to the volley of bad news on the overall economy — a growing fiscal deficit, a weak rupee and resurgent inflation. Good profit growth is one reason the stock market has rallied over the past few sessions, despite the other problems clouding the horizon. But hold the celebrations: There is little to suggest that companies will continue to sail smoothly in the coming quarters.
Illustration: Jayachandran / Mint
The advance taxes that companies have paid to the government are one clear indication that profits have not taken a nasty tumble between April and June. The ABN Amro purchasing managers’ index — a useful leading indicator corporate activity — for June suggests that output and new orders are rising, while inventories of finished goods are falling. The index does not suggest that manufacturing activity is slowing. That’s the good news.
But it is hard to believe that the various pressures on the economy will not flow into company results at some point or the other. That’s as far as net profits go. Cash flows could already be under pressure, which is not exactly unexpected at this point of the business cycle. The investment spree of the mid-1990s ensured that there was significant overcapacity in many industries. So, companies could expand production in the current boom without investing in new factories. Greater efficiency and modest spending on expansion have helped companies earn more cash.
Five years into an unprecedented business expansion, Indian companies are now facing capacity constraints. They have been putting money into new capacity. Less cash is left for shareholders. The economic slowdown — albeit a mild one — could add further pressure on cash flow. Our daily Mark to Market column said on Saturday that Tata Motors would have ended 2007-08 with negative free cash flow, or cash generated from operations minus capital spending, but for an unusual fall in its working capital. Other companies are likely to face similar pressures in the months ahead.
Indian companies have far better financials than many of their peers in Asia. But the slowdown in the economy could expose some of the mistakes made of late. They are unlikely to be disastrous. But investors are likely to discover that there is far more trouble out there than the first quarter results will imply.
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