Revenues rise, but input and interest costs eat into profits

Revenues rise, but input and interest costs eat into profits

Mumbai: Revenues of Indian firms continued to grow in the first quarter of fiscal 2011-12 (April-June for most Indian firms), but high interest costs and commodity prices pushed down profit earned per rupee worth of goods sold, to the lowest in at least 24 quarters.

That metric could go lower next quarter, said an expert. “The indication is that a slowdown is getting visible. The demand in interest-rate sensitive sectors will be hampered going forward. The next quarter may be worse," said Raamdeo Agrawal, director and co-founder of Motilal Oswal Securities Ltd.

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Revenue of 27 of the 30 companies that constitute the BSE Sensex and for which data is available for the past six years increased 23.66% in the quarter over the same period a year ago. This is the fastest revenue growth in the past four quarters. Net profit, however, grew 8.03%, the second slowest rate of growth in the past four quarters. And net profit margin, or net profit expressed as a proportion of sales, was 12.84%, the lowest in at least six years. The reason for this: total expenses for the 27 companies was at its second highest in 24 quarters, as was interest expenditure, or the cost incurred by companies in servicing their loans. Late last month, the Reserve Bank of India raised its key policy rate by 50 basis points—the 11th increase since March 2010, to fight ballooning inflation. As a result of this, interest rates have gone up by 4.75 percentage points to 8%.

“Margin pressures will be quite prominent and interest pressures will hurt. The bigger concern is that the slowdown is evident and profit growth might not hold out. Risk of earnings (not meeting targets is) still there and somewhere we feel the interest rates will peak in coming months," said Gaurav Dua, head of research at Sharekhan Ltd.

The trend is similar for companies that are part of the National Stock Exchange’s Nifty index. In this case, revenue for 44 companies grew 24.65%, the fastest in four quarters, while net profit grew 5.68%, the second slowest in the same period. Net profit margin for the companies was, at 11.01%, the lowest in at least 24 quarters, and the interest cost was the second highest in the same period.

For the quarter ended June, interest coverage ratio, a measure of the debt burden on companies, stood at a six-year low of 16.84 for these 44 Nifty firms. The ratio is calculated by dividing a company’s earnings before interest and taxes by interest expenses. A lower ratio means higher leverage.

In both cases, Mint’s analysis excluded earnings from subsidiaries.

Apart from higher interest costs, the firms have also been hit by the rising prices of raw materials, although this trend is already beginning to reverse. And that, say analysts, could mean a better showing by the companies towards the end of this fiscal year, but only if nothing else goes wrong.

Raw material prices have cooled off in the past few months, with the Thomson Reuters/Jefferies CRB Index close to its recent low of 316.12. As on Friday, the index was at 326.53, down 11.88 points from a high recorded in late April.

Most firms hedge against the rise in commodity prices using forward contracts, and because of this the full extent of a change in input costs will only be felt in the quarters ahead, analysts add.

“Commodity prices are coming down and I expect margin pressures to soften now. We maintain that the second half of the fiscal will be better than the first half, when the reversal in the cycle starts. This holds good only if everything in the global economy goes well and there are no more shocks from western economies," Dua said.

For the quarter ended June, though, even the performance of companies that are part of the broader BSE-500 Index mirrored that of the Sensex and Nifty firms: revenue rose 29.16%, net profit by 5.35% (the slowest in four quarters), and net profit margin was 7.43%, the lowest since the second quarter of 2008-09.

Indeed, brokerages and mutual fund houses have already started cutting their earnings estimates for the year.

Kotak Securities Ltd said in an 8 August report that though Indian markets are attractively valued, earnings could drop.

“Earnings face downside risks, but we note that our FY2012 BSE-30 Index EPS (earnings per share) is down only 2%, from ,200 to 1,225 at the start of the reporting season," it said.

At Friday’s close, the Sensex was trading at a price-to-earnings multiple of 18.38. On a forward earnings basis, the index is trading at an FY12 earnings multiple of 13.89, according to Bloomberg data. The actual EPS of the index is at 1,119.36, while its estimated FY12 EPS is 1,212.31, Bloomberg said.

According to Saurabh Mukherjea, head of equities at Ambit Capital Pvt. Ltd, people expect that at a nominal gross domestic product growth rate of 14-15%, EPS will also grow at double digits, but that history has proven otherwise. EPS growth will be in single digits this year, he added.

“Our forecast for FY12 EPS is around 1,160, with a year-on-year growth of 6%," Mukherjea said. “We might be the lowest on the Street, but I see consensus moving towards our estimate as cost pressures are pushing earnings growth down."

Yogesh Kalwani, head of investment advisory at BNP Paribas Wealth Management, said last week that his firm was “factoring in a 3% decline in Sensex EPS estimates. If there is no rate hike in the forthcoming monetary policy, the markets will take it positively".

If there is a downgrade on index earnings forecasts on a wider scale, it could trigger more selling in Indian equities.

Stock markets across the world have declined over the last two weeks over fears of a double-dip recession in the US and euro zone debt uncertainties. Amid global turmoil, high commodity prices and inflation, key Indian indices have lost more than 17% in the year so far. On Tuesday, the Sensex declined 0.65% and the Nifty, 0.73%.

“The earnings picture has become increasingly grim and we expect renewed selling by the Street on the back of heavy consensus downgrades," Mukherjea said.

Graphic by Paras Jain/Mint