Commodity prices, rising interest rates crimp profits

Commodity prices, rising interest rates crimp profits

Mumbai: Rising interest rates and commodity prices are hurting profitability at Indian firms although clear signs of an economic slowdown are yet to emerge from first quarter earnings numbers.

An analysis of 119 companies, which have thus far reported results for the three months to June and for which comparable numbers in the past 12 quarters are available, shows that while year-on-year profit growth has been the slowest since June last year, net profit margins are at their lowest in two-and-a-half years.

Average earnings of these companies rose 25.92% for the quarter, but profit margins dipped to a 10-quarter low of 12.7%. This was mainly due to higher expenses and interest costs. The average net sales growth of this set of firms rose 25.96% from the year-ago quarter, lower than the previous quarter, but higher than the September and December 2010 quarters.

Total expenses as a percentage of net sales were at a 10-quarter high of 77.1% and interest cost as a percentage of net sales was at an eight-quarter high of 13.63%. For calculating interest cost, banks have been kept out of this analysis. In absolute terms, excluding banks, this set of firms paid Rs3,590.13 crore in interest, the highest in at least the past 12 quarters.

“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.

The Reserve Bank of India (RBI) has raised its key policy rate 10 times since March 2010 and many expect the central bank to continue with its rate-tightening cycle at its quarterly monetary policy review to be announced next week, to tame high inflation in the world’s second fastest growing major economy. RBI keeps a close tab on non-food manufacturing inflation, a proxy for core inflation, and corporate profitability to decide on the policy rate movement.Wholesale price inflation was 9.44% in June and core inflation was 7.2%.

Banks have raised loan rates by about 1.75 percentage points since January, making money costlier for both corporate as well as individual borrowers.

Though profitability has taken a hit, sales continue to grow at a robust pace. This, according to market watchers, is worrisome. “There is an impending danger because consumption is growing strong at a time when corporates may be forced to scale down production and investments due to high costs. This will result in higher inflation due to supply shortage," said C.J. George, managing director of Geojit BNP Paribas Financial Services Ltd.

“The key to inflation control is no longer with RBI and the government will have to take supply-side steps at the earliest. I hope RBI will take a break from raising interest rates," he said.

Indian firms and banks have been lobbying hard to convince RBI that any further interest rate increase will seriously hurt growth prospects.

Out of the 119 firms whose numbers have been announced so far, 12 are from auto and auto ancillary companies, a rate-sensitive sector. Net profit margins of these firms was at 9.97%, lower than the 12.7% average of the entire set of companies.

Information technology firms, relatively insulated from the high interest rate scenario, fared better in terms of margins. Seven companies in the sector had an operating profit margin of 21.41%. Six firms in the pack are part of BSE’s Sensex. Their earnings grew 22.32%, while net profit margins were at a nine-quarter low of 19.66%. Total expenses as a percentage of net sales were at 65.77%, the highest since December 2008, when the world witnessed an unprecedented credit crisis in the wake of the collapse of US investment bank Lehman Brothers.

To be sure, the sample size is too small and it’s too early to call it a slowdown as yet. According to a section of market analysts, the scenario is getting gloomier, but things may improve later in the year.

“The numbers that have come so far are not surprising. Margin pressures should peak in the second quarter as raw material prices will see some stability," said Gaurav Dua, head of research at brokerage Sharekhan Ltd.

The stock market seems to have already factored in a lull in corporate profitability. While the MSCI Emerging Markets Index fell 1.94% year-to-date, the Sensex lost 9.78%. On Wednesday’s close of 18,502.38 points, the Sensex was at a price-to-earnings multiple of 16.7.

Foreign institutional investors, the key drivers of Indian markets, have bought stocks worth a net $2.2 billion (9,790 crore) during the year so far after pumping in a record $29.36 billion last year.