Mumbai: Earnings of listed Indian companies in the March quarter grew at the slowest pace in three quarters as rising input costs eroded profit margins even as sales remained buoyant, riding on higher prices.

The earnings season has largely been disappointing with downgrades dominating upgrades, analysts said. Not surprisingly, markets have fallen 3.31% since the start of the earnings season.

“While we expected a margin squeeze, overall, the extent of it was higher than what we thought," said Apurva Shah, head of research at brokerage Prabhudas Lilladher Pvt. Ltd.

Profit at 27 of the 30 companies that constitute the benchmark Sensex, for which data is available for the past 23 quarters, grew 4.4% in the March quarter over the year-ago period, having expanded at an average 12% in the previous nine months. Sales growth was higher at 20% for these companies, in line with the previous three quarters.

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“The overall numbers appear depressed because of major disappointments like State Bank of India (SBI) and Oil and Natural Gas Corp. Ltd (ONGC)," said Sanjeev Prasad, strategist at Kotak Mahindra Capital Co. Ltd.

SBI’s net profit was down 98% in the March quarter while that of ONGC saw a 26% decline.

The trend has been similar for Nifty firms. The aggregate profit of 44 Nifty firms, for which past data is available, grew 2% even as sales grew by 20%. All the Sensex firms are part of the 50-stock Nifty index.

The lower-than-anticipated numbers add to the growing macro concerns that have brought markets down by 10% so far this year. India has been the worst performing Asian market as concerns over a spike in the prices of crude and other raw materials, a slowdown in economic growth as well as corporate earnings and delays in government approvals to key projects have spooked foreign investors, who have sold shares worth $500 million (Rs 2,245 crore today) so far this year.

Among major input costs, increases in raw material prices have hit profitability of companies the hardest. Raw material costs as a proportion of net sales for Sensex firms rose to 24.5% in the March quarter, the second highest level in 20 quarters, according to Capitaline data.

The trend in the broader market is similar.

A Mint analysis of 361 firms in the BSE-500 universe shows that raw material costs as a proportion of net sales rose to 36.3%, the second highest level in 18 quarters. The 361 firms are those for which data is available for the past 23 quarters. Firms that constitute the BSE-500 Index account for 93.5% of overall market capitalization of the exchange.

Profit growth for this set of firms was slightly better at 10.7%, owing to the lower base in the year-ago period.

Though raw material prices have cooled off in the past few months, with the Thomson Reuters Jefferies CRB Index down 1.4% over the past three months, the absolute level of commodity prices is still high.

Most firms hedge against the rise in commodity prices using forward contracts and because of this, the full extent of rise in input costs will be felt in the quarters ahead, according to analysts. Besides, firms will also have to contend with the brunt of rising wages and higher interest costs.

Though India’s gross domestic product (GDP) growth in the March quarter at 7.8% fell below expectations, it is still too early to call a near-end to the Reserve Bank of India’s rate-tightening cycle, with inflation above 8% remaining the main policy concern, Singapore-based Leif Lybecker Eskesen, chief economist for India at Hongkong and Shanghai Banking Corp. Ltd, wrote in a 31 May note.

Historically, the rise in policy rates have had a delayed impact on corporate profitability and there is no reason to believe that this time will be different, said Saurabh Mukherjea, head of equities at Ambit Capital Pvt. Ltd.

High input costs and the slowing economic growth rate mean that firms will find it increasingly difficult to pass on rising input costs and maintain margins. Most economists expect GDP growth to be less than 8% in fiscal 2012.

Earnings downgrade

Many analysts have already cut earnings estimates for fiscal 2012 and say that there could be further 2-3% cuts in the offing as the delayed impact of rising policy rates, wage inflation and a slowdown in demand arising out of slower growth take effect in the coming quarters.

Consensus estimate for earnings per share (EPS) of Sensex firms for fiscal 2012 has slid down to 1,244 per share from 1,260 per share just ahead of the earnings season, according to Bloomberg data.

A downward revision to earnings estimates is likely to continue as the reduction in profit growth arising from a demand slowdown will take longer to get built into the estimates, said a 1 June note by Rakesh Arora, head of research at Macquarie Capital Securities India (Pvt.) Ltd. The Sensex EPS is likely to be around 1,225 for fiscal 2012, the note added.

In fiscal 2011, profits of Sensex firms grew 10% after a 15% profit growth in fiscal 2010. The Mint earnings analysis excluded earnings from operations of subsidiaries.

The consolidated numbers of Sensex firms, which most brokerages track, have also seen slower growth. The Sensex EPS grew by around 16% in fiscal 2011 after rising 26% in fiscal 2010, according to estimates by Religare Capital Markets Ltd.

About half the profit growth of Sensex firms came from overseas operations last year, according to Tirthankar Patnaik, strategist at Religare Capital Markets. That and the fact that one-third of Sensex firms are commodity-based may help them protect margins to some extent, Patnaik said.

While valuations appear reasonable now with Indian markets trading at 14.5 times forward earnings, continuing concerns about a slowdown mean that the market may need to consolidate before it moves up, wrote Arora of Macquarie in his note.

“Consumption seems to be slowing down a bit and the investment cycle is yet to pick up, reflected in very low demand growth in cement and steel over the last few months," he said. “In our view, the market needs to consolidate at the current levels before it can move up, but another 7-8% dip can’t be ruled out."

Graphic by Ahmed Raza Khan/Mint