The June quarter corporate results for Indian companies were not expected to be anything to write home about. Nor have they been. The only consolation is there has been some improvement from the March quarter, mirroring the sighting of green shoots in the economy.
For instance, according to the Centre for Monitoring Indian Economy (CMIE) database, the June quarter results of 3,160 non-financial companies show an increase of 5.7% in operating profit and 2.8% in reported net profit when compared with a year ago. That may not seem much, but we have to consider that both operating and net profits contracted sharply in the preceding two quarters. Indeed, the contraction in net profit from the year-ago period was as much as 30% in the March 2015 quarter and 39% in the December 2014 quarter, according to the CMIE database; so there’s no doubt that there has been an improvement.
Sales growth, however, continued to be negative, compared with a year ago, albeit a bit less negative than it was in the preceding two quarters. That obviously means profitability has improved. Operating margin in the June quarter for this sample of 3,160 companies was 14.88%, well above the March quarter’s 12.95% (the March-quarter figure is based on a sample of 3,387 non-financial companies). As a matter of fact, operating margins during the June quarter were the highest since September 2010. Interestingly, this improvement wasn’t all due to lower raw material costs—the cost of raw materials and stores and spares as a percentage of sales was very low at 40% in the June quarter, but it was slightly higher than the March quarter’s 39.5%. For manufacturing companies, however, this yardstick was the lowest in a long time, reflecting the fall in commodity prices. Companies also kept a tight leash on other expenses.
Indeed, a CLSA note on India market strategy dated 18 August, on the June quarter results, was titled “Margin expansion visible". The brokerage says Ebitda (earnings before interest, taxes, depreciation and amortization) margin improvement was better than expected and was visible across quite a few domestic sectors. CLSA believes the best is yet to come in terms of lower raw material prices and companies will see more benefits in future. Note though that the public sector oil companies contributed hugely to the margin improvement.
Companies’ financial conditions also seem to have improved slightly in the June quarter. That is seen from interest expenses being a bit lower, as a percentage of operating profit. The interest cover, too, has moved up, indicating more leeway for companies to meet their finance costs. Among banks though, asset quality concerns continue.
But then, the turnaround in the economy has been expected for quite some time now. Note that, in spite of the improvements mentioned, analysts’ earnings estimates have on the whole been revised downwards during the June quarter results season. The CLSA note says FY16 and FY17 earnings for the companies that make up the Sensex have seen downgrades of 2.8% and 2.6%, respectively, since 1 July. A Bank of America Merrill Lynch report on India Equity Strategy dated 17 August says it expects a further reduction in FY16 earnings growth for the Sensex companies, to around 12%. Similarly. the CLSA note says, “We believe that the risk of more earnings downgrades exists in capex cycle plays viz. capital goods, cement, PSU banks etc."
A recent earnings report by Barclays says, “All sectors, barring energy and telecoms, have seen downgrades to FY16E earnings since the start of the current quarter." Analysts, of course, have a bias towards rosy estimates.
Nevertheless, in spite of the earnings downgrades, the lack of growth in revenue and few positive earnings surprises, the market has remained more or less flat through the earnings season. The Indian market continues to be one of the best performing emerging markets this year.
And that has happened despite the recent Parliament session dashing reform hopes for the near future, in spite of exports being in the doldrums and pervasive excess capacity not holding out much hope for a speedy revival in capex. The monsoon, too, has been playing hide-and-seek. The rupee has started to slip and Moody’s has recently lowered its estimate of gross domestic product, or GDP, growth for India. But there has been some improvement in industrial production and the survey-based purchasing managers’ indices show an uptick. More importantly, inflation is very low and a rate cut by the central bank is a distinct possibility. That should hike consumption, at least urban consumption, which will also get a big boost from the Seventh Pay Commission award. Brokerage reports are full of optimism on this front.
The point is that as long as liquidity continues to be abundant, it has to go somewhere. India is at least growing, which is more than can be said of most parts of the world. And in the current global environment, a bit of growth goes a long way. Note that the MSCI index for the euro zone is up more, in dollar terms, than MSCI India this year. In fact, developed markets are doing much better than emerging markets.
The Bank of America Merrill Lynch survey of fund managers for August points out that investors are now underweight emerging markets by the greatest margin ever. The proportion of fund managers underweight emerging markets is now more than during the Lehman crisis, thanks largely to the volatility in the Chinese stock markets and now in the currency as well.
Yet, India is still the investors’ favourite among emerging markets, supported by hopes of the long-awaited recovery and it’s interesting that in spite of all the pessimism about emerging markets, the number of Asia-Pacific investors overweight India has increased this month. That should cushion any downside due to much-anticipated raising of interest rates by the US Federal Reserve.