Q2 results analysis: Lack of pricing power, high costs squeeze profit margins

The endless wait for corporate earnings recovery continued in the September quarter, as costly inputs, rising interest rates and a lack of pricing power combined to squeeze profits at some of India’s largest companies.

According to Mint research, adjusted net profit of 119 companies in the BSE 200 index grew at 7.97% from the year-ago quarter, the slowest in a year. Financials and energy companies were excluded as they follow a different earnings model. The analysis excluded extraordinary profit and loss items.

Revenues grew 14.1% from a year ago, slower than the 16.9% growth in the preceding quarter. In the September quarter of 2017, adjusted net profit and revenue were up 5.52% and 10.45%, respectively.

“This is not surprising at all. It boils down to the fact that pricing power is missing,” said Dhananjay Sinha, head of research at Emkay Global Financial Services Ltd. He added that costlier raw materials and a depreciating rupee have been hurting importers.

Aggregate raw material cost of these companies in the September quarter rose 16.8% to its highest in at least 17 quarters. The net profit margin stood at 9.32%, the narrowest in 12 quarters.

“There is a very clear trend that revenue growth is much healthier than profit growth, because of input costs pressures, mainly because of crude price-related damage,” said Gaurav Dua, head of research at Sharekhan by BNP Paribas.

Crude oil prices rose 23.7% since the start of 2018 to the end of September quarter. They are currently down 22.8% from their 2018 peak of $86.29 per barrel seen on 3 October.

Despite the recent decline in crude prices, margin pressures are expected to continue, since interest costs are edging up.

“The cost pressures, if we include interest costs, I think have not fully reflected in P&L,” said Mahesh Nandurkar, India strategist at brokerage CLSA. Banks have recently hiked their MCLRs (marginal cost of funds based lending rate) and bond yields have risen as well. Interest costs for the September quarter for the 119 companies were up 17.4%, their highest pace since the quarter ended December 2016. “At the core, earnings are not really growing much. Higher costs and lack of pricing power is hurting. We are in a modest profit growth zone for a long time, roughly 10 years now,” said Sinha.

The scenario is not seen improving any time soon.

“This trend will continue for a while due to constraints arising from demand scenario and lack of increase in productivity of capital. The pricing power is also missing. These are structural issues,” said Sinha. “The new normal is much lower. The best-case scenario looks like 8-10% earnings growth for the next few years,” he added.

Others shared the view.

“September quarter earnings are quite disappointing,” Nandurkar told reporters on 14 November at the CLSA India Forum. “From the bottom-up perspective, earnings downgrades are persisting. In fact, in the last quarter, we saw one of the largest earnings downgrade in the last 11-12 quarters. That trend still continues,” added Nandurkar. However, a large part of that is associated with larger provisioning of the banking sector and not really an increase in non-performing loans, Nandurkar said.

Dua of Sharekhan said consensus earnings for the Sensex were cut down by 4-5% for FY19 and 2-2.5% for FY20.

ami.s@livemint.com