The financial results for the quarter ended June raise some doubts about the “India growth story". Analysts at Citigroup Investment Research and Analysis point out in an interesting earnings review report that foreign subsidiaries of Indian firms contributed 80% of the growth in net profit last quarter. Just two foreign subsidiaries, Hindalco Industries Ltd’s US-based unit Novelis Inc. and Tata Motor Ltd’s UK unit Jaguar Land Rover, accounted for as much as 40% of the total growth in profit last quarter.

So while the reported earnings growth of Sensex companies (excluding oil) looks impressive at 34.4%, growth in “domestic only" earnings is weak at 7.5%. Note that last year’s June quarter represented a low base, since the pick-up in the Indian economy was still gathering steam. While revenue growth was healthy, margins shrank owing to higher commodity prices.

Also See Losing Steam (Graphic)

The Citi report also points out this is the second quarter running that it had over-estimated earnings. It had estimated earnings growth of 13% for Sensex ex-oil companies, while reported growth was just 7.5%. In the March quarter, it had estimated growth of 30%, while reported growth was just 21%. The analysts note that such earnings misses were historically not a problem in the Indian market.

Importantly, while foreign subsidiaries drove growth last quarter, total earnings from these firms accounted for a small fraction of total Sensex ex-oil earnings for the quarter. As Citi’s analysts point out, this makes it an extreme quarter. In other words, last quarter’s growth is not sustainable—foreign subsidiaries won’t continue to drive growth in the coming quarters. The year-ago June quarter represented an extremely low base for developed economies such as the US and Europe, and earnings were bound to rise sharply for companies with operations in those companies. Some firms such as Corus ran losses in the year-ago period, and reported a sharp jump in profit, thanks to higher commodity prices. This trend will be sustained, at best, for another quarter, after which the low base effect will disappear.

The Citi reports disconcertingly states that with profit momentum being fuelled by commodity-based/cyclical foreign subsidiaries, India’s domestic growth/valuation premium could well be challenged. Between mid-July and early August, it had seemed like weak results were affecting valuations of Indian stocks, what with the MSCI India index underperforming the MSCI Emerging Markets index by around 4%. But since then, the MSCI India index has recouped some of those losses and its level of underperformance since the results season began in mid-July is only around 2%. There is clearly a case for a sharper correction.

Graphic by Ahmed Raza Khan/Mint

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