Home / Opinion / Market recovery: A long, torturous affair

The just-concluded earnings season of listed companies in India shows why the economy’s recovery is likely to be a long and torturous affair. The aggregate numbers of large-cap firms show an improvement over the previous quarter but a closer look at the earnings data shows that the improvement is only restricted to a few companies and sectors.

Aggregate net profit margins of 44 Nifty firms for which past data is available rose by 10 basis points (bps) in the September quarter to 12%, according to Capitaline data. One basis point is one-hundredth of a percentage point. The modest recovery in margins has been driven by a sharp rebound in revenues. Net sales for this set of firms grew 10% compared with the year-ago period, after witnessing single-digit growth in the past three quarters. The gains in revenues and margins have been led mostly by export- oriented sectors such as information technology (IT) and pharma that benefited from a cheaper rupee. Barring a handful of private banks and automobile firms, other companies performed as poorly in the September quarter as in the previous three quarters.

The aggregate performance of the manufacturing sector has been the worst in a year. Net profit margins of 26 Nifty manufacturing firms (excluding oil and gas firms that have volatile earnings) shrank 75 bps to 11% in the September quarter. Net profits fell 20% even as net sales grew 1% over the year-ago period for this set of firms. The broader market fared even worse. The net profit margins of 279 manufacturing firms in the BSE-500 universe, for which data for the past five years is available, saw net profit margins drop to a seven-quarter low of 7.8%. Even as net sales of these 279 firms grew at 6% over the year-ago period, double the growth rate in the June quarter, net profits fell by 16%. Profit margins of these firms have been consistently falling over the past two years, and the trend continued in the September quarter.

Rising raw material costs and elevated interest costs have depressed earnings and crimped margins across sectors. The weak rupee benefited exporters but hurt domestic manufacturers who bore the higher cost of input imports. Smaller firms that failed to hedge their currency risks suffered more. Tepid demand has meant they have been forced to absorb most of the cost increases, rather than being able to pass it on to customers.

The weak run of Indian industry does not look likely to end soon. The official factory output numbers in the past few months have been depressingly low. A 5 November report by the Hongkong and Shanghai Banking Corp. Ltd showed that the Purchasing Managers’ Index is still below the water-mark of 50, indicating a contraction in activity. To a large extent, the problems plaguing the industry relate to infrastructural constraints such as power shortages. A sustained industrial revival is unlikely without easing such bottlenecks.

Firms are also seeing a pile-up of inventory, indicating weakening demand. With interest costs expected to rise further, margin pressure will only increase in the coming quarters. While foreign earnings, especially of bigger firms, are likely to compensate for the sluggishness of the domestic economy, a broad-based revival is still far off.

The stock market seems to be acknowledging the bleak prospects of a recovery in the broader market. While key benchmark indices such as the 30-stock Sensex and the 50-stock Nifty have seen gains this year on the back of foreign inflows, smaller stocks have been hammered. Despite a small-cap rally over the past month, year-to-date returns are still negative for these firms. While the Sensex has risen 6% year-to-date, the BSE mid-cap and the BSE small-cap indices have fallen 12% and 18%, respectively, over the same period.

The only sectoral indices to see any gains this year have been those of IT, pharma, consumer goods and automobiles. The rally in even these sectors may be running out of steam. For instance, consumer goods firms are likely to be hit hard by a spike in input costs, and slowing discretionary spending, over the next few quarters. The concentration of foreign ownership in export oriented-firms and sectors tell the same story: of limited expectations from the domestic economy.

The dichotomy in market performance is likely to continue with fund flows favouring companies having sizeable foreign earnings. The latest earnings numbers underline why the broader market remains as vulnerable to a funding shock today as it was before the emerging markets rally began in mid-August.

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