India earnings surprise market, but headwinds seen ahead

India earnings surprise market, but headwinds seen ahead

Mumbai / New Delhi: Indian companies reported better profits than expected in the June quarter, but revenue remained subdued amid weak demand and analysts cautioned that inflationary pressures in the coming quarters could erode cost benefits that have aided earnings.

Among 66 companies surveyed, nearly four out of five posted better-than-expected profits in the most recently completed quarter, while only half of them have beaten sales forecasts, according to Reuters polls.

Banks have made especially handsome profits, largely on treasury gains. For cement and consumer goods makers, lower input costs have bumped up profits on modest sales increases. At drug firms, the firming rupee has pushed up values of forex hedges.

“This entire quarter is a story of cost-cutting because if you look at the net profit perspective it is almost among the best amongst the past seven quarters," said V.K. Sharma, head of research at Anagram Stock Broking. “But if you look at it from the sales point of view it has been the worst."

“This trend will at the most continue for one quarter but once inflation raises its head, more or less between September to December, then things have to be looked at differently."

So far, investors have cheered the results, with the Sensex rising nearly 14% since it opened on 10 July when IT bellwether Infosys Technologies kicked-off the season with a forecast-topping 17% rise in profit.

Companies have benefited from a drop in raw material costs, interest costs and staff expenses as well as from the government’s stimulus measures like cuts in factory gate duties.

“It’s only because of the one-time advantage of raw material costs," said Jayesh Shroff, a fund manager at SBI Mutual Fund, which manages $7 billion. “I don’t know how sustainable it is."

Demand has slowly returned in the economy, spreading beyond rural areas which had shored up consumption when the financial crisis had pinched urban pockets. But the recovery is moving slowly and challenges loom ahead.

For example, steel demand, a key gauge of economic activity, is unlikely to outstrip supply, the chief of India’s top steel maker SAIL said on Thursday.

Sales of trucks, which track trade and freight activity, continue to fall, and industry officials say it will be a long time before volumes pick up.

Car sales, a barometer of consumer confidence, have risen in recent months, but the industry lobby has said it is worried about a flattening pace of growth month-on-month.

Monsoon woes

India’s monsoon rains, crucial for farm output and rural demand, have been short of normal this season. On Monday, the central bank said incipient signs of inflation could be intensified if the weak monsoon rains hit agricultural growth.

“We will have to keep our fingers crossed in the next two weeks because this is when the story will unfold," said Arun Kejriwal, strategist at Kris Research.

“If the monsoon makes it then it’s good. And if it doesn’t make it, then we are in for some real bad times."

The outlook for demand growth is uncertain, although analysts said the worst is over.

“Cost is going to be on a rising curve and if that does not result in to higher demand then we will have cost-related pressures into the books of the companies," Deven Choksey, chief executive at brokerage KR Choksey, said.

Some analysts said share prices are running ahead of earnings growth, and could trend downwards after the season has ended.

“Markets are slightly overpriced at this juncture," Ambareesh Baliga, vice president at Karvy Stock Broking, said. “

Indian stocks trade at around 17.5 times one-year forward earnings, lower than valuations for the main indexes in Shanghai and Hong Kong but well above levels in Brazil, Russia, South Korea and Indonesia.

“The expectation bar has moved up," Baliga said.“Now it’s got to be seen if going ahead they can keep up that pace."