
Early birds warn of a stressful Q3

Summary
- Initial earnings point to weakening demand in the December quarter, following lacklustre consumer spending in Q2.
A worrying trend is emerging for India Inc. as the third-quarter results trickle in. Initial earnings suggest demand worsened in the three months through December, suggesting consumers further cut back on spending after a tepid second quarter.
A Mint analysis of the first 200 companies that have declared their results shows a 1.5% year-on-year drop in their topline. That contrasts with the 9% annual revenue growth these companies reported in the September quarter. Sequentially, revenue contracted nearly 7%.
Consumption had slowed in the second quarter ended September due to minimal government spending, sticky inflation and sluggish wage growth—reflected in India’s GDP expansion cooling to a seven-quarter low of 5.4% in Q2. Investors hoped for a rebound during the festive and wedding season, but early numbers portend little relief ahead.
“After Q2, (performance) expectations are not very high in Q3. Earnings are generally expected to grow mid-single digits this season," said Hari Shyamsunder, vice president and senior institutional portfolio manager at Franklin Templeton Mutual Fund. “If earnings per share downgrades remain low, the market will gain more confidence on the sustainability of earnings going ahead."
The banking, financial services, and insurance (BFSI) sector, which has long served as a reliable anchor for the corporate sector during uncertainty, is showing signs of distress.
The topline for the BFSI cohort fell nearly 10% year-on-year during the quarter, while net profit growth slowed from 19.5% in Q2 to 14.7% in Q3. Banks have been grappling with high costs of deposits, which are impacting their interest income “With systemic loan growth and deposit growth converging at around 11.5% as of December, and net interest margins under pressure from weak Current Account and Savings Account (CASA) growth, the situation for banks remain lacklustre in the near term," highlighted a Nomura Global Markets Research report.
While India’s slower-than-expected GDP growth continues to weigh on consumption, the Reserve Bank of India’s clampdown on unsecured retail loans has also curbed aggregate demand. This moderation in unsecured borrowing, coupled with the return to pre-pandemic spending patterns, has led to a decline in the earnings of BFSI companies in Q3.
Revenue outside the BFSI sector grew around 2% over the previous year, falling to a four-quarter low in the last three months.
Limited margin upside
Despite slowing demand, corporate profits rose at a faster pace of 12% on-year in October-December, compared with a 5.4% growth in the previous three months. Cost-cutting measures amid slowing margin tailwinds led to improved profitability for India Inc. As a result, operating profit margins for companies excluding the BFSI segment increased by 90 basis points (bps) on-year and 400 bps sequentially in Q3. Net profit margins also rose 90 bps both on-year and sequentially.
“Historically, demand and earnings have been tightly correlated; however, India Inc.’s restructuring (costs control, balance sheet improvement) has ensured improvement in margins, despite weak top lines," said a recent Nuvama Institutional Equities report. But the brokerage also pointed out that even though corporate balance sheets are stronger than pre-covid levels, scope for margin improvement remains limited when demand growth is much weaker.
“With inflation remaining strong, the post-covid moderation in raw material prices is disappearing," said Souvik Saha, investment strategist at DSP Mutual Fund. “Discount generated sales volumes in the mass segment and rising input costs are likely to keep profit margins under check in Q3."
Premiumization play
Premiumization continues to offer hope and could support India Inc.’s profitability as margin tailwinds disappear. Shoppers Stop Ltd, with nearly two-thirds of its revenue derived from premium products, saw standalone revenue jump almost 9% on-year (up from 7% and 8% in Q2 and Q1, respectively), even as same-store sales growth plateaued at 4%. The strength of premium discretionary spending also propelled Indian Hotel Co.’s revenue by 30% on-year and boosted its operating margin by 230 bps to 40.9% in Q3.