Markets should take cost savings in Q1FY21 with a tinge of scepticism2 min read . Updated: 04 Aug 2020, 10:24 PM IST
Experts say companies may be compelled to eventually reinvest the savings or pass on the benefits to clients and customers for competitive reasons.
As the first-quarter earnings barrels ahead, India Inc.’s Q1 operating profitability is showing surprising resilience. While revenues plunged along expected lines, the remarkable cost-cutting exercises have meant that they lowered the impact on operating profit growth. That’s kept the hopes running high in the market that Indian companies’ sharp cost-cuts could support earnings growth this year.
On that count, the first quarter numbers may be painting an over-optimistic picture. In fact, while revenue growth so far plunged along the expected lines of about 27% for 33 Nifty companies, operating profit growth has not been hit as badly. Due to the relentless savings, operating profit fall was contained to about 1% year-on-year, shows data from Motilal Oswal Financial Services.
In fact, corporates have saved big during the first quarter. The lockdown meant that travel and boarding, advertising and sales promotion costs were cut back. Some corporates even cut back on salaries and other fixed costs such as rentals. Electricity and freight costs were lower for most manufacturing units. But while all this is good for corporate profitability, most of these cost-cuts may not persist when normalcy returns.
In fact, analysts said that cost-cuts may have to be passed on to the clients. “It would be imprudent to extrapolate the cost savings achieved by companies in Q1 in perpetuity as companies may be compelled to eventually reinvest the savings or pass on the benefits to clients and customers for competitive reasons," said Kotak Institutional Equities analysts in a client note.
In the case of pharmaceutical companies, travel and sales promotion costs, which were sharply lower in Q1, are expected to rebound post-covid-19. Some sectors, such as IT, too, have benefited hugely due to lower travel costs. For them, savings in travel costs are unlikely to carry on into the next year. In fact, for IT companies, there is a chance that some of these benefits may have to be passed on to clients when contracts are re-negotiated, said analysts.
Consumer companies have saved considerably on advertising expenditure and sales promotion this quarter. That too is expected to step up gradually in the next few years. “We expect advertising and promotion expenses to gradually recover over FY22-23 as companies compete once again for the mind and market shares," said Kotak analysts. Besides, cement companies benefited from lower freight, power and fuel costs, which could rise once the economy picks up.
Further, analysts said expenses may already start inching up in the forthcoming quarters. Corporate activity has started to pick up during the unlock phases, which will add to the costs in the future. As most of these savings may not persist, the over-optimism on the operating profit front may be unwarranted.