India Inc's sales, profit move in opposite directions

The net sales growth declines 4.4% in September quarter, the second worst in eight years.

The second quarter earnings season is turning out to be a study in contrast.

India Inc's revenues and profits are now moving in opposite directions, thanks to a combination of poor demand and a collapse in global commodity prices. 

For 622 companies whose Q2 numbers were available till Monday morning, net sales were down 4.4 per cent on a year-on-year (y-o-y) basis (second lowest in eight years), while adjusted net profit was up 7.7 per cent, growing at the fastest pace in the last four quarters. 

Falling petroleum products prices is the main reason for the decline in net sales.

If the results of four companies from the oil and gas space - Reliance Industries, Cairn India, MRPL and Petronet LNG - are excluded from the sample, net sales would have gone up by 4.9 per cent over the September 2014 quarter, while net profit would have risen 10.1 per cent. 

For a closer analysis of Q2 results, Business Standard analysed the operations of 505 companies from the real sector (excluding oil and gas and financials).

Their net sales grew 2.4 per cent while net profit was up seven per cent. There is good news at the operational level.

The core-operating margins of these 505 companies (excluding financials and oil & gas sector) reached a 23-quarter high of 18.9 per cent of net sales. 

The previous high was at 20 per cent in the October-December 2009 quarter during the post-Lehman period recovery. 

Margins in the second quarter were up 61 basis points (bps) on y-o-y basis and 12 bps on sequential basis. One basis point is one-hundredth of a per cent. 

Profit growth would have been even higher but for India Inc's rising interest burden. 

Finance cost was one of the fastest growing cost head for companies in the second quarter and was up 10.1 per cent on a y-o-y basis during the quarter, growing at twice the pace of growth in operating profit (up 5.1 per cent). 

Analysts say this data could get worse as most of the top indebted firms in sectors such as metals, power and infrastructure are still to declare their second quarter results (see chart). 

Besides oil prices, falling prices of other commodities too have led to the divergence in net sales growth and net profit growth. India Inc has only passed a part of lower raw material costs to the customers.

"There has been a marked decline in raw material and energy cost especially in the manufacturing sector but companies have passed on only a part of their cost savings to customers. This has expanded their margins and partly explains the divergence. Secondly, a fall in commodity prices has depressed top line for commodity producers pulling down the overall top line growth," said Swati Kulkarni, executive vice-president and fund manager-equities at UTI AMC. 

A similar situation had emerged post the 2008 Lehman crisis when global commodity prices including crude oil had collapsed.

This had led to a record double-digit growth in net profit during 2009-10 despite a tepid top line growth as the chart indicates. 

A fall in commodity prices and resulting price correction in many sectors hide the volume growth and give a misleading picture of the underlying demand growth in the economy.

"A below par top line growth doesn't mean there is no volume growth. It just shows the price effect and most companies across sectors are showing volume growth even if it's in low single digits," Kulkarni added. 

Others, however, say it would be tough for corporates to maintain the current level of profitability unless there is a secular demand growth in the economy.

"Boost from commodity prices would wear off in the next one or two quarters unless demand growth picks up. A sustained rise in earnings requires strong growth in the economy but it looks doubtful at the moment," said a senior analyst with a foreign brokerage, who is not authorised to speak.