Why India Inc's record-high Q3 earnings are misleading

Gains largely from lower operating costs, higher product prices and a decline in banks’ provisions.

India Inc’s quarterly net profit reached a record high of Rs 1.64 trillion in the third quarter ended December 31, 2020, mainly due to gains from higher commodity prices and a big swing in banks' earnings.

The combined net profit of 3,323 listed companies that have declared results so far was up 68.6 per cent year-on-year (YoY).

In comparison, earnings were up six times (534 per cent) in the second quarter and 6.5 per cent in the corresponding period last year.

Most of the gains in corporate earnings came from lower operating costs, higher product prices — especially industrial commodities — and a sharp decline in banks’ provisions for bad loans.

The combined net sales of these companies, including lenders' interest income, was up just 1.2 per cent YoY during the quarter -- only slightly better than the 3.9 per cent YoY decline reported in the June-September 2020 quarter.

This was the first quarter of top line growth for India Inc after five consecutive quarters of decline.

Sectorally, the biggest gains in earnings were reported by banks, metals & mining companies, cement makers, oil & gas majors, and mobile operators.

The record-high earnings in the third quarter are, however, misleading as earnings on a trailing 12-month basis and earnings per share (EPS) remain well below the previous high.

The companies reported a net profit of Rs 3.27 trillion on a trailing 12-month basis in Q3FY21 against Rs 3.39 trillion a year ago and an all-time high of Rs 4.44 trillion in the March 2017 quarter.

This is important as trailing 12-month profits are used to calculate EPS and their price-to-earnings multiples.

Also, the V-shaped recovery in the overall earnings is not representative of entire India Inc as a handful of companies account for a lion’s share of the incremental growth in earnings in the third quarter.

YES Bank, for example, alone accounted for nearly 18 per cent of the YoY swing in India Inc earnings in the third quarter.

YES Bank had reported a net loss of Rs 18,560 crore in Q3FY20 that turned into a net profit of Rs 151 crore in the current quarter.

Other companies with large exceptional swing in earnings include Reliance Communications, Indian Overseas Bank, IDBI Bank, Jaypee Power Ventures, Bank of Baroda, Indian Oil, Vodafone Idea and Bharti Airtel.

While banks gained from a sharp dip in provisioning for bad loans, others reported one-time gains from asset sales or gains from inventory.

Excluding these, combined net profit growth works out to a modest 10 per cent in Q3FY21.

India Inc also gained from a sharp decline in raw materials and energy cost resulting in an expansion in operating margins.

The operating margins of mainline (ex-banks & finance) reached a record high of 19.7 per cent of net sales in Q3FY21, up 400 basis points on Y-o-Y basis.

One basis point is one-hundredth of a per cent.

The bottom line was also boosted by a decline in interest rates.

India Inc’s combined interest cost was down 2 per cent Y-o-Y in Q3FY21 and interest burden on revenues (interest to net sales ratio) declined to a seven-quarter low of 12.4 per cent.

Analysts said a slow pace of recovery in the top line and the recent rise in commodity and energy prices have raised some concerns about the sustainability of the earnings.