What saved India Inc in Q1?

Succour has come from a drop in international prices of crude oil and commodities

Whenever Dalal Street is in the doldrums for a while, there emerge some events that send the benchmark index soaring again.

After the rupee’s dull run in July-August 2013 had hurt the bulls towards the end of 2013 and early 2014, information technology exporters and pharma companies had come to the rescue.

This time, succour has come from a drop in international prices of crude oil and commodities.

Lower input prices have led to a recovery in corporate earnings, despite subdued demand, keeping hopes alive after a wash-out in the January-March 2015 quarter.

Around 2,300 companies that have declared their June-quarter earnings so far (excluding financial and oil & gas ones) have seen their combined net profit declining three per cent on a year-on-year basis.

This is a sharp improvement from the 10.6 per cent corporate profit decline seen in the previous quarter.

Their combined adjusted net profit (excluding non-recurring gains and exceptional items) stood at Rs 60,322 crore (Rs 603.22 billion) in the June quarter, compared with Rs 62,191 crore (Rs 621.91 billion) in the year-ago period. The sample excludes Sun Pharma and Vedanta, which have seen mergers & acquisitions recently.

The companies in the sample also reported a small improvement in their topline growth, thanks to consumers using part of their savings from lower fuel and energy costs for spending a little more. The companies’ combined net sales rose one per cent to Rs 87.5 lakh crore (Rs 87.5 trillion) in the June quarter.

This was better than 0.1 per cent growth seen in the March quarter of 2014-15.

The improvement was almost entirely led by lower raw material and energy costs. While raw material cost was down 2.3 per cent on a year-on-year basis, power & fuel cost declined 2.6 per cent. India Inc’s raw material intensity declined to a four-year low of 32.6 per cent (of net sales) in the June quarter, compared with a high of 36.8 per cent in the March 2012 quarter.

In other words, every Rs 100 worth of sales now require raw materials worth Rs 32.6, against Rs 33.7 a year ago and Rs 36.8 fours year ago.

The corresponding ratio for energy cost was 6.0 per cent in June this year, against 6.2 per cent a year ago.

This sent operating margins soaring, cushioning the impact of poor demand in the economy.

Core-operating margin (excluding other income) rose to a four-year high of 15.5 per cent of net sales during the quarter, compared with 15.4 per cent in the year-ago period.

Earnings growth was led by the companies that had a major impact of the falling crude oil and commodity prices.

The combined net profit of capital goods makers more than doubled in the June quarter, thanks to a sharp fall in the prices of metals, their key input, despite a contraction in net sales.

Other big beneficiaries were textile makers, which gained from lower cotton and fibre prices; tyre makers, which gained from lower rubber prices; oil refiners, from lower crude oil prices; and makers of alcoholic beverages, from fall in the price of molasses.

On the downside, IT majors  continued to face headwinds from a poor demand and rising wage costs in the April-June period, while top line growth of FMCG companies fell to a four-year low of two per cent.

The question now is: Can lower input costs alone drive corporate earnings in the absence of secular demand growth?

The bulls think they can.

“Given the current trend, lower commodity prices will boost earnings for at least two more quarters; after that, we can expect a revival in demand.

"This keeps me optimistic about the current bull run,” says Devang Mehta, senior vice-president & head of equity sales at Anand Rathi Financial Services.

Some expect a cost-led economic recovery, like the one witnessed after the Lehman crisis of 2008.

“The income that was earlier spent on importing high-cost energy, gold and commodities will now be spent in the domestic economy, boosting demand and economic growth,” says G Chokkalingam, chief executive officer, Equinomics Research & Advisory.

Others are keeping their fingers crossed, waiting for a demand revival in the economy.

“Margin expansion is only visible in the consumer segments where companies have some pricing power.

"But in the business-to-business segment, such as capital goods, IT, metals and cement companies, manufacturers have been forced to pass on the benefits to consumers.

"This might eventually happen in consumer segments as well, if volume growth doesn’t pick up,” says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.

It doesn’t make sense to compare the current episode with the post-Lehman recovery.

“There is no matching fiscal stimulus now and most countries face deflationary pressures. This has led to decline in exports, worsening the demand environment,” Sinha adds.

Image: Students of Swaminarayan Gurukul holds tricolour to mark the celebrations of 69th Independence Day in Ahmedabad. Photograph: PTI