1. India Inc makes slow progress

India Inc makes slow progress

With the benefit of softer input prices fading, room for margin expansion limited.

By: | New Delhi | Published: November 7, 2016 6:43 AM
High frequency indicators show demand remains weak and anecdotal evidence suggests the festive season hasn’t seen any fireworks. High frequency indicators show demand remains weak and anecdotal evidence suggests the festive season hasn’t seen any fireworks.

Despite a host of companies having done well India Inc’s performance for the three months to September so far has been less than ordinary. With the benefits of softer commodity prices fading away and revenues growing at a very modest pace, profits remain under pressure. The ratio of raw material costs to sales — for a clutch of 563 companies — fell just 17 basis points in Q2FY17 compared with falls of 282 bps, 192 bps and 484 bps in the previous three quarters. With total expenditure rising after several quarters, the operating profit margin for the sample of 21.5% was the same as in the June quarter though better than in the March and December quarters.

However, analysts believe there is “low possibility of further expansion in gross and ebitda margins given commodity prices have either firmed up or have been steady in the past six months. Zinc prices, for instance, are at five year highs. Moreover, gross and ebitda margins, they point out are already at very high levels; so, for instance at Mahindra &Mahindra, for instance, ebitda margins are expected to go up by just about 10 basis each in the next few years. At HeroMoto, operating margins are estimated to fall in FY18 and FY19 after rising in FY17 to 16.2%. “The question is whether companies will be able to sustain the margins at higher levels of commodity prices and have to reduce margins to grow volumes if economic recovery disappoints,” Kotak Institutional Equities wrote in a report.

High frequency indicators show demand remains weak and anecdotal evidence suggests the festive season hasn’t seen any fireworks. Sales of commercial vehicles (CV) have slowed sharply over the last few months with less-than-anticipated cargo to be ferried. The uptick in demand for trucks in the busy season might be muted, analysts say. Meanwhile, railway freight traffic continues to fall for more than six months now.

Critically, in a sign that industrial growth remains weak, the import of non-gold, non-oil imports has contracted in 12 of the 13 months to September. There are, however, some bright stops — air passenger numbers, for example, continue to trend up as does the production of steel.

However, competitive intensity and a slowing global economy continue to be headwinds. The good monsoon could help boost consumption demand but trends from the core sector suggest sluggishness. Almost all cement companies have fared poorly in Q2FY17. Ambuja Cements reported a 7% y-o-y drop in volumes resulting in a fall in stand-alone revenues of 4% y-o-y and ebitda of 6% y-o-y. ACC reported a 10% y-o-y fall in cement sales, a new low for the company, which has been hard pressed to grow volumes for many years now. With costs rising –freight up 8% y-o-y—the firm saw a drop in ebitda, down 15% y-o-y.

JSW Steel reported average numbers with good volumes but unless steel prices rise meaningfully, profits could be under pressure;Q2Fy17 saw a sequential drop ebitda /tonne following a fall in steel prices. Other firms in the infra sector continue to fare poorly; Adani Power reported weak numbers even though it has accounted for compensatory tariffs which are yet to be finalised. At ABB, while revenues were weak, order inflows were strong, rising 30% y-o-y.

Consumers remain shy of spending on big ticket items. Most housing finance companies have reported a fairly sharp slowdown in disbursements in Q2FY17 to sub-15%. They have also indicated a moderation in the retail segment over the next few quarters. Even HDFC’s disbursements to individuals although good at 20%, was lower than in Q1FY17. Two-wheeler manufacturers are unlikely to post any unusually good sales volumes during the festive season; one player indicated the industry growth would be limited to single digits. Demand in the rural markets remains muted. HUL’s domestic consumer business grew just 2% y-o-y, thanks to a fall of 1% in underlying volumes and weak 1% growth in net operating revenues missed expectations. Analysts estimate earnings for HeroMotocorp’s will grow by just 6% compounded between FY17-FY19 given volumes are likely to grow at this pace during this period.

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