Corporate earnings growth, the critical factor that lured investors from India and abroad, is likely to lose its sheen in the coming months. There are signs that all is not well with India Inc?s earnings and it?s time to take a reality check.
First cut numbers of the last quarter results from 1,900 companies show aggregate sales have grown 25% year-on-year. This is easily one of the best records in the past seven years. But earnings have dipped by 8% on a sequential basis. This means the growth rate of earnings at 14% year-on-year is the lowest recorded in nearly six years. This too would not have happened if the ?other income? factor was not in play.
Other income as a percentage of profits before tax is at a record high of 47%. A Morgan Stanley research report says, ?This probably indicates that companies were investing their excess cash balances in riskier assets, including equities. The yields may have gone higher in FY08 if the quarterly earnings trends are any indication. With the asset markets turning volatile, it is quite likely that the net financial income growth falls in FY09.?
The trend in expense growth has caught up with the sales growth trend. Real efficiency was noticed in the quality of earnings after the second quarter of FY06. Since then, India Inc?s margins were on the climb, purely due to low input cost, high volume penetration and even sheer operational efficiency.
?The bad news is that raw material costs have increased sharply in the last three years. Power & fuel and raw material costs for companies rose from 40.9% of sales to 45.8% of sales in the last five years,? says an HSBC Global Research report. Hence, clearly, had it not been for the other income factor, profitability would have been lower.
India Inc is also getting caught in the commodities squeeze. Usually, a rise in commodity prices triggers a section of the stock market to gain. But in India?s case, the share of commodity companies?excluding oil sector?is only 11.4% of the total market capitalisation, and their earnings are around 19% of the total earnings.
In comparison, commodity companies have 33% share of the market capitalisation in emerging markets and account for 34% of the earnings. The global average is around 20% for both the parameters.
Therefore, given the rate at which inflation is rising, the freewheeling time for India Inc might just be over. Serious cost-cutting measures, as witnessed after the 2001 tech-debacle, could well be round the corner.
Already, many overseas investors have begun seeing India as an expensive investment destination. Credit Suisse sees India and China as the most expensive in the Asian markets and see the Sensex at 13,00 levels.
Adding to this is the political uncertainty. An HSBC Global Markets analysis reckons, ?Political risk is a major reason behind our cautious view on equity markets in the short term; we think sentiment towards Indian markets is not likely to improve in the short term.?