Expect more earnings downgrades for India Inc
That revenues for the Sensex set of companies fell for the fourth consecutive quarter, in the three months to September—the first time in history—is evidence of what shape the country’s top corporations are in. To be sure, top-lines have come off primarily—the fall was 7.5% y-o-y in Q2FY16—because of the steep fall in the prices of commodities; it must be recalled that prices of crude oil, metals and other such items had just started trending down in the July-September period of 2014. But even non-commodity players—auto producers, makers of engineering goods, FMCG firms and telcos—aren’t able to rustle up revenues easily in an environment where demand is weak. So, Hindustan Unilever is dropping prices to ensure it is able to push volumes; consumer staples’ volumes grew by low single-digit levels in Q2FY16, much as what has happened for two quarters now, though trends differ across categories. Also, companies are spending more on advertising and promotions as they attempt to defend market-shares in a low-growth and competitive environment; Asian Paints, whose volumes are estimated to have grown by just 5%, has been selling more of the less-expensive products as consumers downtrade. Meanwhile, both car and two-wheeler companies have been offering discounts to woo customers.
But while consumers can be coaxed to buy, it is a lot harder for producers of capital goods, who aren’t able to grow their businesses because companies aren’t ready to grow theirs. Revenues of manufacturers of industrial goods grew by about 8% y-o-y, but that may not sustain. That Larsen & Toubro should need to trim its guidance for both order inflows and revenues is unfortunate; it merely shows how reluctant companies are to invest in new capacity. They cannot be blamed because the fact that there is enough of a surplus going, and very little sign that this will be used up in the near future. Even if they were to assume demand would revive in the next couple of years, and some fresh capacity might come in handy, they are hamstrung by the large amounts of debt on their balance sheets and the inability raise equity capital. As such, investment activity will remain subdued as reflected in a drop in order inflows and slow execution in projects which are stalled for want of land or fuel. It is, therefore, not surprising that the supply of materials such as cement continues to outstrip demand—capacity utilisation is estimated at 71%.
Against this backdrop, it is not surprising corporate results have been mediocre; if the Sensex set of companies reported only a 2.4% y-o-y fall in profits, it was merely because several bottom-lines were supported by exceptional receipts, else the fall would have been bigger. Going by the fresh slippages at banks, a whole host of companies, both large and small, remain stressed suggesting cash flows will remain under pressure. As the base effect for commodity prices begins to wear off over the next couple of quarters, gains from expanding gross margins will stop kicking in. Unless, of course, there is an uptick in demand that drives up revenues. That seems unlikely at least for another six to eight months given not too many jobs are being created. While urban consumption may get a bit of a lift following salary increases for government employees, that may not sustain. For consumption to see a meaningful recovery, rural incomes need to rise. With neither investment nor consumption really driving the economy, corporate earnings are likely to remain subdued for a few more quarters.