Markets push up share prices before fundamentals justify if rates have peaked, the economy can't do worse
Over 800 companies including a majority of top corporates have declared their Q1, 2012-13 results. Topline (revenue) growth has been reasonable at 17 per cent in comparison to Q1, 2011-12. There’s a big 21 per cent ‘other income’ component. Operating margins are reasonable at around 34 per cent but interest costs have risen 30 per cent and now stand at over 17 per cent of revenue.
Bottomline (net profit) growth is just below 10 per cent. In fact, majority of corporates have registered lower than 10 per cent growth in net profits. A relatively small group has generated the bulk of the profits.
Several trends are visible. One is that many corporates have tried to pad their bottomline cosmetically, by generating other income. Another is that interest costs have eroded India Inc’s net margins. Quite a lot of that other income is non-recurring in nature so the net profit growth, paltry as it looks, may be unsustainable as well. In certain cases, such as Larsen & Toubro (L&T), the order-book has declined although current growth and margins remain respectable.
Now, try looking at those results in the light of inflation. Between April-June 2011 and April-June 2012, the wholesale price index rose by almost 9 per cent. Discounting the WPI’s effects on growth, very few companies have actually beaten inflation. During this period, government securities have offered yields of above 8.5 per cent and bank fixed deposits have offered about 50-100 basis points more than treasuries. Most corporate loans have been accessed at interest rates running at above 12.5 per cent. Entrepreneurs must be wondering why they bother running a business in the current environment. In fact, many corporates have gone slow on investing in capacity expansion and sitting on their cash.
Three or four sectors have delivered good results, however. Banks, IT, Cement and FMCG are a few big sectors that have done really well and there are smaller performers like agro-chemicals. Looking a little closer, FMCG is riding on the excellent performance of Hindustan Unilever (HUL).
The sector won’t do badly in coming quarters but the Q1 jump in profits (where HUL provided the major impetus) is unlikely to be repeated. IT is riding on a weak rupee and if global growth slows any further, even that may not be enough to shore things up. In agro-chem, Bayer Crop Sciences and Excel Crop Care seem to be the major performers.
Cement appears to be a sustainable trend across the industry. As a whole, the sector has improved its performances over the past three quarters. This is amazing given that construction, infrastructure and real estate (all key consumers) are doing poorly. Prism Cement has seen a turnaround, while ACC, Ambuja Cement have both done well.
Banking shows a divide. The results overall are better than expected. But private sector banks have done better as a whole. They have fewer NPAs, at the gross level and much less in the way of exposure to restructured corporate debt. It’s a moot point how long banks can maintain current net interest margins (NIMs). Credit growth is average.
Many banks will follow SBI’s lead and cut rates to try and drive offtake.
The more recent macro-trends suggest that the global slowdown also continues. Exports have dropped 5 per cent in June, and about 1.7 per cent for the quarter. Imports have slumped even more, reducing the trade gap from $46 billion in Q1, 2011-12 to $40 billion in Q1, 2012-13. This was at least partially because international crude prices eased.
Extrapolating from the past three quarters, it’s clear that India Inc will not be able to improve its earnings much until interest rates start coming down, at the very least. The RBI’s latest Credit Policy pretty much knocks on the head any hopes of that happening in Q2. The central bank has acknowledged the effects of high rates by cutting GDP projections.
This leaves one with an interesting situation as a long-term investor. There are many intrinsically sound, cyclical businesses currently in a depressed state. Sectors such as automobiles, auto-ancillaries, capital goods, infrastructure providers, and so on, are performing well under the ‘trend rate’. When they bounce, they will probably bounce spectacularly. But when will that be?
Instinct says wait a little longer before investing in downtrending sectors because the economy hasn’t bottomed yet. However, it is also true that markets can anticipate cyclical upticks and push share prices up long before the fundamentals apparently justify it. If rates have hit their peak, the economy can’t do much worse even if things don’t get better. It’s a difficult call to make. Waiting could be wrong.
In the 1990s, the trading community started relying on the “Greenspan Put”. Every time there was a crisis, Greenspan, then chairman of the US Federal ...