Corporate earnings hit fresh roadblocks in Q1

Flat profit growth in June quarter as consumption takes a knock and exporters continue to struggle

Dalal Street’s hopes of double-digit growth in corporate earnings for the financial year 2017-18 after three years of poor showing look exaggerated, given the weak performance of corporate India during the first quarter of the fiscal year.

The combined net profit (adjusted for exceptional gains or losses) of 1,261 companies — excluding those in the oil and gas, and banking sectors — was up just 0.3 per cent year-on-year (y-o-y) during the April-June 2017 quarter, only a notch better than the 1 per cent decline during the March 2017 quarter.

In comparison, the sample net profit was up 6.3 per cent during the corresponding period a year ago.

The outlook worsened during the quarter with top line growth hitting a six-quarter low. The combined net sales of the sample were up 4.4 per cent on a year-on-year (y-o-y) basis, down from the 10.8 per cent y-o-y during the corresponding quarter a year ago and the 5.5 per cent y-o-y during the fourth quarter of FY17 (see the adjoining charts).

The numbers don’t look pretty for the entire sample, which includes energy and financials, either. The combined net profit of all 1,654 companies was down 0.8 per cent y-o-y during the quarter, growing at the slowest pace in the last four quarters. In comparison, net profit was down 2.7 per cent during the corresponding quarter a year ago and up 12 per cent in the March 2017 quarter. Adjusted profit has been considered because a few big companies — mainly Vedanta, Tata Steel, and Tata Motors — have reported large exceptional gains and losses in the last two years.

Net sales growth decelerated to 8.7 per cent during the quarter against 11.5 per cent during the March 2017 quarter but better than the 3.5 per cent y-o-y growth a year ago.

This is well below what most brokerages had reckoned on at the beginning of this financial year.

For example, the combined net profit of the NSE Nifty 50 companies was expected to grow 26 per cent during FY18. In comparison, the combined net profit of 46 Nifty companies in our sample was flat during the quarter. Most brokerages are now expected to downgrade their earnings expectations.

“Earnings have been well below expectations with contraction in profit growth against earlier expectations of an acceleration. The operating margins have softened, with many sectors showing pricing pressure as volume growth has declined. I expect further downgrades to the forward earnings estimates for benchmark indices such as the Nifty," says Dhananjay Sinha, head of research and strategist, Emkay Global Financial Services.

According to him, the earnings expectations for the next three quarters of FY18 have increased but it may not be possible to compensate for the poor earnings growth of the first quarter.

Others say that the headline numbers underestimate the earnings slowdown in mid- and small-cap companies. “The goods and services tax (GST) disruption has been much greater than anticipated among second- and third-tier companies in many sectors. This may keep earnings growth suppressed for a while,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory. 

The contraction in earnings growth can be attributed to a deceleration in consumption and the poor showing by export-intensive sectors such as information technology (IT) and pharmaceuticals. Consumer-goods companies and auto-makers reported a decline in their top line growth during the quarter because their customers and dealers deferred purchases in the run-up to the GST roll-out on July 1.

This is another shock to consumption after the pain owing to demonetisation in the December 2016 quarter.

The numbers for domestic non-cyclical sectors were adversely impacted due to the GST despite some positive contribution from cement and construction companies. The combined net profit of companies ex-financials, energy, IT, pharma, and metals was down 5.5 per cent y-o-y during the quarter — the worst in the last nine quarters. These companies had seen their net profit rise by 8.3 per cent a year ago and decline by 2 per cent in the previous quarter. Their net sales were up 2.9 per cent, down from the 13.5 per cent y-o-y growth a year ago and 2.4 per cent growth in the previous quarter.

Analysts also doubt the sustainability of growth recovery in the construction and investment-related sectors. "Cement companies largely gained from a favourable base effect and higher realisations but volume growth remains tepid. A mild uptick in revenue growth for construction and engineering firms will run out of steam in the absence of a revival in corporate capex, which is not on the horizon," says Chokkalingam.

IT and pharma companies were the biggest laggards during the quarter, reporting their worst top line and profit growth in nearly three years. Revenues of pharma companies contracted for the second consecutive quarter while their profits halved during the quarter. At their peak these two sectors together accounted for nearly a quarter of corporate profits; their contribution is now down to 18.2 per cent.

The results also highlighted the continued vulnerability of public sector banks (PSBs). Most of them, including the State Bank of India, the country’s largest lender, reported a further surge in their non-performing assets. 

As a result, profits declined further, hitting their ability to make incremental corporate lending. This raises a question on the fate of corporate capex.

Private sector banks and retail lending non-banking finance companies now seem to be the only game in the town for the bulls. These two sectors continued to grow in double digits by stepping into the breach in the market created by the inability of PSBs to make incremental lending.

For example, the combined net profit of the NSE Nifty 50 companies was expected to grow 26 per cent during FY18. In comparison, the combined net profit of 46 Nifty companies in our sample was flat during the quarter. Most brokerages are now expected to downgrade their earnings expectations.

“Earnings have been well below expectations with contraction in profit growth against earlier expectations of an acceleration. The operating margins have softened, with many sectors showing pricing pressure as volume growth has declined. I expect further downgrades to the forward earnings estimates for benchmark indices such as the Nifty," says Dhananjay Sinha, head of research and strategist, Emkay Global Financial Services.

According to him, the earnings expectations for the next three quarters of FY18 have increased but it may not be possible to compensate for the poor earnings growth of the first quarter. Others say that the headline numbers underestimate the earnings slowdown in mid- and small-cap companies. “The goods and services tax (GST) disruption has been much greater than anticipated among second- and third-tier companies in many sectors. This may keep earnings growth suppressed for a while,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory. 

The contraction in earnings growth can be attributed to a deceleration in consumption and the poor showing by export-intensive sectors such as information technology (IT) and pharmaceuticals. Consumer-goods companies and auto-makers reported a decline in their top line growth during the quarter because their customers and dealers deferred purchases in the run-up to the GST roll-out on July 1. This is another shock to consumption after the pain owing to demonetisation in the December 2016 quarter.

The numbers for domestic non-cyclical sectors were adversely impacted due to the GST despite some positive contribution from cement and construction companies. The combined net profit of companies ex-financials, energy, IT, pharma, and metals was down 5.5 per cent y-o-y during the quarter, the worst in the last nine quarters. These firms had seen their net profit rise 8.3 per cent a year ago and decline 2 per cent in the previous quarter. Their net sales were up 2.9 per cent, down from the 13.5 per cent y-o-y growth a year ago and 2.4 per cent growth in the previous quarter.

Analysts also doubt the sustainability of growth recovery in the construction and investment-related sectors. "Cement companies largely gained from a favourable base effect and higher realisations but volume growth remains tepid. A mild uptick in revenue growth for construction and engineering firms will run out of steam in the absence of a revival in corporate capex, which is not on the horizon," says Chokkalingam.

IT and pharma companies were the biggest laggards during the quarter, reporting their worst top line and profit growth in nearly three years. Revenues of pharma companies contracted for the second consecutive quarter while their profits halved during the quarter. At their peak these two sectors together accounted for nearly a quarter of corporate profits; their contribution is now down to 18.2 per cent. The results also highlighted the continued vulnerability of public sector banks (PSBs). Most of them, including the State Bank of India, the country’s largest lender, reported a further surge in their non-performing assets. 

As a result, profits declined further, hitting their ability to make incremental corporate lending. This raises a question on the fate of corporate capex.

Private banks and retail lending NBFCs now seem to be the only game in the town for the bulls. These two sectors continued to grow in double digits by stepping into the breach in the market created by the inability of PSBs to make incremental lending.