Low demand eats into input cost benefits

Core operating margins in July-Sept quarter down 165 basis points, sequentially

A slowdown in demand stole the benefits of lower commodity prices in the July-September quarter this year, with companies struggling to push volumes in a tepid market and finding their margins declining sharply.

The gains from the global crash in commodity and energy prices seem to have ended, as poor volume growth raised the burden of overheads and fixed costs, including interest and depreciation.

Core operating margins during the July-September quarter was down 165 basis points on a sequential basis (quarter-on-quarter) and 34 basis points on a year-on-year (y-o-y) basis. The core operating margin (excluding other income) declined to 13.7 per cent in the quarter, down from 15.4 per cent in the June quarter and 14.1 per cent during the second quarter of previous financial year.

Raw material intensity for companies (excluding financials and energy) was at a four-year low during the second quarter. Raw material costs declined to Rs 31.50 for every Rs 100 of revenues in the quarter from Rs 32.4 in the first quarter and Rs 34.1 a year ago. At its peak, around four years ago, the corresponding ratio was 37.5.

The analysis is based on the previous 16 quarters' results for 2,297 companies, excluding banks, non-banking finance companies, brokerages and oil and gas companies. The sample also excludes Vedanta and Piramal Healthcare that went through corporate reorganisation recently. It would not be correct to compare their financials across quarters, said experts.

Combined net sales for the sample was up 1.6 per cent on y-o-y basis in the second quarter - and fifth consecutive quarter of single-digit revenue growth. However, it was marginally better than 1.5 per cent y-o-y growth reported in the first quarter.

Net profit was down for a third consecutive quarter though the pace of decline moderated, thanks to a sharp rise in non-core earnings - other incomes, foreign exchange gains and tax reversals. The combined net profit (adjusted for extraordinary gains) was down 0.4 per cent, an improvement from 2.9 per cent decline reported in the first quarter of the current financial year.

It could have been worse as core-operating profit (excluding other income) was down seven per cent on y-o-y basis during the quarter against 1.3 per cent growth in the previous quarter.

The blow was cushioned by a sharp 33 per cent y-o-y jump in other income as companies reported currency gains and tax reversals during the quarter.

"Anecdotal evidence in sectors such as consumer goods suggests that manufacturers have begun to offer discounts and freebies to push-up volume growth. For example in the FMCG sector, most companies reported a faster growth in underlying volumes than revenues, suggesting price cuts. The trend will only intensify if the slowdown persists," said Dhananjay Sinha, head, institutional equity, Emkay Global Financial Services.

Others blame it on the differential impact of global commodity crash on Indian corporates. "The growth continued to be marred by a fall in global commodities and delay in recovery of domestic economy," wrote the Motilal Oswal Research team in their earnings preview for the second quarter. While the former is pulling down growth and profitability in global cyclical (metals and energy producers), the latter is hitting earnings in capital goods, construction and infrastructure and public sector banks.

On the one hand, small and medium sized companies (small and mid-cap companies) reported better profitability than bigger companies (large-caps). The combined adjusted net profit of BSE 500 companies excluding Nifty 50 was up 3.6 per cent on a y-o-y basis in the second quarter against 3.2 per cent decline reported by 33 Nifty companies in our sample.

Nifty companies however grew faster with 3.5 per cent y-o-y growth in net sales compared to 1.1 per cent growth reported by BSE 500 companies ex-Nifty. Experts blame it on a bigger presence of global cyclicals such as metal producers and Tata Motors in the Nifty universe.

Demand slowdown is widespread with companies across key sectors of the economy such as FMCG, pharma, telecom, financial services, metals & mining, capital goods, infrastructure and energy reporting a further moderation in growth over the previous quarter. Automobiles, power and IT companies were exceptions with a sequential improvement in revenue and profit growth.

All hopes are now on a public investment led demand growth in the second half of the current fiscal. "The government has front-loaded a part of the public investment especially in the highway sector. There is a hope that it will provide some support to the demand in the second half of the fiscal but we are keeping our fingers crossed given the lag effect of big ticket public investment," added Sinha.

Earnings in the second half of FY16 may also get a boost from base effect as the current slowdown manifests itself during the October-December 2014 quarter. This will provide some ammunition to bulls on Dalal Street who remain committed to the rally despite the growing gulf between stock valuations and underlying corporate earnings.