Genuine cyclical recovery underway

Revenues have grown by about 5% for a sample of 190 companies, with net profit too rising considerably

Results for the March quarter have started pouring in and the initial signs are encouraging. Revenues have grown by about five per cent for a sample of 190 companies that Business Standard examined on Monday. Net profits are also up considerably — about 23 per cent for the sample, ex-financials. The net margin has also risen significantly. But, while the costs of raw materials and finished goods fell considerably, employee costs shot up 44 per cent for this sample. Interest costs rose about 14 per cent, though bank credit remained muted, growing by about 12 per cent.

While this is a small sample, it contained 15 Nifty companies and therefore, it covered a large chunk of the organised workforce. Among others, it also tracked big employers such as Reliance Industries, Tata Consultancy Services, Infosys, Maruti and ITC. This may signal some sort of tightness in terms of employable labour. The rising interest costs, at a time when capex has not expanded much, could also imply some sort of lag in the credit cycle.

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Let's assume the employee costs will mitigate proportionately, as more results come in. However, this trend of rising employee costs was also noted even in Q3. Employee compensation has risen across the board in multiple sectors. So, this may indeed be a genuine trend.

Employee cost is a service sector cost and it is inflationary at two levels. First, businesses will try to pass it on and directly load it into the cost of services and products. Second, a labour force (using the term broadly) which has more money in the pocket will generate more demand, which should push up the costs of goods and services up, as well.

Moreover, this cost (higher employee compensation) will not be captured in any of the inflation indices as they currently stand. That inflationary impact will eventually be captured of course, once it results in generally higher prices for goods and services.

At one level, this may be a good thing in that it could help the economy bootstrap out of a recessive situation where demand has been persistently weak. There is capacity to spare in many sectors so that extra demand could be met without too much trouble. However, at another level, this could result in "invisibly" overheating of the economy. By the time it shows up in the cost of sundry goods and services, inflation may have actually climbed considerably.

Such caveats aside, this seems to be a genuine cyclical recovery. Many of the big winners are part of the commodities value-chain. Steel has made a comeback what with import protection, fertilisers and other petrochemicals have seen a big positive move as raw material costs dropped along with crude and gas prices. Cement has also seen volume offtake rising. The paper industry has also seen an uptrend.

If the normal pattern of cyclical expansion holds, there should be a turnaround for the construction industry because that is the major consumer of cement and steel. Most construction majors have not declared results yet. For what it's worth, construction equipment manufacturers are generally not listed but anecdotal evidence suggests that these firms have also seen a good quarter.

Construction firms are among the most beaten-down of sectors. They have seen shrinking volumes and rising debt levels over the past few years. It's too early to say things with much confidence. But an aggressive trader could start looking at the possibility of major gains in the construction sector.