Increasing costs

Interest cost is affecting profitability

An examination of the Q4FY23 (January-March 2023) results of some 500 listed companies indicates a slowdown in profitability, though revenues have grown and there are early signs of consumption picking up. Costs have gone up due to inflation. The rising cost of financing and increasing wage bills are all hitting margins. For this overall sample, operating revenues have grown 14 per cent year on year. But operating expenses have also grown 13 per cent while employee-related costs are up 23 per cent and interest costs have risen by a whopping 37 per cent. Operating profits are up 16 per cent, but thanks to high finance costs, net profits are flat — up by a nominal 0.7 per cent.

When volatile sectors such as refineries, banks, and non-banking financial companies (NBFCs) are excluded, the results look worse. Revenues are up 12 per cent but operating profits are down 4 per cent, and net profits are down 11 per cent with interest costs spiralling up 39 per cent. In a sense, this may be a normalisation of economic conditions. FY22 had seen corporate profits rise to 4.3 per cent of gross domestic product, which was a decadal high in ratio terms. This happened on the back of a combination of relatively low inflation, tax cuts, and cost-cutting. The interest-inflation cycle clearly reversed in FY23. The central bank started increasing rates in May 2022, and there’s little flab left for corporations to shed.

Banks incidentally enjoyed a reasonably strong Q4, despite rate hikes. Credit expansion hit 32 per cent and fee-based incomes grew 24 per cent for a sample of 25 listed banks. However, interest costs also rose by 36 per cent as the credit-deposit ratio tightened and banks started to pay more for funding. Adjusted net profits grew by 32 per cent for the sector. NBFCs also did well with 35 per cent growth in net profits. The higher cost of finance indicates deposit rates have risen, which in turn implies monetary conditions will further tighten since banks always raise their deposit rates with a lag. On the consumption front, automobiles and fast-moving consumer goods are considered. The FMCG sector has seen a 22 per cent rise in net sales, with a 35 per cent rise in earnings before interest, taxes, depreciation, and amortisation (EBITDA) and a 36 per cent rise in net profits, despite interest costs rising 39 per cent. The automobile sector has seen an 18 per cent rise in net sales, and a 31 per cent rise in EBITDA along with a 29 per cent rise in net profit. The two-wheeler majors have all delivered enhanced sales and profits. This suggests some revival in consumption.

IT sector results have been in line with corporate advisories, which ranged from “cautious” to “pessimistic”. The slowdown in global growth has impacted their growth and margins. With most of the IT majors having declared results, 17 per cent (constant dollar) growth in revenues has translated into only a 7 per cent rise in net profit. Most public-sector enterprises and many pharma majors have not yet declared results so there could be some changes in the overall story. However, it’s apparent that, while consumer sentiment may have seen an uptick, the twin drags of inflation and higher interest costs are starting to bite into profits.