Cautious optimism

Corporate India has shown enough resilience in the March 2006 quarter. The 965 companies that have so far declared their results have shown better growth in net profit than that in operating profit. The increase in operating profit has in turn been better than the growth in sales. From shareholders' point of view, it's great news. On sales growth of 27.55 per cent in the March 2006 quarter over the corresponding period of the previous year, the growth in operating profit has been slightly better at 27.84 per cent, but the growth in net profit has been a whopping 40.1 per cent.

Sales growth of 27.55 per cent is excellent on its own, making the January-March 2006 period the best performing quarter of FY06. With soaring commodity prices, there has been some pressure on the raw material front, with costs for these 965 companies, going up 25.22 per cent. But this includes companies in the software, financial and logistics sectors, which do not use raw materials. For manufacturing companies, the rise in raw material costs has been higher at 27.12 per cent on sales growth of 23.6 per cent. Nevertheless, the operating profit growth for these companies was 30.14 per cent as the increase in employee costs was just under 15 per cent.

Employee costs have been on the rise too, but not as much for the manufacturing sector. For the entire corporate sector, employee costs have risen 23.31 per cent, less than the rise in raw material costs. But for the top 30 software companies, employee costs have risen 53.42 per cent compared to a 37.55 per cent rise in revenues. Still operating profits grew marginally higher than revenues at 37.93 per cent. Thus, either raw material costs or employee costs -- depending on the nature of business - - have put pressure on operating profit growth, which has been slightly muted. On the other hand, India Inc's net profit growth has been far more impressive, with a tight control on interest costs, which grew only 20.61 per cent, and relatively lower depreciation charges, which went up 19.04 per cent. The increase in taxes has been quite low at just 11.83 per cent, which has pushed up India Inc's bottom line.

While the picture indicates a blockbuster performance, there are a few things investors need to remember. First, software companies, the early birds to announce their results, skew the numbers. Their depreciation costs are low, most of them are debt-free and their taxes are low since they enjoy significant export incentives. Plus, there are companies such as Reliance Industries, BPCL, Kochi Refineries and Bharti Airtel, which have huge pre-tax profits, but their tax outgo as a percentage of pre-tax profits is less than 10 per cent. No wonder then that operating profit margins for the 965 companies have gone up.

No doubt, corporate performance has been impressive in the March 2006 quarter with a little help from other income, which has risen 21.52 per cent. But it is too early to extrapolate this trend to predict that the overall results are going to be equally strong. One still needs to wait for the other index heavyweights such as ITC, L&T, ONGC, Tata Steel and Tata Motors, which are yet to announce results. Also, going forward, the cost pressures, be it on account of raw materials or employees are not going away. In addition, the uptrend in interest rates and higher depreciation charges on account of expansion plans of some companies are not going to result in similar growth in profitability over the next few quarters, unless demand remains strong.