Editorial: Companies in the downturn

In a typical business cycle, one would have expected a downturn to witness an across-the-board softening of both sales and profit growth, the former affected by both smaller volumes and lower prices of goods and services. However, the Indian economy, and for that matter the global economy, is not in a typical business cycle. The supply shock generated by rising prices of oil and other commodities has pushed the inflation rate and the growth rate in opposite directions. The impact of this on corporate performance depends on whether the rising prices of output offset the rising prices of inputs as well as declining volumes. Analysis of the quarterly results of 639 companies, by the Business Standard Research Bureau (reported on Tuesday), highlights the fact that one sector’s threat is another’s opportunity.

 

Sales for the entire sample grew by 34 per cent over the corresponding quarter of last year, significantly faster than the 20 per cent rate of growth achieved in 2007-08. This suggests that rising prices more than offset declining volumes. In contrast, though, net profits for the sample, which had grown by an impressive 38.5 per cent in the corresponding quarter of last year, decelerated to a more mundane 18.4 per cent this year. Clearly, rising input costs made a huge dent in profitability. The net impact of this was to take operating margins down by close to 3 percentage points, to just below 20 per cent. While this reflects weaker performance, the margin numbers are still good enough to inspire confidence about the sustainability of current operations and capacity expansion plans. In short, the aggregate picture shows a downturn, but is not bleak as standard downturns go.

However, the sectoral picture looks quite different. The sharp increase in global commodity prices has been a boon for companies who produce these. Refineries, mining, trading and fertiliser companies (112 in the sample) registered over 50 per cent sales growth and over 40 per cent profit growth. Of course, this means that margins came down somewhat for even these companies, because of a sharp increase in operating costs. The performance of fertiliser companies (9 in the sample) was striking, with an 89 per cent increase in sales and a massive 431 per cent increase in profits. With issue prices remaining fixed, the increase is presumably reflective of increased subsidy payouts. On the refineries front, private refineries have been in the limelight as a consequence of demands that a windfall tax be levied on them because they export all their products. The profit numbers, however, do not indicate any windfalls; Reliance Industries, the largest of the private refiners, increased profits by only 13 per cent over last year. As long as a refiner is buying its crude oil from someone else, its profitability is determined largely by its operating efficiency.

Companies in the sample outside these four sectors performed much more modestly. Sales grew by just about 16 per cent over the previous year, while net profit declined — albeit marginally. Rising input costs and the fluctuations in the exchange rate both took their toll. For these sectors, the business cycle is very real indeed.

Meanwhile, the fact that turnover growth is quite rapid while margins have shrunk suggests that companies are still focusing on growth, even at lower realisation — perhaps because their margins are very high by historical standards and there is room to take a hit on that count in order to keep business coming in. And since a large number of companies are sitting on free cash, it is also likely that they will keep investing for the future, as a result of which investment demand may not show a big drop. What this suggests is that, while companies recognise the fact of the downturn, they are less bleak in their outlook than many have assumed — either because they don’t think the downturn is very serious, or because they have the reserves to ride out the storm.