With economies worldwide shrouded in gloom, a slowdown in India Inc.’s Sep-tember quarter (Q2FY09) earnings was expected. Despite this recalibration, the sharp year-on-year (y-o-y) fall of 26 per cent in net profit for the universe of the BSE 500 companies as against a growth of 28 per cent in the corresponding quarter last year (Q2FY08) appears disturbing. No wonder the Sensex slipped below the psychological barrier of 10,000 in November, dropping by over 20 per cent since September. Markets have evidently factored in this performance in the share price.
However, during tough times every bit of information has to be looked at with a magnifying glass and positives cannot be overlooked. That the oil marketing companies (BPCL, HPCL and Indian Oil Corporation), which suffered a combined loss of Rs 12,000 crore due to huge subsidy burden, have contributed to this significant drop in earnings cannot be ignored. The fate of these oil companies is mired in politics and is beyond economics. So, if we remove these culprits from the list, there is a marginal y-o-y growth of 3.5 per cent in the net profit as against the 30 per cent growth in Q2FY08. Another positive point is that almost half the companies from this list have outperformed the index companies with respect to earnings.
Sales performance for this universe (475 declared results as on 7 November 2008) indicates that the volume of business was strong, resulting in a 37.89 per cent y-o-y growth as against 16 per cent in Q2FY08. However, this BSE 500 Index set of companies (which represents almost 93 per cent of the total market capitalisation on BSE and covers all 20 major industries) reeled under input cost pressure. Rising raw material cost, up by 58 per cent, was a major drag and the ratio of raw material cost to sales shot up to 60 per cent in Q2FY09 (53 per cent in the corresponding period last year). No wonder the operating profit margin (OPM) dipped by 775 basis points (bps) to 17 per cent on a y-o-y basis. The impact of the softening commodity price is yet to be reflected in the performance. Interest cost, however, grew at a much slower pace—37 per cent for Q2FY09 against 49 per cent in Q2FY08.
To get a much clearer picture of how Q2FY09 turned out to be, we analysed the performance of five key sectors that constitute 29 per cent in market capitalisation of the BSE 500 companies—fast-moving consumer goods (FMCG), healthcare, banking, automobile and information technology. Their respective BSE sectoral indices have been used for this analysis.
Fast-moving consumer
Goods (FMCG)
Performance of the BSE FMCG index set of 12 companies shows that spending in consumer goods has not slowed down despite the inflationary trend and the uncertain economic environment. Sales for Q2FY09 has grown 21 per cent y-o-y compared to 16 per cent a year ago. Marico (an OLM stock pick) has outperformed the index with a sales growth of 30 per cent. Close on its heels is Ruchi Soya and Britannia Industries (both OLM stock picks) with sales growth of 28 per cent. United Breweries and Godrej Consumer Products also saw good topline growth, but their net profit slipped significantly.
OPM declined for all companies largely due to pressure on the raw material front. Raw material cost to sales increased to 58 per cent in the latest quarter as against 54 per cent in the corresponding period last year. The impact of the declining commodity price is not reflected in the latest quarter results possibly due to inventories held at higher price levels. But, FMCG companies have been able to restrict the OPM fall to the extent of 161 bps due to cost control measures and price increases. The full impact of the price increases seen over the last few months may have a positive effect on the operating margin in the next quarter. And the impact of lower commodity prices will be felt October (when international commodity index Reuters-CRB dropped the most) onwards.
The adjusted net profit (excluding exceptional income) has grown 6.73 per cent against 1 per cent in Q2FY08. Colgate Palmolive, Dabur India and Marico (part of OLM’s FMCG stock picks) have posted double-digit growth rates, outperforming the BSE FMCG index profit growth. The BSE FMCG index itself was the most stable in terms of holding share price (BSE FMCG index went down 3 per cent y-o-y, while BSE 500 slipped 51.50 per cent y-o-y).
Going forward, one cannot rule out a slowdown in purchasing power and consumer spending, given the uncertain economic environment. However, companies have adopted various methods to tackle this—new product launches, packaging style and strong brand positioning. Companies with a mixed approach—focusing both on rural and urban sectors—are likely to maintain their growth rates. FMCG intake from the rural sector is still around 35 per cent, indicating potential for growth. It would be prudent to watch out for companies with a diverse portfolio basket, especially in those segments that lack substitutes and do not have significant exposure in the premium space.
Healthcare
The BSE Healthcare index witnessed a 28 per cent growth in sales in Q2FY09 as against 13 per cent a year ago. This uptrend can be attributed to steady growth in the domestic market, new product launches in the regulated markets and growth in the contract research and manufacturing services (CRAMS) business.
Rising input cost (up by 14 per cent as against a fall of 5 per cent in Q2FY08) due to a supply crunch of active pharmaceutical ingredients and intermediates in China has affected the sector’s OPM. It slipped 68 bps in the latest quarter, a less severe drop when compared to other sectors.
Many companies from this sector had to suffer due to the losses on account of depreciation of the Indian rupee against the dollar. These companies have high foreign exchange (forex) liabilities in the form of foreign currency convertible bonds (FCCBs). For instance, Ranbaxy Labora-tories suffered a forex loss of Rs 309 crore due to exchange differences on foreign currency borrowings. Aurobindo Pharma incurred a loss of Rs 105.10 crore for similar reasons. Adjusting such forex impact, this index has registered a net profit growth of 12 per cent y-o-y against a 1 per cent growth in Q2FY08. Divi’s Laboratories, Glenmark Pharmaceuticals, Lupin, Opto Circuits, and Sun Pharma-ceuticals have outperformed the BSE Healthcare index in both topline and bottomline growth significantly.
The sector’s long-term growth potential is intact. While pressure on margins may continue, it may see volume-based growth, especially as drugs worth $60 billion will go off patent in the next few years.
Banking
This sector grew at a faster rate than many others in Q2 FY09. The total income for BSE Bankex set of companies was
Even during the high interest rate regime in Q2FY09, the net interest margin (NIM—a profitability measure of banks’ investment decisions) for most banks remained flat compared to Q2FY08. OPM was stable at 16 per cent. Bank of India remained the most profitable (as measured by OPM) bank with a significant growth in its NIM. The asset quality of Indian banks improved significantly. Of 18 companies in the Bankex index, the net non-performing asset of 12 banks improved over the previous quarter.
The recent cuts in cash reserve ratio (CRR), repo rate and statutory liquidity ratio (SLR) will free funds for banks to lend at a higher rate than the one they were receiving by investing in government securities (in case of SLR) or keeping cash idle with RBI (in case of CRR). Also, these rate cuts could lead to declining interest rates amid moderating growth and inflation. All this means more business and higher margins for banks in the coming quarter. The only major concern for the banks in the near term will be commercial loans turning bad in case of slow economic growth.
Automobile
Higher interest rates and raw material costs took their toll on the auto industry. High repo rates and CRR limited the ability of finance companies and banks to finance auto sales, which was the main driver for its volume growth. Sales impact was mixed. Sales volume for cars and commercial vehicles (CVs) was the most affected while two-wheelers escaped the impact (largely due to Hero Honda). Overall, the net sales for the industry grew at 13 per y-o-y in Q2 FY09.
However, the industry’s quarterly expenses grew faster—at 17 per cent compared to 10 per cent during the same period last year. Higher raw material costs ate into the margins of these companies resulting in a 498 bps drop in OPM from Q2 FY08 level. Q2FY09 y-o-y growth in operating profit and net profit was negative at -27 per cent and -18.47 per cent, respectively.
Major players saw a drop in their profit growth over the previous quarter, barring Hero Honda Motors (OLM stock pick) and Bosch. Dismal sales in October and slowdown in production by many major players indicate that their is more pain ahead. CV makers Tata Motors and Ashok Leyland have decided to cut back production. Ashok Leyland is opting for a 3-day week till December, while Tata Motors plans to stop production of CVs in Pune and Lucknow for six days this month. Although the recent CRR and repo rate cuts is a positive step, it will take some time for demand to resume. Meltdown in commodity prices will be a relief to contracting margins.
Information Technology (IT)
The September quarter had mixed news flow for the Indian IT companies. Leading US financial institutions collapsed and many of them were clients of Indian IT companies (Lehman Brothers, for instance, was a client of TCS, Wipro and Satyam). The scenario could have been worse had the rupee not depreciated against dollar leading to higher revenue in rupee terms.
Companies in the BSE IT index registered a cumulative net sales y-o-y growth of 30 per cent in Q2FY09, faster than 22.67 per cent in Q2FY08. Most of the companies reported net sales growth of around 25 per cent, while Satyam Computer Services (OLM stock pick) and MphasiS grew higher than their peers. However, the operating profit growth for the index declined over the same period last year. OPM dipped by 268 bps. Rupee depreciation could have improved the margins for these companies had they not hedged against currency fluctuations at a higher rate. As a result, net profit growth halved to 13 per cent compared to Q2FY08. The crisis in the West will certainly affect the revenues for Indian IT companies. Pressure on the margins will continue as the pricing ability of the companies may get hit.
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