Companies see rise in sales in Q4, but high input costs hit profits

Growth in net sales was the best in three quarters

MUMBAI: Indian companies reported a pick-up in net sales in a silver lining to corporate performance in the March quarter, but rising material costs crimped their profit growth.

Analysts say it’s difficult to predict a timeline for a significant earnings recovery in light of the upcoming implementation of the goods and services tax (GST), which may disrupt growth in the near term.

A Mint analysis of the earnings of 2,348 companies, for which comparable data is available for 12 quarters, showed that aggregate net sales increased 5.07% from a year ago in the three months to March 31, the best performance in three quarters, and net profits after adjustment for extraordinary items dipped 3.7%.

The analysis excluded extraordinary profit and loss items. Financial and energy companies were excluded from the analysis because they follow a different earnings model.

“Sales growth is far more important, and it is a good sign. Margins have eroded as commodity prices have improved materially, pushing up the input costs,” said Nirav Sheth, head of equities at SBICap Securities Ltd.

“Even as government expenditure is picking up, investment demand shows no momentum. We cannot expect an economy to recover unless the latter gains traction,” added Sheth. Others agree. “Improving sales growth is a silver lining. With demonetisation, there seems to be some substitution of non-organised sector by organised sector,” said Dhananjay Sinha, head of research, Emkay Global Financial Services Ltd.

Net sales at the 50 companies in the National Stock Exchange’s Nifty index rose 14.77% while their adjusted net profit dropped 5.31%. At the 30 companies listed on BSE Ltd’s benchmark Sensex, net sales rose 3.54% and net adjusted profit dropped 4.8%.

Despite a decline in interest rates, the interest coverage ratio (ICR) of companies declined. That’s because even as borrowing costs have come down, company earnings have not moved up commensurately.

The ICR is the ratio of debt and profitability used to measure a firm’s ability to service its debt. The lower the ratio, the more difficult it is for the firm to pay interest.For the sample of 2,348 firms, ICR dropped to 2.62, the lowest in four quarters.

Meanwhile, margins contracted as raw material costs shot up in line with a rebound in commodity prices. In calendar year 2016, the Bloomberg Commodity Index of 22 raw materials, from oil to metals, gained 11.4% and Brent crude oil gained 21.65%.

Even as they erased declined 2.47% and 8.23% respectively in the March quarter, the cost of these commodities to the companies would rise because of the lag impact. “Margins are contracting as input costs are rising, and this trend is likely to continue. Even as demand is improving, it is not enough to capture the rise in costs,” said Sinha of Emkay.

Operating margins for the 2,348 firms under study dipped to 16.31%, the lowest in four quarters. Raw material costs as a percentage of net sales was 36.24%, the most in at least 17 quarters.

The GST, billed as India’s biggest tax reform since Independence in 1947, is likely to be implemented from July 1. That may disrupt corporate earnings growth in the near term.

“It is difficult to predict what will happen once GST is implemented. Overall, we should see better performance in FY18, largely as global economy is doing better but at the same time, Indian pharma and IT (information technology) are taking a hit,” said Sinha, who expects Nifty companies’ net profit to grow by 10% in the year to March 31, 2018.