Demand weak, but Q2 sales up on restocking post GST

Cement, automobiles, select consumer items lead volume growth

MUMBAI: Indian companies reported a slight improvement in the business environment in the September quarter from the preceding three months amid lingering issues surrounding the goods and services tax (GST) and depressed rural demand, a review of the latest earnings reports showed.

Earnings of Indian companies are still to recover fully from the twin effects of the uncertainties surrounding the GST implementation and the shock cash ban that was announced about eight months preceding that.

Restocking of goods by traders and distributors post July 1, when the new indirect tax system came into effect, lifted sales of companies somewhat from the preceding June quarter, when economic growth in Asia’s thirdlargest economy increased at the slowest pace in three years.

Demand in the first few weeks following the implementation of GST was slow as businesses were still adjusting to the new tax system, said Ravi Gopalakrishnan, head of equities, Canara Robeco Mutual Fund.

“The results declared by companies so far have been mixed, but largely around expectations. Volume growth in sectors such as cement, automobiles and select consumer items have been better than expectations, thus translating into better margins,” Gopalakrishnan said.

While a focus on reducing costs in the September quarter has had encouraging results, underlying demand is still weak when compared to the year earlier period, analysts said.

Net sales of 172 BSE-listed companies, which have reported quarterly earnings, rose at a faster pace of 8.55% in the September quarter compared with the 5.84% growth in the preceding three months, data compiled by database provider Capitaline showed. Net profit after adjustment for one-time items of these companies increased 6.09% in the fiscal second quarter from 4.43% in the preceding three months.

In the quarter ended September 30, 2016, net sales of the companies slowed to 9.03%, the lowest in three quarters, while adjusted net profit rose 10.31%. The review excludes banks, financial services firms and energy companies.

Revenue growth still remains subdued for most consumer companies, said Prateek Parikh, an analyst at Edelweiss Securities Ltd. “There is some bounce-back just due to restocking; however, toplines of rural-focused companies in the first half of FY18 remain weak. It’s worth noting that Hindustan Unilever’s average volume growth in the last six quarters (period of normal monsoon) is just 1%,” Parikh added.

In the September quarter, net profit margin of the 172 companies expanded marginally to 14.79%, while operating profit margin widened slightly to 24.46%. Raw material costs of companies also declined in the year so far despite a 6.37% rise in Brent crude prices in 2017.

Analysts say valuations of Indian markets are at elevated levels and earnings downgrades continue. An earnings recovery, they say, will take some more time as GST transition woes will linger on.

Bloomberg data shows Nifty companies’ consensus earnings per share forecast for the current fiscal has been cut by 9.1% since April and for 2018-19, it has been reduced by 4.6%. The 50-share Nifty index trades at 20.9 times 12-months forward earnings, making it one of the most expensive benchmark gauges.

“We believe there could be some more downgrades to earnings. Valuations of Nifty are on the expensive side as of now and unless earnings growth picks up meaningfully, these valuations are not sustainable. We believe earnings revival is still 3-4 quarters away,” said Vinod Karki, vice-president, strategy, ICICI Securities Ltd.

Year to date, the Sensex and Nifty benchmark indices have gained 24-26% while MSCI World and MSCI Emerging Markets have risen 16.18% and 28.76%, respectively.

“While aggregate downgrades could continue, the pace is likely to moderate with improvement in the upgrade-to-downgrade ratio. Markets valuations are undoubtedly expensive mainly due to a very suppressed earnings growth owing to temporary disruptions from structural reforms. Hence, our view is that high valuations could sustain for much longer,” added Parikh.