LIVING IN SLOW MOTION

India Inc's June '08 quarter results don't seem to paint a rosy picture. But is the situation really as bleak as it appears? Ramkrishna Kashelkar and Santanu Mishra sift through the numbers to try and find a silver lining…

 ANOTHER QUARTER is behind us and there seems to be no respite for India Inc. Incremental growth is hard to come by as companies try to beat rising raw material, energy and interest costs. The manufacturing sector has been badly hit on all these counts, while the services industry is faring much better. And this time round, India Inc has another reason to despair — the provisions to account for an increase in companies' debt liabilities due to depreciation in the rupee against the dollar. In the June '08 quarter, major companies were hit by mark-to-market (MTM) losses on their foreign exchange (forex) exposure.
    The detailed 20-quarter analysis of
1,019 companies shows that Corporate India's net profit growth is now in single digits — the lowest in the past 20
quarters. The 'other income' factor, which had lent support to the weak earnings in the past few quarters, has fallen drastically. However, the most worrying aspect of the results is that even operating margins are showing signs of weakness.
    For the quarter ended June '08, India Inc has reported a 25% jump in operating income to Rs 299,800 crore. The sample excludes banks (since their accounting standards are different), oil companies (which are incurring heavy losses due to under-recoveries) and those companies for which data for the past 20 quarters is not available. Net sales growth in the June quarter was higher than that in the March quarter, but this was mainly due to rising inflation.
FEELING THE PINCH: Majority of the companies have tried to pass on the rise in their raw material costs unsuccessfully, which, as a proportion to net sales, have risen to their highest level in the past two years.
    As a result, operating profit margins — which had started their downward journey in the March quarter itself — have stagnated to a 10-quarter low of 18.2%. As the prices of crude and coal soared to record high levels globally, energy costs have soared for India Inc as well.
    India Inc has started feeling the heat of soaring inflation and interest rates. In the latest quarter, companies' interest cost has jumped by 62%, accounting for nearly 3.3% of their sales — which is a four-year high figure.
MARK-TO-MARKET LOSSES: The depreciation of the rupee has highlighted two types of losses. The first category is the MTM losses arising from the revaluation of derivatives contracts. The second category is the translation losses due to increase in the value of foreign currency loan in rupee terms.
    The first category of losses is mainly incurred by companies in the IT sector, which hedge their revenues. (The IT sector gets a major chunk of its revenues from abroad). These companies were booking gains till last year, when the rupee was appreciating. But now that the trend has suddenly reversed and the rupee has depreciated by around 7% quarter-on-quarter, these companies are reporting MTM losses.
    For instance, Tata Consultancy Services (TCS), which booked a gain of around Rs 60 crore in the June '07 quarter, has reported a loss of Rs 76 crore for the June '08 quarter. Here, it is important to understand that as long as companies have not closed any of these derivatives positions, the loss is notional and there will not be any cash outflow.
    The second category of loss is incurred by those companies which have taken foreign currency loans to fund their expansion plans. As the rupee depreciates, their liability increases in rupee terms. For instance, if the loan amount was $1 million last year, when the rupee-dollar exchange rate was at Rs 40/dollar, the rupee liability was Rs 4 crore.
    As the rupee depreciates to Rs 43/dollar, this liability will increase to Rs 4.3 crore. This extra Rs 30 lakh will hit the profit and loss statement of companies.
    The companies which have reported such losses are from different sectors and include Ranbaxy Laboratories (Rs 193 crore), Tata Steel (Rs 303 crore), Tata Motors (Rs 200 crore) and GE Shipping (Rs 138 crore), among others. In Fits And Starts
MANY OTHERS, including Reliance Industries (RIL), have followed the Companies Act and accommodated MTM losses in their balance sheet. As per the accounting standards, this should have been reported in the companies' profit and loss statement. Whatever be the situation, one thing is certain — the depreciating rupee has affected the profitability of companies in the June-ended quarter.
MANUFACTURING VS SERVICES SECTOR: The combination of high inflation and interest rates has hit the manufacturing sector the most. The 766 companies in the manufacturing space have reported just 3.5% growth in net profit during the June '08 quarter, despite a 25% jump in net sales. Their operating margins have fallen by 160 basis points (bps) to 16.5% in the June quarter.
    Meanwhile, the 253 companies from the services sector have posted a healthy y-o-y growth rate in net profit, compared to the previous quarter. The services sector has also witnessed a marginal growth in operating margin to 23.2%, over the March '08 quarter.
    IT, non-banking finance, shipping, telecom, hospitality, entertainment and media are the main industries representing the services sector. IT and telecom sectors have reported encouraging numbers, with healthy growth in bottomlines, supported by an increase in operating margins on a sequential basis.
    Non-banking financial companies (NBFCs) have had a tough quarter, with operating revenues as well as other income falling on a yo-y basis. But their net profit growth is almost flat, compared to the year-ago period. The entertainment and media sector has reported a 79% jump in its net profit, mainly because its largest constituent, Zee Entertainment, wrote back substantial tax provisions.
    Higher day rates due to buoyancy in trade have helped the shipping industry to post high revenue growth in the June '08 quarter. However, high fuel costs, dry-docking expenditures, as well as forex losses have weighed heavily on operating margins, bringing down the aggregate net profit.
    In the manufacturing segment, industries such as capital goods and consumer durables have put up a better performance in the June '08 quarter, contrary to popular belief.
    The aggregate net profit of 24 consumer durables companies has grown 22.4% during the June '08 quarter, against 14.5% in the June '07 quarter. This is supported by a marginal improvement in operating margin, while the growth in other income is lower. Similarly, the capital goods industry has reported 17% profit growth, as its operating margins have expanded.
    The chemicals industry has also outperformed the overall trend. Despite high energy prices, the surge in prices of commodity chemicals has helped the industry to expand its operating margins to 18.8% from 14.7% in the corresponding quarter of the previous year.
    The sales of 47 chemical companies have risen 41%, which is a combination of volume growth, as well as price increases. This has helped the industry to post a massive 86% jump in net profit, despite a fall in other income and rise in energy and interest costs.
    Fertilisers, plastic goods and steel are the other manufacturing industries which have performed better, compared to the corresponding previous quarter.
    However, the pharmaceuticals and FMCG industries have posted dismal results, despite endorsement from several experts, which has led to a better performance on the bourses.
    The pharma industry's aggregate net profit has fallen 18% y-o-y, mainly due to forex losses and spurt in interest costs. Its operating margins have remained healthy, and are only slightly weaker than the year-ago levels.
    The FMCG industry's profit has grown just 5%, much lower than the 17% seen a year ago. The industry's operating margins have weakened, despite sales growing at 22% — the highest in the past five years.
    Other high-profile industries which are going through tough times are auto & auto ancillaries, cement, power, hospitality, real estate and textiles, most of which have witnessed a fall in their aggregate net profits vis-à-vis the June '07 quarter.
SUMMING IT UP: Despite the overall grim picture, there are a few factors which can have a positive impact on India Inc in the long run. Growth in the capital goods industry indicates that Corporate India's huge capital expenditure (capex) plan is mostly on track, despite the rising interest rate scenario.
    Global crude and coal prices have come off their peaks and are likely to ease further over the next six months. This will ease inflationary pressures, as well as the energy costs of domestic companies.
    Last year, we had seen India Inc accounting for forex gains to boost its profits, when the rupee was appreciating. With the rupee turning weak again in '08, the notional losses reported by Corporate India are weighing heavily on profits. This implies that the extent of slowdown may actually be lower than what the numbers suggest. Similarly, a weak rupee will favour export-led industries.
    ramkrishna.kashelkar@timesgroup.com