Investors need to watch next two quarters before jumping into any conclusion

The September 2009 quarterly result of India Inc. does not provide strong signs of recovery.  ECONOMISTS and stock market analysts have been raving about the 'recovery in Indian economy' in the last few months. Some people have started believing that last year's problems were just a blip and the economy is back in its normal growth trajectory. The quarterly result analysis of over 2,000 companies, however, reveals that a secular      demand growth is still a few quarters away and the current growth largely reflects the impact of the government's stimulus packages. The sectors that were direct beneficiaries of the fiscal largesse –automobiles, metals and tyres — are witnessing a volume growth, while others continue to struggle. Overall, there is no sign of a demand growth that can put India Inc back on growth trajectory firmly, despite a clear improvement in sentiment. There is a slight sequential improvement in performance and investors need to watch next two quarters before jumping into any conclusion.      An analysis by ET Intelligence Group shows that the aggregate net sales of 1,700 Indian companies that reported their quarterly results for the September quarter, excluding those in oil & gas, banking and financial sectors, declined marginally by 0.6% compared with the year-ago period. And this is the slowest quarter India Inc witnessed in several years. The manufacturing sector, which will play the key role in economic revival, is still grappling with problems. The aggregate net sales of 1,200 manufacturing companies (ex. oil & gas) marginally declined in September 2009 quarter. And this is the first time in last several quarters that topline of this segment witnessed a decline. More importantly, the sector doesn't seem to be responding much to the government action to pull the economy out of slowdown. It is true that higher base of September 2008 quarter might have slowed down the comparative growth numbers. But this fact, alone, can't explain the revenue decline in sector. Almost half of all the companies in two key industries – capital goods and basic material – reported a decline in topline. The basic material segment, which includes sectors such as metal, cement and chemicals, reported a y-o-y decline of 13%. Bulk of this decline has come from lower commodity prices. The capital goods sector, however, grew at a mere 3%, the lowest quarterly growth rate posted by the sector in the last three years. Barring a few players, the sector is still going through a challenging phase. Capital goods sector is a very important sector for the recovery and represents the investment sentiment among corporate. Both the consumer segments, consumer cyclical and consumer non-cyclical, reported better results in the quarter. Both segments grew at around 15%, which is higher than the growth rate seen in the last 3-4 quarters. It shows      that consumers have more      confidence than corporate.      According to a recent survey, India topped the Nielsen's consumer confidence index and this is definitely a good sign. It means that the recovery may be driven more by consumption demand rather than investment demand.      The government's attempt to provide more disposable income in the hands of general public through reduced effective tax rates, lower interest rates and different development schemes like NREGA seems to be yielding result. The consumer cyclical sectors such as auto and consumer durables witnessed strong demand. For instance, the aggregate revenue of consumer durable sector grew at 8%, the highest in the last four quarters. The automobile companies also witnessed record sales in the passenger car and two-wheeler segments. But the sales of heavy vehicles, which are related to investment, remained subdued indicating the cautious approach of corporate India.      The difference in consumer and corporate confidence can also be gauged from the fact that growth in retail credit offtake has picked up whereas the growth in corporate credit has slowed down. Overall, the credit growth is yet to take-off.      Like the manufacturing sector, the service sector (excluding banking & financial sectors) also witnessed a decline in its topline in the quarter. The growth in revenue of two prominent segments, IT and telecom, remained subdued compared with the year-ago period. The IT sector, however, witnessed sequential growth in its revenue numbers and the industry is more optimistic about growth than it was in the previous quarter. Telecom is going through a turbulent phase due to a price war among service providers. The sequential decline in its profitability numbers provides little solace. The two sectors account for around half of the revenue coming from all service sector companies. Overall, the aggregate revenue of 500 services companies (ex. banking and financial services) declined by a marginal 0.4%, the lowest in the last several quarters.      Overall, the performance of India Inc, in terms of revenue, is not very encouraging compared to the previous quarter. Only 40 companies, out of a sample of 2000 companies, managed to move out of the negative growth zone in Jun '09 quarter to positive territory in Sep '09 quarter. (See the chart)      Amid all this, the positive news, however, is that Indian companies reported better-than-expected growth in bottomline in spite of pressure on topline. The companies undertook strong internal cost-control measures to reduce different operating expenses on advertising, branding, employee benefits and office expenses. The prices of many commodities such as metals and crude oil in September 2009 quarter were around 30-50% below their year-ago levels.Searching For Greener Pastures  THIS helped companies, mainly in the manufacturing sector, to report lower growth in their raw material and power & fuel cost.      The aggregate raw material and power & fuel cost of 2000 companies declined by around 6% and 9%, respectively, the steepest fall in at least 12 quarters. Lower operating expenses resulted in an 11% y-o-y growth in aggregate operating profit, the highest in the last four quarters.      The aggregate operating margin at 19% reflects the expansion of 30 basis points on a sequential basis. The concern, however, is that there is little scope for many companies to further tighten their internal expenses. Also, September 2008 quarter represents the peak of commodity cycle and hence there was a sharp decline in raw material cost in September 2009 quarter. But such a drop may not be there in next two quarters. Hence we may not see any further expansion in operating margin going forward, unless the demand really picks up.      The impact of a lower interest regime and companies' reluctance to raise more debt was also visible in September 2009 quarter. The aggregate interest expense in the quarter remained almost flat when compared with the same period last year. The depreciation, a fixed non-cash expense item, however, grew at its usual pace but faster than operating profit. As a result of all these factors, the aggregate net profit grew at a lower pace of 4%, reckoned on a y-o-y basis. This growth rate in net profit, however, is the highest in the last four quarters.      To conclude, the quarterly results for September quarter do not foretell any significant improvement in economic conditions. It is crucial, therefore, to watch out the performance of the companies in the next two quarters. Any growth in bottomline in next two quarters has to come from revenue growth. Hence, investors need to take a cautious approach while investing in stock market.      santanu.mishra@timesgroup.com