Stock prices, they say, are slaves to earnings. But if you take stock of the Indian equity market’s performance over the last three years, you won’t get that impression.
Between March 2013 and now, the S&P BSE Sensex has zoomed from about 18,800 points to about 26,500 points – an absolute gain of 41 per cent. But the earnings per share of the companies that make up the Sensex have inched up from ₹1,180 in FY13 to about ₹1,340 (trailing 12 months), an increase of just 13 per cent. But with the US Fed resuming its rate hike cycle and global bond yields rising in recent months, the macro arguments for high equity valuations are weakening.
Therefore, for stock prices to push higher from here, a revival in profit growth is imperative. So does India Inc’s report card over 2016 show signs of an incipient revival? If the aggregate picture is lacklustre, are there individual sectors or sub-sectors that show promise? Here’s an analysis.
Sensex: Green shoots
The performance of Sensex-30 companies sprouted tentative green shoots over the three quarters of 2016 (January-March, April-June and July to September). Revenues for these firms expanded by 4 per cent in these nine months after contracting in 2015. Operating profit margins improved on the back of tumbling raw material costs.
But net profits charted an inconsistent path from quarter to quarter. After rising by a heartening 7.5 per cent in the March quarter of 2016, profits dipped by 1.4 per cent in the June quarter. The latest September quarter has again brought hope, with Sensex profit growth at 5.1 per cent. Surprises from automobile firms, oil companies and PSUs contributed to this improvement.
But while Sensex earnings may be important to gauge market direction, let’s not forget that much of the money that has been made in the Indian markets in recent years has been from betting on non-index stocks.
Therefore, we attempted to gauge earnings trends for the listed universe as a whole by analysing the profit performance of 1,780 NSE-listed companies (including banks).
Broader market: Signs of revival
Unlike the Sensex 30, the earnings scorecard of the broader market showed a clearly improving trend over the three quarters of 2016. The net profit for this universe showed a 6.6 per cent growth in the September quarter, after an 8.7 per cent decline in June and a steeper 18.7 per cent fall in the March quarter of 2016. The return to profit growth is significant after two fiscal years of declining profits.
From a deeper dive into results, it is clear that treasury profits for banks, and savings in raw material costs for manufacturing companies (with declines in industrial metals and packaging costs) played a big role in the recent profit revival. While the overall revenue growth for the 1,780 companies showed only a mild recovery — at 2 to 5 per cent in the three quarters of 2016, ‘other income’ expanded by 14-20 per cent in each of the quarters. This mainly represented investment income for holding companies and treasury gains on bonds for banks.
For manufacturing firms, the global commodity meltdown came in handy, reducing the ratio of raw materials-to-sales from 51.8 per cent a year ago to 50.5 per cent in the latest September quarter. While wage bills proved difficult to quell, firms trimmed ad spend, selling and administrative expenses. This lifted operating profit margins to 17.2 per cent in the September quarter from 15 per cent four quarters ago.
The downward slide in interest rates has been slow to benefit India Inc, but its effects have begun to show up in corporate results from June onwards. Rising interest cover (4.2 times in September from 3.8 in June) has helped India Inc manage the profit rebound in the September quarter.
Going forward, while the recent spike in global commodity may wipe out some of the raw material savings, better profits for the commodity and energy majors, returning pricing power due to higher inflation, and nose-diving interest rates may give a leg-up to overall profit growth. (See accompanying story).
Opportunities from divergence
With both sales and profit growth still stuck in the single digits, India Inc’s aggregate results offer cause neither for excessive optimism nor gloom. But if you’re an active investor, it is the divergence in growth between sectors and companies that you should be looking out for.
So after slicing and dicing the report card of the 1,780 firms, we arrived at some promising trends.
Strong on demand
With demand trends quite weak across the economy, sales growth proved hard to come by for most of India Inc. But select sectors defied this trend, by managing double-digit sales growth for the last three quarters, either through better volumes or through judicious price action.
Cement (16 per cent sales growth in the first nine months of 2016), automobiles (12 per cent), auto components (14 per cent), NBFCs (14 per cent) were some of the obvious bets here. While cement benefited from firm prices, autos and auto components witnessed good volumes from strong urban consumer spending - mainly on passenger vehicles. NBFCs capitalised on the go-slow by banks to step up loans to retail and small-ticket borrowers.
Many of these stocks have already been discovered by the markets and marked up to fancy valuations. However, some under-the-radar sectors such as sugar (24 per cent sales growth in first nine months), hardware (17 per cent), agrochemicals (12.3 per cent) and brokerages (13.6 per cent) surprised and may still be worth exploring. A sharp fall in sugar inventories, propping up prices, has helped sugar firms report a jump in revenues. Agrochemical makers benefited from the strong monsoon and kharif crop, improving agri inputs offtake. Stock and commodity brokers have seen a surge in income from higher trading volumes.
Hanging on to double-digits
Similarly, even as large swathes of India Inc struggled to get to single-digit growth this year, some sectors have managed bumper profit expansion.
Some of the less hyped sectors which saw a material step-up in profit growth rates in the first nine months of 2016 were agrochemicals (36 per cent net profit growth), tyres (33 per cent), paints (58 per cent), credit rating agencies (28 per cent), chemicals (42 per cent), readymade garments (40 per cent growth) and Infrastructure (27 per cent).
Some of these sectors saw a majority of the players deliver a profit improvement (agrochem, tyres, readymade garments, paints, NBFCs, FMCGs). But in others, there was extreme divergence. In the entertainment space for instance, if Zee Entertainment, Dish TV, Eros, Inox Leisure and PVR delivered profit jumps, others such as Zee Media or TV18 saw profit slumps.
Most sectors which registered strong profit growth seem to have capitalised on low raw material prices from the commodity meltdown. With prices of industrial metals and oil edging up sharply in the last couple of months, these cost savings may moderate from here on. However, firms with pricing power may be in a position to hold on to decent margins.
Software and pharma — two sectors that are not much favoured by the markets right now — score high marks for earnings consistency. While pharma firms managed a 26 per cent growth in aggregate profits in the first nine months of 2016, software firms delivered 16 per cent, both on top of expanding earnings for the last two years.
By managing to grow their profits at far higher rates than the entire listed universe, during challenging times for both the domestic and global economies, these sectors have lived up to their defensive tag.
Dramatic turnarounds
Given the challenging sales environment, there were not many instances of turnarounds from losses to profits. But the ones that managed it put up an impressive show.
The 30 listed sugar producers raked in ₹2,205 crore in profits in the first nine months of 2016, against losses of ₹1,940 crore in the same period last fiscal.
Helped by the monsoon effect, fertiliser makers turned around from aggregate losses of ₹84 crore (across 15 players) to profits of ₹882 crore in the first nine months of 2016.
With mobile and data network rollouts getting a renewed push, telecom equipment makers registered a total profit of ₹1,808 crore against losses of ₹253 crore last year. The metals and mining pack did not return to profits, but managed to shrink its losses by over 60 per cent, from ₹10,046 crore in losses last year to ₹3,681 crore in the first nine months of this year.
There were other sectors registered large jumps in their aggregate profits. Plantation firms managed ₹354 crore in profits against just ₹91 crore in the same months last year. The five gas distribution firms saw a quantum leap in total profits from ₹2,496 crore to ₹4,835 crore this year. The 25 players engaged in infrastructure development saw their aggregate profits improve to ₹4,928 crore in the first nine months of this year, against ₹3,799 crore in the corresponding period last year.
While hunting for investment opportunities in this pack, it would help to pay close attention to the source of the turnaround. Given that the raw material savings of the last few months may not last, bet on them only based on a healthy sales outlook.
Losing speed
If a number of under-the-radar sectors registered a surprising improvement in growth, the listed universe also featured a fair share of large and fancied segments that lost speed this year, after performing reasonably well last year. Banks, obviously, topped this list.
With private sector banks joining their State-owned cousins in recognising large loan slippages, aggregate profits for the banking sector in the first nine months fell by 93 per cent, on top of a 65 per cent contraction in FY16.
Power generation firms, which managed a 26 per cent profit expansion last fiscal, saw the pace of growth slow to 6 per cent in the first nine months of 2016. As the base effect kicked in, refinery majors also had to make do with single digit profit gains after last year’s windfall. While non-ferrous metal makers sharply reduced losses, steel majors saw losses widen.
Some of the highly fancied sectors in the market, such as construction materials (7.5 per cent profit growth in nine months against 52 per cent last year), healthcare and hospitals (losses of ₹19 crore YTD against profits of ₹370 crore in the same time last year) and jewellery (profits shrank from ₹1,448 crore to ₹608 crore for the sector) disappointed with sharply lower profitability this year.
Given that these sectors have not been able to capitalise on a benign cost environment to improve their profitability, their only hope in the months ahead will lie in a demand revival for their goods or services.
(The article first appeared in BusinessLine.)