First signs of recovery in December quarter corporate earnings
Why in news?
Corporate earnings showed the first signs of recovery in the December quarter as the negative effects of demonetization and the subsequent goods and services tax (GST) implementation started to reverse, but analysts stopped short of calling it a full-blown turnaround.
- A Mint analysis of 2,040 listed companies showed that aggregate net profit, after adjusting for one-time gains and losses, rose 11.1% in the three months ended December, the highest in the past four quarters. This sample excludes banks, financial services firms and oil & gas companies.
- The earnings were a mixed bag with early signs of economic recovery.
- Consumer staples and cement companies posted double-digit volume growth (on a very low base) after many quarters. Metals continued to post robust topline and profit growth. The key drivers for third-quarter earnings growth are base effects, fading disruptions from GST, demonetization, the Real Estate (Regulation and Development) Act and higher commodity prices. We think these should be the key factors going ahead as well,
- During the quarter, both operating profit margins and net profit margins of these companies were at a five-quarter high, even as raw material costs increased. However, interest coverage ratio, which measures a firm’s ability to cover its interest costs, was at a 15-quarter high, rising to 3.47 times.
- Operating profit margin widened to 19.39% from 17.8% in the September quarter. Net profit margin expanded 1.63 percentage points to 7.12%
- In the months ahead, rising Brent crude prices will impact profit margins, said analysts. This will be especially so for companies in the paint and aviation sector as oil accounts for a large portion of their expenditure. Brent crude is currently trading at $63.97 per barrel, an increase of 18% since the beginning of the financial year.
- Rising commodity prices, a sign of strengthening global growth, are another reason why analysts are wary of predicting a turnaround.
- The business momentum is now getting back to its earlier pace, but higher energy and commodity prices have begun to bite domestic manufacturers, with companies reporting an increase in per unit cost of raw materials and energy.
- Indeed, the recovery in corporate performance is not translating into a significant earnings upgrade. Bloomberg data shows Sensex companies’ consensus earnings per share forecast for the current fiscal have increased 0.9% since the beginning of the earnings season. For the next fiscal, they have gained just 0.2%.
- Market valuations are certainly high, but one should keep in mind that this is not an India-specific phenomenon. Across the globe, market valuations are elevated, perhaps a function of subdued earnings growth. As earnings growth improves, market valuations will normalize,
- In December, industrial production showed robust growth for the second straight month, growing at 7.1%, while retail inflation slowed to 5.07% in January, indicating that the economy may be stabilizing.