Uneven earnings across sectors, input cost pressures and rising interest rates coupled with a weaker rupee could dampen the pace of corporate earnings.
Radhika Pandey and Pramod Sinha writes:
The COVID-19 pandemic has derailed the economy but been a boon for listed companies. The sharp corporate tax cut in 2019 and the pandemic-induced cost reduction boosted corporate earnings. The year of the pandemic was also when Indian companies repaired their leveraged balance sheets. Due to the loose monetary policy regime characterized by low interest rates during the 2020-2021 financial year, companies have deleveraged by repaying high-cost loans with funds raised through bond issuances. Repaying existing high-cost debt has reduced interest costs and made businesses more profitable. Going forward, the extraordinary surge in earnings may see some moderation due to higher interest rates and a weaker currency.
The economic disruptions caused by the COVID-19 pandemic caused non-financial corporate profits to plummet in the April to June quarter of 2020. However, with the gradual easing of restrictions, the profits of listed non-financial corporates declined. recorded healthy growth in the following quarter (July-September). In the July-September 2020 quarter, the rise in profits was mainly due to cost cutting, as business sales growth remained in negative territory. Companies have opted for various cost-cutting measures such as cutting salaries, postponing capital expenditure plans and reducing advertising expenses. However, in the following two quarters of fiscal 2021, the increase in profits was accompanied by an improvement in sales. Thus, the increase in profits in the second half of fiscal 2021 was due to an increase in production rather than a rationalization of costs.
Although earnings remained robust, rising commodity prices and increasing input cost pressures have led to a moderation in the pace of earnings growth over the past three quarters. With the Reserve Bank of India (RBI) raising the policy repo rate, amid sustained inflation and supply chain disruptions, the corporate sector could see further erosion in profit levels over the coming quarters.
While headline earnings numbers show robust growth in quarterly corporate financial performance since the pandemic, two issues merit attention. First, is the strong growth seen in earnings across the board, or is it driven by a handful of sectors? This requires a deeper sector analysis of earnings. Second, with Wholesale Price Index (WPI) inflation remaining in double digits for over a year now, what is the picture of overall earnings after adjusting for inflation?
While the average quarterly nominal profits of listed companies would have doubled in the eight quarters from June 2020 compared to the previous eight quarters, a disaggregated analysis could present an assessment of the sectors that have been hit hard by the pandemic. Nominal earnings growth during a period of low and stable inflation provides a true gauge of growth. However, in recent months where the WPI has remained high for an extended period, it is prudent to use an appropriate deflator to express nominal profit levels in real terms. Such an analysis could serve as a useful guide for policy intervention.
Rather than looking at the growth rate of a particular quarter, it is useful to make a comparison of average real profits before and after COVID-19 (using eight quarters from June 2020 and the previous eight quarters). This comparison would give an idea of which sectors staged a smart recovery and which ones are still languishing below pre-COVID-19 profit levels.
Analysis of the inflation-adjusted earnings of a common sample of listed non-financial and non-oil companies for the period from June 2018 to March 2022 reveals interesting sectoral variations. Oil and financial companies are excluded because they follow a different revenue model. Sectors such as metals and machinery posted higher profits on strong demand in domestic and global markets as commodity prices firmed. Contact-intensive services such as hospitality and tourism saw profits below their pre-COVID-19 average. Driven by a drop in consumption, sectors such as food and agri-food and paper and paper products are still below average real profit levels before the pandemic. Due to an increase in metal prices, sectors that use metals as raw materials, such as automobiles, transportation equipment and transportation services, have seen their profit margins shrink. Sectors such as textiles and consumer goods posted higher profits than before.COVID-19[feminine] medium, but the magnitude of the increase is moderate.
Going forward, the depreciation of the rupee coupled with a surge in global crude oil prices would further inflate companies’ input costs and erode their margins, especially those that rely on imported inputs and raw materials. However, export-oriented sectors, including labor-intensive sectors like textiles, clothing, footwear and handicrafts, could benefit. Moreover, for the benefits of a weaker currency to materialize, exchange rate volatility must moderate. Services such as information technology should also benefit from a weaker currency. But the sector must face its problems related to attrition.
At the same time, rising borrowing costs due to two consecutive rate hikes by the RBI will weigh on corporate margins. A sustained rise in interest charges could reverse the deleveraging trend observed over the past two years.
Views are personal.