Business Today

Pinched, not punched

Ajay Srinivasan | Print Edition: June 12, 2011

The year 2011 began with multiple headwinds for Indian equity markets, raising concerns over corporate growth and profitability. The turmoil in West Asia raised the prices of crude and other essential commodities while the sovereign debt crisis in peripheral Europe led to increased nervousness. Domestically, persistently high inflation coupled with tight domestic liquidity, interest rate hikes by the Reserve Bank of India and visible risks to fiscal consolidation led to several red lights flashing over the equity market. Overall, global economic growth momentum remains weak and domestic growth momentum is clearly showing signs of moderation.

The top 100 companies that have declared fourth quarter results so far have, nonetheless, seen a robust revenue growth of 28 per cent year-onyear, the highest in the last nine quarters, resulting partly from the higher realisations due to inflation coupled with strong demand. However, profit growth was 14.1 per cent year-on-year, down from 28.7 per cent in the last quarter, dented by higher depreciation, increased financial expenses and to some extent the high base effect. Financial costs grew 39 per cent during the quarter reflecting the adverse impact of the interest rate hikes on corporate profitability.

Given the surge in financial expenses, we could have drawn parallels with 1996/97, when a similar situation existed, but the inherent fundamentals of Indian companies have strengthened substantially since then.

 Srinivasan's take

  • Revenue growth of 28% in Q4 by Top 100 fi rms is the best in the last nine quarters
  • Profi t growth dips to 14.1% from 28.7% in Q3 mainly due to a rise in financial expenses
  • Inflation has a positive impact on revenue growth but hurts corporate profitability
  • However, the mix of businesses lends immunity to the economy and capital markets from major shocks
  • Positive signs on the crude, commodities and dollar fronts to boost market sentiment
  • With fund flows to emerging markets likely to surge, India will need to woo global investors with the right policies to fund its growth aspirations

For one, Corporate India has become more global, with about 40 to 45 per cent of the earnings of Sensex companies coming from businesses that have global dependence. Two, the corporate balance sheet has become underleveraged with a debtequity ratio of about 0.5x as against 1x in the 1990s.

Three, markets have become much more diversified. The top three sectors by market cap - banks, energy and information technology, or IT - do not seem as vulnerable as they were in the 1990s. With the liquidity deficit off its peak and banks increasingly hiking their lending rates along with deposit rates, their net interest margins may contract a bit but remain healthy on the whole.

Realisations of domestic oil companies are not much impacted by global oil prices due to government subsidies. Further, 50 per cent of the earnings of the index heavyweight, Reliance Industries, come from gas which is not impacted by international price movements. Further, IT, being a service sector and broadly unleveraged, is relatively immune to domestic interest rate hikes and global commodity prices. Overall, 45 per cent of the earnings estimated for the top 100 companies have low exposure to domestic variables since they are derived from global cayclical sectors like metals and oil and gas and global non-cyclical sectors like IT and health care.

Further, the Indian economy itself has become well-diversified. The service sector, which is less leveraged, has lower capital intensity, is more globalised and has extremely low correlation with commodity prices, is, to a large extent, shielding the economy from the current challenges. Therefore, less than one-third of the top 100 companies that have declared results so far have seen downgrades in their earnings estimates.

Further, despite the worst financial crisis in many decades, earnings of the top 100 companies have registered a compound annual growth rate, or CAGR, of over 19 per cent over the past five years, distinctly higher than the 15 to 16 per cent nominal growth in India's GDP during the same period.

However, variables such as commodity prices, inflation, and global and domestic economic and demand growth will continue to impact future expectations and market sentiment. The positive news is that crude prices are showing signs of tapering off. Further, slower growth in most developed economies, reduction in risk premium, and the expected end of the Quantitative Easing II in the US will reduce commodity prices. The US dollar is likely to strengthen, led by the recent shift in investor preference from commodities to lower risk assets.

The net speculative position in crude as a percentage of open interest has fallen from 30 per cent during February to March 2011 to 15 per cent currently, and the US 10-year treasury yield has fallen from levels of 3.5 to 3.7 per cent in February to 3.16 per cent at present.

The differential growth rates globally will ultimately enhance fund flows towards emerging markets. We need to increase confidence amongst the global investor community so that we can become the key beneficiary of such flows, not just portfolio flows but also the more long-term foreign direct investment flows. Towards this end, it is important to restart the reform process, improve governance standards, overhaul social and physical infrastructure and remove other bottlenecks to make India an attractive place to do business. We also need to ensure we are able to channelise India's savings into productive areas. A combination of these factors will give us the capital we need to fund India's growth aspirations.

The author is Chief Executive of Financial Services, Aditya Birla Group

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