The fourth quarter of the last financial year, 2014-15, was an unmitigated disaster for Indian companies. Even after adjusting for extraordinary items, profits
for the universe of the top 1,600 companies listed on
the stock exchanges shrank by 19 per cent year on year.
Profit growth for the blue chips on the Nifty was not very
different; for the Sensex, the fall was around nine per cent.
(All these numbers, and those that follow, exclude banks
and financial companies, as is the convention. They are also
marginally sensitive to exactly how you account for one-time write-offs, and so on.) Over the entire financial
year, Sensex companies recorded no profit growth - the first
time that’s happened in a decade-and-a-half, if you exclude
the crisis year of 2008-09.
We’re in the middle of the season in which results are
declared for the first quarter of this financial year, 2015-16,
and the early news is not encouraging. Remember, the first
quarter of both 2014-15 and 2013-14 showed strong corporate profit growth; 32 per cent for those 1,600 companies
in Q1 2014-15, and 33 per cent in Q1 2013-14. This helped
gross value added - and thus gross domestic product - to
post a respectable growth recovery in each of those quarters. But the 215 companies that have reported results so
far show net profit growth of only five per cent; for the 14
Nifty companies that have declared first-quarter results so
far, profit growth is only 4.2 per cent.
This may, of course, still change; the majority of companies are yet to declare their results. But the signs aren’t
good. The Nikkei India purchasing manager’s index measure of output (PMI output) fell below 50 for the first time
in June 2015 since the new government took over last May.
Both Crisil and Edelweiss, in reports issued in early July,
predicted an around two per cent dip in profits in the first
Should one still be “bullish on India”, as I keep on getting
asked by investors passing through Delhi? Well, the question isn’t really clear. In the short term, I don’t think anyone can reasonably expect a solid recovery in corporate
earnings. True, even absent that, share indices might still
increase - even given high price-earnings multiples -
because the rest of the emerging-markets world is presently in such a mess, and so foreign capital might flow into
Indian shares regardless.
But without a recovery in earnings, it’s very difficult to be
optimistic in the medium term, once stability returns to the
rest of the world, and profit growth returns to Europe after
five years. (There have been several positive surprises in
first-quarter corporate results from that troubled continent.)
The long term is, of course, another matter. Let’s look at
the pros and cons.
The biggest ‘pro’-India argument seems to be, essentially,
reversion to the mean. Profit margins are below their historic levels, measured in various different ways. According
to Morgan Stanley, the earnings margin for non-finance
companies (before interest, depreciation, taxes and amortisation) was 25 per cent in the May 2007 quarter; it’s hovering around or just above19 per cent today.
In the boom years, from 2003 to 2008, earnings per
share grew at about 20 per cent (annually, compounded);
since then, at about one per cent (according to Franklin
Many people find the ‘mean reversion’ argument persua-
sive. I do not; I think this genuinely underestimates the
possibility that there has been a structural alteration in the
nature of corporate earnings since perhaps 2008, and par-
ticularly since 2012. A blind faith in reversion to the his-
toric mean presupposes the same economic model for the
corporate sector, calibrated similarly, applies in 2003 and
in 2015. This is simply not the case.
One argument is that margins will have to rise, since
India is a net commodity importer, and we seem to be
beginning a long period of low commodity prices. Akash
Prakash has estimated the decline in petroleum, palm oil,
coal and fertiliser prices as together saving India $75 billion on the import bill. Certainly, this positive supply shock
has got to make a difference. But I’d argue much of the positive impact has been expended in its moderation of inflation, and in giving the government fiscal room.
In addition, while there may be a worldwide decrease in
commodity prices, in India, commodity prices have moved
in the opposite direction structurally. After decades of subsidised natural resources, many Indian companies will
have to pay high prices - in some cases, well above notional
‘market’ prices - for those resources.
In truth, we already know, at this point, what needs to be
attended to in order to restore earnings growth - which I
should not need to add, is the first step towards greater
value-added and GDP growth, more tax revenue for social-
sector spending, and a job-creating expansion of the pri-
vate sector. We know, because we now understand and
accept - after the noise and obfuscation of the UPA years,
which blinded analysts and columnists alike to the real
problem - what has broken down.
First: there will be no sustained earnings recovery unless
investment recovers. The sharp drop in private fixed capital
formation is the crucial component of the slowdown in
GDP; also, an increase in investment - when fuelled by
proper credit - raises earnings disproportionately. But an
investment recovery depends on four things: first, on the
absence of excess capacity; second, on the recovery of
demand; third, on credit being available and not prohibitively expensive; and fourth, on the presence of a clear and
manageable risk-return profile. At the moment, not one of
these four exists.
On the first point, RBI surveys suggest capacity utilisa-tion is just under 10 percentage points below what it was in
early 2011; the seasonally adjusted trend is still downward.
Unless existing capacity looks like it’s being stretched,
nobody will invest. But without a demand recovery - the
second point - why would over-capacity end? Demand cannot come in the short to medium term from exports, given
anaemic world growth. It cannot come from domestic
household consumption, since rural wages - the engine of
recent demand growth - have collapsed. In what has to be
the gloomiest of signals, for the first time in a decade Coca-Cola cut production, in the quarter ended June.
The third point is knottiest, especially in political-econo-my terms. Most sectors that you rely on for investment are
over-laden with debt; for infrastructure operators, in 2014-
15, debt as a percentage of sales was a startling 256 per
cent. Overall, interest costs grew 10 per cent last financial
year; for the early reporters, interest costs went up 19 per
MIHIR S SHARMA
ShaILeSh anDraDe/reU TerS
Should one still be
‘bullish on India’?
Narendra Modi is running out of time and goodwill;
his government needs to focus more.
‘over the entire financial year, Sensex companies recorded no profit growth - the first time that’s happened in a decade-and-a-half, if you exclude the crisis year of 2008-09,’ says Mihir S Sharma.
August 7, 2015