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March 2018 corporate financials belie hopes of earnings turnaround

by Mahesh Vyas

Financial statements of listed companies show reasonable topline growth but, the growth in net profits is not very good. The expected turnaround failed to materialise once again.

Total income of non-finance companies in the quarter ended March 2018 was 12.4 per cent higher than it was in the corresponding quarter of 2017. Topline growth was adversely impacted by export incomes declining by 10.7 per cent and “other income” declining by 18 per cent.

Net sales grew well by 13.8 per cent. Given that inflation has been quite benign, this also translates into a reasonable real growth in sales.

Operating expenses grew by 12.1 per cent - a pace that is 170 basis points lower than the growth in net sales. As a result, the broad measure of profits - profits before interest, depreciation and taxes (PBDIT) grew by a handsome 19.1 per cent in the quarter ended March 2018. Going by recent trends, this is a pretty handsome growth rate.

Interest expenses have not grown much in recent years as borrowings have not grown much which in turn, is explained by the low growth in net fixed assets of companies. In the last 12 quarters, the average y-o-y growth in net fixed assets and borrowings has been around 6.5 per cent. As a result, the y-o-y growth in interest expenses has steadily declined from an average of 10.3 per cent during the 12 quarters ended March 2016 to 4.5 per cent in the following 8 quarters.

In the quarter ended March 2018, interest outgo increased by 8.6 per cent, y-o-y. Increase in depreciation charges was also benign at 7.8 per cent. Growth in both, interest expenses and depreciation charges have been lower than the growth in profit before depreciation, interest and taxes. As a result, profit before taxes grew by a robust 28 per cent.

This is where the happy story of corporate performance stops. Tax provisions have shot up and more importantly, when adjusted for extraordinary transactions, the profits story collapses. Tax provisions were up by 57.6 per cent. This brought down the net profit growth estimate to 13 per cent. Then, adjusted for prior period and extraordinary transactions (P&E), the net profit growth turns out to be a paltry 1.9 per cent.

This poor growth in earnings (PAT net of P&E) in the March 2018 quarter belies hopes once again, of a turnaround in corporate earnings.

Non-finance companies recorded a healthy growth in PAT net of P&E during the five quarters ended December 2016. The average y-o-y growth in these profits was 24 per cent with a minimum growth of 12.3 per cent and a maximum of 37.8 per cent. The preceding five quarters had averaged an 8 per cent fall. Three of the five quarters had recorded a y-o-y decline. Therefore, the five quarters from December 2015 through December 2016 were a period of recovery.

The quarter ended March 2017 was the beginning of a reversal. The five quarters from the one ended in March 2017 through the one ended in March 2018 (latest) are a period of profits languishing again. The average y-o-y growth in PAT net of P&E was -2.6 per cent during this period. The quarters ended June 2017 and September 2017 took the brunt of the fall. Profits were down y-o-y by 25 per cent and 6 per cent in the two quarters, respectively. Possibly, these quarters suffered the adverse impact of demonetisation and GST.

PAT net of P&E showed signs of a revival in the quarter ended December 2017 as it pencilled a 13.2 per cent growth over the year-ago quarter. This naturally gave rise to the view that the impact of demonetisation and GST are behind us and earnings can start rising once again.

As the quarterly results for the March 2018 quarter trickled in during late April and May, profits growth showed brief signs of sustaining that higher growth rate but, by the end of the season, the quarter disappointed with a sub-2 per cent growth.

PAT net of P&E is the most important measure of profits and its performance in March 2018 has been disappointing. But, operating profit, which is PBDIT net of P&E and also net of other income (PBDIT net of P&E and OI) has done much better. This is encouraging. Operating profits grew 22 per cent y-o-y, in March 2018. This was the third consecutive quarter of positive growth in operating profits and fourth consecutive quarter of improvement in the growth rate.

Operating profit margin has improved from a recent low of 12.3 per cent in March 2017 to 14.3 per cent in March 2018.

But, margins are yet to improve to regain their levels before demonetisation. Demonetisation reversed a trend of rising margins that began in 2014. Operating margins had ramped up from about 11.5 per cent in 2014 to 15 per cent by end of 2016. Then they fell to an average of less than 14 per cent. Similarly, net profit margin of 2017 remains lower than its average 2016 level.