The Hindu Business Line : Eventful quarter

On the face of it the Indian corporate sector appears to have recorded yet another quarter of satisfactory growth in sales and profits. But the performance is not without certain aspects of concern to managers and policymakers alike. For instance, net profits may have risen by 25-30 per cent — the variation depending on the composition of the sample chosen for analysis — but there is reason to believe that the growth in earnings may be losing steam. The rate of growth in net profits is only marginally ahead of that in sales. This is in marked contrast to the experience in recent years when net earnings rose by as much 50 per cent annually on a compounded basis.

Two other factors reinforce the belief that corporate performance is under some stress. First, profits adjusted for one-time incomes make the performance far less inspiring than the numbers suggest and, second, operating margins are increasingly coming under pressure from a combination of rising input costs and intensifying competition, which forces companies to keep product prices low. Not surprisingly, a third of the companies analysed showed a decline in net profits compared to the same period last year. Throw in the fact that the strong performance of a handful of sectors such as information technology (a traditional out-performer), cement (a beneficiary of the housing boom) and sugar (that has gained from a global hardening of prices) boosted the overall numbers, and a clearer picture emerges of the prevailing external environment.

The onset of a difficult phase in corporate performance could not have come at a worse moment. The flaring up of hostilities between Israel and Lebanon and the nuclear stand-off between Iran and the West threaten to push the price of oil ever higher. The global economy, which has weathered the challenge of a trebling of oil prices in the last two years, is slowly losing the capacity to absorb fresh increases without letting it affect the latent growth impulses in the system. If that should lead to a flight of portfolio capital to safe havens at home, valuations of Indian equities could go into a tailspin. If overseas investors in convertible bond offerings of Indian corporates choose not to exercise the conversion option, there could be a squeeze on cash flows.

It is worth remembering that roughly half the population of medium- to large-cap stocks is quoting at an earnings multiple of over 15, making them less attractive to domestic investors. In the circumstances, the prospects for the corporate sector depend on how successfully the Government manages the two seemingly conflicting objectives of fiscal prudence and ending oil sector distortions in the near future.