Firms show increase in profits even as sales fall

The BSE Sensex, India’s benchmark stock market index, reached an all-time high of 44,825 on Wednesday, November 25. There is reason to believe that speculation and external tailwinds, rather than strong fundamentals, are the main driving factor behind this rally.

The average PE (price earnings) multiple of Sensex companies , which measures the price of a stock as a multiple of its earnings per share, has risen to 31.49 in the current month, the highest since 1998-99 . Net foreign institutional investment thus far this year is ₹1.56 lakh crore (as of 27 November) compared to ₹40,422.92 crore in the same period last year. The latest quarterly results of 30 companies comprising the BSE Sensex show that corporate profits turned the corner in the second quarter (July-September) of the current fiscal year.

Inflation-adjusted net profits of these companies, which declined by 45% year on year in the quarter ending June, increased by 24% year on year in the September quarter. An HT analysis of at least 2,400 companies using the Prowess database of the Centre for Monitoring Indian Economy (CMIE) shows that this trend holds for the larger universe of companies as well. This recovery in corporate earnings, however, should not be inferred as a broad based turnaround in the economy.

Not only are there significant sector-wise differences in performance, rising profits have come on the back of cost-cutting rather than sales growth. Experts believe that this could generate headwinds for aggregate demand and, therefore, incomes.

Corporate profits increased in September quarter CMIE’s Prowess database has 2,409 companies for which quarterly results are available for the last five years up to September 2020. An HT analysis shows that inflation-adjusted net profits for these companies increased by 165% on an annual basis in the quarter ending September in contrast to an around 80% fall seen in the last two quarters. This increase in profits is the highest in five years; the growth has been from ?32,839 crore in September 2019 to ?87,282 crore in September 2020.

Not all sectors have performed well Of the 2409 companies in the Prowess database, 1,381 are manufacturing firms, 337 are financial services firms,544 are engaged in services (other than financial), 21 are mining firms,16 are electricity companies and the rest (110) are in construction and real estate. Not all of them have been able to achieve growth in profits. A detailed sector-wise break up shows that while profits for the financial service firms and services companies (other than financial) increased by at least 100%, they fell by around 160% for sectors such as construction and real estate.

Higher profits do not mean sales numbers are back Profits have grown in the most recent quarter although sales fell. Inflation-adjusted sales fell by 12.6% on an annual basis in the September quarter for the 2,409 companies in the Prowess database. This is an improvement from the June quarter, when sales fell by 34%. This is only the second instance in the last five years when net profits have increased while sales fell. A breakup across sectors shows that like profits, sales performance has also varied across sectors. While mining firms saw their inflation-adjusted sales contract by over 30%, for financial service firms this was less than 1%.

Cost-cutting explains rise in profits

How did corporate profits rise despite a fall in sales revenue? An analysis of the Prowess database confirms that the answer lies in lower costs. Total inflation-adjusted costs for the 2,407 firms for which data is available came down by 19.3% in the September quarter. While this is lower than the 30% fall in costs in the June quarter, it needs to be remembered that most of the June quarter was spent in a stringent lockdown, when operational costs must have come down.

The Prowess database also gives a break-up of costs for the 30 Sensex firms. An analysis of these numbers shows that companies have cut costs across most heads including salaries. While non-salary costs were coming down from before the pandemic, salary costs came down for the first time in the June 2020 quarter (since September 2014) and this trend continued in the September quarter.

WHAT DOES THIS INDICATE?

In a recent article on the CMIE website, Mahesh Vyas, the MD and CEO of the business information company, said that higher operational efficiencies led to bumper profits for listed Indian firms in the September quarter. “The extraordinary increase in profits in the September 2020 {quarter} originates in the operational efficiencies of the manufacturing and banking sectors. Both have seen a sharper fall in their operating costs compared to the fall in their topline (sales)”, Vyas writes. Madan Sabnavis, chief economist at CARE Ratings, said the fall in sales and a rise in profits indicates that companies are cutting costs to enable this, and that this is actually not a sign of recovery but a case of the companies managing their own finances. He added that the cost-cutting reflected low demand conditions.