Growth pulse: Margins reflect economy’s pain
Feb 10 2013 , New Delhi
Key industries show drop in profit margins, revealing bruises of the slowdown all over
A study of PAT (profit after tax) margins of the BSE 500 basket of companies that have announced their earnings so far in the ongoing results season clearly marks out the leaders and laggards of India Inc, and throws light on some of the fundamental weaknesses of the economy.
Several key industries of the economy have reported a drop in profit margins in the December quarter, including mining, capital goods, steel, cement, power, realty, consumer goods and FMCG. In fact, the contraction was worrisome in mining and capital goods. At the same time, most IT firms and large banks have seen larger expansion in PAT margins than what many analysts on Dalal Street had estimated.
Data available with the corporate database of Capitaline show that the average PAT margins of 331 firms from the BSE 500 index, which have reported their December quarter earnings so far, stood at 11.61 per cent, showing an improvement of 11.71 percentage points from the previous quarter. This was the second best average margin in the past six quarters.
Of these, 155 companies have managed to report higher PAT margins on a sequential basis, while 176 firms have failed to match their margins of the previous quarter. Profit margin is defined as the ratio of profit earned to total sales receipts over a defined period. It is a measure of profit per unit of sales, or the amount of profit accruing to a firm from the sale of a product or service. It gives an indication of efficiency and captures the amount of surplus generated per unit of the product or service sold.
A lower-than-normal profit margin indicates a tough environment for a business, which could be due to increased competition, rise in cost of production or a general rise in other expenses such as interest outgo on debt, cost of litigation and other external expenses. However, a tight profit margin could sometimes be the result of a business trying something new, which may be good. But if low profit margin stems from some core problems inside the company, it is a signal to desert that stock.
Increased earnings of a company may not always mean that its profit margin is improving. In times of distress, companies often try to conceal the real health of a business, by artificially bloating bottomlines through external accruals, which are not generated through sales or services. PAT margins expose such aberrations and reflect the right picture of the business environment.
When IT firm Cognizant reported its numbers for the fourth quarter this past week, the double-digit rise in revenues and 16 per cent jump in profits did impress many, but analysts expressed concern over the narrowing of its gross margin to 40.9 per cent from 41.7 per cent, which signalled a 19 per cent rise in input costs.
“Cognizant revenue guidance was in line with our thesis that its YoY revenue growth premium over Indian vendors is diminishing. Cognizant’s large revenue base and high historical growth have resulted in a YoY decline in quarterly growth, compared with an improvement for Indian vendors,” said Bhuvnesh Singh of Barclays.
Companies that are able to expand their PAT margins over time generally get rewarded with share price growth. A sequential or year-on-year expansion in PAT margin indicates either a reduction in costs and/or the firm’s ability to raise prices. Investors often use profit margins to compare efficiencies of companies in the same industry and also between industries.
The ongoing results season saw firms like Sesa Goa, JP Power, Crompton Greaves, Alstom India and Adani Power reporting negative profit margins, and as a result net losses.
In the IT basket, Infosys, Satyam Computer and Polaris reported tightening of profit margins sequentially in the December quarter, but the rest of the league such as TCS, Wipro, HCL Tech to mid-cap players such as KPIT Infosys, Persistent System, NIIT Tech, Tech Mahindra, MindTree, Oracle Financial Services, Financial Technologies and Geometric, among others, saw margin expansion.
Among banks, biggies like ICICI Bank, HDFC Bank, PNB, Axis Bank and many others like Kotak Mahindra Bank, Vijaya Bank, OBC and Bank of India posted margin expansion, but a few others like Indian Bank, Union Bank, United Bank, BoB, IDBI Bank, IOB, SBT, Uco Bank, among others, have seen erosion in margins.
Three big refiners, Reliance Industries, Essar Oil and MRPL saw sequential drop in margins, and so was the case with most power companies such as NTPC, Adani Power, NHPC, Neyveli Lignite, Torrent Power, Reliance Power, SJVN and JP Power.
“Earnings, so far, point towards better-than-expected Ebitda margins and, more importantly, FY14 earnings seem to be getting upgraded (though marginally), first time in several quarters,” brokerage Edelweiss Securities said in its review of the first batch of earnings numbers.
Ebitda margin is the ratio of Ebitda (earnings before interest, taxes, depreciation and amortisation) to sales revenue. It is an even better gauge of a company’s financial health and evaluates a company’s ability to earn a profit.
All realty players reported lower margins for the December quarter, barring three — Sobha Developer, Puravankar and Indiabulls Real Estate. Steel majors JSW Steel, Jindal Stainless, Jindal Saw also felt the squeeze, but Uttam Galva, Bhushan Steel and Usha Martin did better. In the telecom space, all major players saw margin erosion, which was 2.06 percentage points on a sequential basis in the case of Bharti Airtel.
Some of the pharma firms, considered a defensive sector in times of slowdown, too faced margin squeeze, with Cipla, Jubilant Life, Aurobindo Pharma, Novartis India and Biocon leading the pack. In the capital goods space, Alstom India and Crompton Greaves were the worst performers in terms of erosion in PAT margin, while Bhel, Havells, HEG too suffered.
“A look at Q3 earnings thus far gives a bright picture, but margin performance has been below expectation. The 15 Sensex firms (excluding oil) that have reported earnings so far have posted 12.1 per cent, 15.3 per cent and 18.9 per cent growth in sales, Ebitda and PAT, respectively, compared with expectations of 9.2 per cent, 14.1 per cent and 15.3 per cent,” said Tirthankar Patnaik of Religare Securities. zz