India Inc.'s margins to fall off the cliff?

Aug 30, 2010

In this issue:
» Central bankers clueless about double dip recession
» Rs 750 bn of tax payments mired in litigations
» Banks take the easy way to clean NPAs
» Small telecos seek exit route
» ...and more!!

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The global economic meltdown was in some senses a windfall for companies in emerging markets like India. The biggest consumers of commodities either stopped or reduced their consumption dramatically. This meant availability of cheap resources for Indian manufacturers. With sales largely being restricted to buoyant domestic markets, their margins soared. Softer interest costs only added the icing on the cake. The soaring profits earned them valuations several times pre-crisis as markets rewarded them for the windfall.

Now the question is: Will the rollback start soon?

As the last quarter's earnings have shown, input costs have bottomed out. Although developed markets have a long way to recover fully, consumption has picked up. Demand supply gaps have also kept inflation numbers ticking up. A good monsoon may ease this concern only marginally. In the meanwhile, labour has become expensive. Interest costs may have gone nowhere in the US and Euro zone. But the Indian policymakers are keen to keep it going upwards.

Thus it may be a long time before India Inc. goes back to earning the kind of lofty margins earned in early 2009. And investors wary of lower profits in the medium term may want to discount valuations as well. We believe that such a correction could present some interesting opportunities for investors keen to buy the long term story.

 Chart of the day
With rising growth rates, India also stands in the face of energy insecurity. As per a CRISIL report, by 2015, every Indian state will need to source at least 10% of the energy needs from clean sources. Fortunately there are massive sources of renewable energy waiting to be tapped. As today's chart shows, the installed capacities of wind and biomass energy in India are only a fraction of the potential. In fact solar energy that has the maximum potential (20 giga-watt) has barely been tapped. Hopefully these resources will help reduce our dependence on oil and coal.

Source: Mint

Central bankers have received much scorn for their inability to predict the crisis that started in 2008. And they again seem a confused lot when it comes to predicting how this crisis will really end. So the best they can do is meeting again and again and sharing ideas about what's right and wrong for the global economy.

This was the very reason the central bankers (along with some economists) recently met in the US. And once again they were divided over the odds of a renewed downturn. One said, "There's still a significant risk, maybe one chance in three, that there will be a double dip." And then the other retorted that these odds are way too high and instead the chances of a double dip are just "one in 10 or maybe one in 20."

Anyways, whatever these central banks might think of the global economy, they are sure of one thing. And that is - the only way to stay top of any future slowdown will be to continue to print cheap money. Ajit Dayal, the founder of Equitymaster, calls it the policy of rescuism.

He adds, "Given that the Presidents and Prime Ministers of the G-20 have met at least twice since October 2008, and that central bankers have met more times than they can pray 'recovery', and given that the global economy is still on the edge, it would be safe to assume that no one has a clue on what is going on. Or when it will end."

The initiatives to make India's tax structure simple seem to be gathering steam. Take the case of tax disputes for instance. Currently, more than Rs 750 bn of tax payments have been mired in litigations. This represents close to a fifth of the government's annual direct tax collections. And so, to speed up the process of resolution, the IT department has proposed a national e-management system for quick disposal of tax disputes. This move would not only make optimum use of its work force but also free up resources quickly. The move is part of a series of steps planned by the government to make the overall tax system simpler.

It must be noted that direct taxes now are a major resource provider to the central government. These taxes have grown at an average annual rate of 24% in the last five years. They have nearly trebled to about Rs 3,780 bn in FY10 from Rs 1,328 bn in FY05. Thus, in this regard, the government's move to make the tax system simpler and effective makes a lot of sense. It will be a win-win situation for both the government and the people.

The RBI's Corporate Debt Restructuring (CDR) system has seen a sharp jump in the number of cases off late. As per a report in the Mint, CDR system was dealing with 266 cases at the end of July 2010, up from 239 a year back. Aggregate debt being restructured also rose to Rs 1186 bn from Rs 1088 bn during the same period. Part of this rise may be an overhang of the boom years of 2007-08. That was a time when capital raising was very easy for India Inc., and a lot of rash lending took place. The subsequent slowdown meant a drastic change in performance of many companies. And that could well be manifesting itself in the form of this rise in CDR cases.

Another reason could also be an increased incentive for a banks to admit their non-performing loans (NPL) to CDR. Once debtors and lenders enter into CDR, the debt no longer qualifies as an NPL. It is instead counted as a restructured loan. Thus leading to more and more banks being forthcoming about their NPLs. Whereas earlier, they would prefer to rather hide the true level of subprime loans on their books.

If only nature blessed us with more resources. It is easy to think that way. But history shows that natural resources often lead to a lot of misery. And there is no better example than Africa. Its natural bounty has attracted brutal colonists and oppressive regimes for centuries. Even today, everyone wants a stake in Africa. The latest pretext is bio-fuels.

As per Reuters, at least 5 m hectares have been acquired by foreign firms to grow bio fuel crops in 11 African countries. The contracts by European and Asian companies for land to grow sugar cane, jatropha and palm oil to be turned into fuel will involve clearing forests and vegetation. It may be noted that the jury is still out on the net environmental and commercial impact of bio fuels. It may be noted that there is also an ongoing struggle by China and India in acquiring mineral assets in the continent. Clearly, looking towards Africa for mineral and agro resources is a habit the world continues indulge in.

'Cut-throat competition' and 'price wars' are the buzz words in Indian telecoms. The results of all telecom operators have reflected this price war by putting pressure on their margins. The new operators have been bleeding as well. No wonder that some of the new operators have approached DOT offering to surrender the 2G license and spectrum given to them in exchange for the refund of fees of Rs 16.5 bn paid by them.

The DOT is now contemplating various exit options for these new operators. The options range from merging into existing companies to shortening the mandatory period of holding the license by the promoter of the company. If these options come into place, it would lead to the much needed consolidation in the telecom sector. We hope that this would happen soon to bring some rationality in the sector.

After a strong start, profit booking in index heavyweights has brought the Indian indices close to the dotted line. The BSE-Sensex was trading 55 points higher at the time of writing this. Stocks from the IT and engineeringl space saw the maximum profit booking today. Sentiments were positive across the rest of Asia with China and Japan leading the pack of gainers. European markets have started on a cautious note.

 Today's investing mantra
"When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom." - Peter Lynch

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3 Responses to "India Inc.'s margins to fall off the cliff?"


Sep 16, 2010

Good morning

I am very much thankful to you for u r updates the markets in various sectors through u r daily edition of equity master. I expect further follow up like the previous ones in future also.



leonard king

Aug 30, 2010

India Inc. margins are bound to fall, with the rising
rates of interests on corporate borrowings, escalating
input costs will eat in to the corporate earnings. This
is going to become evident from Q2 onwards. The Cos
performances will start getting affected and will be
below the mkt expectations and this will add to the
existing woes of the mkt which is already burdened with
the Global factors


chirag soni

Aug 30, 2010

thanks a lot sir.

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