Next round of growth will come from... - Views on News from Equitymaster

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Next round of growth will come from...

Nov 23, 2009

Indian markets have seen a phenomenal run since March 2009. The Sensex has almost doubled from those levels and stocks across the board have even multiplied 2, 3, or 4 times. During this period, Indian companies, and especially the larger ones, have also refurbished their financial performance. Profits have seen the positive impact of the same. In fact, India Inc.'s profit growth has been strong for two quarters running. But what is still ailing Indian companies is the revival in demand and therefore a recovery in sales. Sales growth for companies across sectors has been mediocre to say the least. Despite this, companies have been able to improve margins. This has come about largely on the back of lower costs - raw material costs, staff costs, and interest costs - all helped by business restructuring. In fact, if one were to go by a Mint report, the 54% growth in profits of India's manufacturing companies in 2QFY10, will shrink to just 8% if one were to take out benefits arising out of lower raw material and interest costs!

Now, that is a big impact that these variables have had on companies' profits..
We however believe that this cannot continue for long. Companies, after some point in time, will have to grow their sales to grow their profits. For that to happen, strong demand has to come back on line again. Now this seems highly unlikely as of now. This is especially considering that lower interest costs, which are expected to spur the next round of demand momentum, are not likely to remain lower for a long time. Inflation is on a rise and so is the RBI's inclination to raise interest rates to cut back on the rising prices..

Of course, one part of the inflation equation is not really in the RBI's hand. We are talking about inflation on account of rising food and commodity prices. But then the RBI will be keen to cut down on any bubble buildup on the credit offtake front. Like what we have seen in the realty space where the central bank recent clamped down on increased borrowings from companies by raising interest rates for real estate loans.

If inflation were to get out of hand again, as is widely expected now, we will see the RBI acting fast. It might raise interest rates directly. Or it might raise lending norms thereby helping increase the cost of funds indirectly. Any of these measures will hurt companies, especially those that rely on bank borrowings for funding their expansion and growth plans.

In short, while we continue to believe in the long-term India story, we remain concerned of the short to medium term. We do not see corporate earnings growth sustaining for long without a pickup in demand. And given the situation we are in at this point in time, it will still take some time for demand to pick up pace again.

In that regards, it will be advisable for investors to stay away from short-term market movements. Pick up stocks for the long term, but only after assessing their quality. And especially stick with companies that do not require large bank borrowings and/or have dirty balance sheets pending for restructuring.

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2 Responses to "Next round of growth will come from..."

N K NIRULA

Dec 5, 2009

Inflationary trends are due the government and RBI policies of printing money without the backing of assets or enterprise values. The increasing government debt scenario, excess liquidity and artificially cheapening our currency vis-a-vis the dollar create these trends.

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Shekhar Vaidya

Nov 24, 2009

I think it is unfair and incorrect to take out the savings from lower raw material costs. When prices of commodities were rising, the industry passes on a major portion of such cost increase to the customers. This inflates revenue as well profits due to 'inventory profits'. The exact opposite happens when the commodity prices drop. The revenue shows degrowth and 'inventory losses' have to be set off against business profits.

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