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Staying Alive - Views on News from Equitymaster
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  • Dec 31, 1998

    Staying Alive

    Or should that be struggling to survive? After promises of growth, India's largest listed companies have had to squeeze profits out of operational and financial efficiencies. Volume growth seems to be a dream that may come true sometime in the future and pricing power determined largely by global forces for most of the Indian companies covered in the 1999 edition of the Quantum Stock Market Yearbook. There will be exceptions to the rule with the software companies and the consumer goods still fairing relatively well. For the year-ended March 31, 1998 the 100 listed Indian companies covered in the Quantum Stock Market Yearbook have managed to increase the net profit margin to 8.7% from 7.8% in FY97. This higher profit in a slowing economy was achieved largely by reducing operational costs. The gross profit margin of the companies surveyed was 23.6% in FY96, 23.4% in FY97, and increased to 25.0% in FY98. 

    At a financial level, the companies also managed to maintain their interest expense at 10% of sales despite a 16% addition to assets (which results in interest being shown as an expense and reduces the profit and loss account, and not capitalised). These larger Indian companies with more negotiating power presumably got their less powerful suppliers and buyers to absorb much of the pain by pushing the working capital burden onto the small companies. The other financier for corporate India was the government - effective tax rates declined from 23.7% in FY97 to 20.0% in FY98. All this contributed to the recovery in the net profit margin from 7.8% in FY97 to 8.7% in FY98. But all that is history. The question now is, with Diwali come and gone, and the promised recovery still elusive what will happen in FY99 and FY2000? 

    Sales of the Quantum 100 will barely increase for FY99 and the next year, if the recovery finally arrives, will me muted because of pricing pressures. Gross profit margins will decline and the effective tax rate will increase. The current lethargy in the economy has resulted in lower capital expenditures which, in turn, will result in lower depreciation benefits and, hence, the higher tax rates. The good thing about the lower capital expenditure is that long term debt will slow and this may result in a lower interest cost - unless the Indian government continues to allow the rupee to weaken. Foreign exchange loans taken by Indian companies in 1994 and 1995 will need to be repaid and re-financed at higher interest costs and with potential fx losses. With the share market unlikely to rise, interest in new issues will be minimal. The most active issues will be rights issues that will be used more as a vehicle for existing managments to increase control over their companies. Share buy-backs will confuse and continue to be modified - like the noise over takeovers. 

    The ability to cut costs and improve operational efficiencies will continue to be the focus for FY99 and much of FY2000. With a government suffering from verbal diahorrea and limited longevity, companies will have to continue to focus on reducing wages per output by lowering salaries per staff, or lowering the number of staff, or making the same number of staff produce more without increasing their salaries. With the wages per employee having grown by 14.6% in FY98 (0.8% in FY97) and the effects of the increase in wages for government employees giving courage to private sector unions to demand more, this will be a tough task for the Quantum 100. 

    And since many of the companies in the Quantum 100 are majority-owned by the government, reducing manpower costs when the prices of onions have increased will be impossible! Exports will continue to be slack and and corporate India will still be a drain on India's fx reserves. In FY98 the Quantum 100 spent US$ 10 billion (40% of India's fx reserves) since their net imports were more than their exports. The government should stop giving incentives to boost exports and force the Indian companies to improve their quality and service and earn their own foreign exchange. 

    One year ago, we expected the Indian economy to show signs of better growth in FY99 - but this may be the worst year and now we can only hope for a better economy in FY2000 picking up steam as it heads into FY2001. Our expectations for a good FY99 were based on the assumption that political stability (which translates into economic stability and job stability) will encourage the Indian consumer to spend and that this consumption will drive the Indian economy forward. The global slowdown, we felt, was "good for the Indian consumer" as prices of products would decline and increase purchasing power. The 18% fall in the Indian rupee has negated much of those potential gains to the consumers and, unfortunately, we are still looking for that political stability that will give the consumer his job stability.

    Meanwhile, even in tough times there is an opportunity for money to be made. Just choose the right sector, and back the right management. 



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