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Can strong earnings growth continue?
Mon, 1 Feb Pre-Open

We are nearing the end of December 2009 quarter result announcements of India Inc. And the overall performance so far has been good to say the least. But while the overall profit growth has been pretty good so far, sales of most Indian companies has yet to pick up pace. This can be seen from the fact that while profits (for the 447 companies from our universe that have announced their results so far) have grown by 24% YoY during the quarter, this has come on the back of just 11% YoY growth in sales.

* Performance of 447 companies from our universe that announced results until last week;
Source: Equitymaster Research

So what reason can we attribute for such a strong growth in profits for India Inc? And is this growth really sustainable or is it just due to a one-time impact of the government stimulus?

The answer to the first question is clear. This quarter's profit growth has largely been on the back of cost cutting from a whole host of companies. Some have seen their staff costs come down. Some have benefited from lower interest payments. And then there are others who have see their raw material costs come down owing to the lower commodity prices (on a YoY basis). Overall, it has been lower cost than higher sales that have led to this strong rise in profits for India Inc in the December 2009 quarter.

Coming to the second question - is this growth sustainable or is it just due to a one-time impact of the government stimulus? Yes and no!

Given that this growth in profits has come largely on the back of cost cutting by enterprises, it isn't sustainable in this form. We mean companies can cut costs only to a certain level to growth their profits. This cannot go on for long. The more businesses cut costs (like by firing employees or freezing pays) the more their sales go down, because consumers (who are also their employees) have less money to spend. We are already seen pay hikes coming back to IT companies.

Then, if are to go by the hints coming out of the RBI, the government's stimulus measures have also helped create such a strong growth in profits for Indian companies. This is especially true of sectors like real estate where the government's policies did not let some companies go bankrupt despite their inability to pay off their heavy debts. The RBI's own low interest rate regime has helped debt-heavy companies restructure their loans.

But this cannot continue for long. The RBI's latest CRR hike stance indicates this. And the central bank has also advised the government to mend its ways and start the process of exiting the stimulus. Otherwise, while Indian companies will enjoy some good times in the short run, they will see the pain postponed for later days.

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