Interest costs hammer profit margins thin

A recovery in profitability is some time away, it appears from the earnings reported by companies for the quarter ended December.

Net profit margins of the top 500 companies have been the second-worst in three years as rising interest costs offset the gains from lower input costs.

For the 181 companies (excluding banks and financials) that have reported numbers so far, aggregate interest cost as a percentage of revenues was up at a three-year high of 2.91%.

As a result, the net profit margins of these companies — representing  nearly half of the total BSE market capitalisation — have been subdued at 8.19%, which is only better than the 7.86% logged in the quarter ended June.

Blame it on a consistent fall in revenue growth, lower contribution of other income and lower transmission of rate cuts by banks due to tight liquidity.

“Revenue growth, which is a function of domestic investment climate and consumption trends, has seen moderation. So, even as the lower commodity prices have helped operating (Ebitda) margins to bottom out, the lower revenue growth has meant companies have not been able to increase operational efficiency. The working capital cycle for leveraged companies continue to remain stringent and interest costs high,” said Rajat Rajgarhia, director Research at Motilal Oswal Securities.

To be sure, a slower increase in input costs (at 13.06% on-year) has helped operating profits grow 19.32% for these 181 companies – the best in the last six quarters.

Still, experts don’t see net profits improving in a hurry going forward, despite the downtrend in the rate cycle kicked off by the Reserve Bank of India.

“For corporates to see improvement in profit margins, the revenue growth has to rebound substantially and the interest rates need to come down by a further 50-75 bps. Considering this, we may have to wait till the second half of fiscal 2014 to see the bottomline improving,” said Rajgarhia.

Bharat Iyer, India equity strategist at JP Morgan, doesn’t see that happening anytime soon as system liquidity remains tight and reducing lending rates without a commensurate decline in borrowing costs implies reduced profitability for banks.

“Against this backdrop, it is not surprising that the banking system’s response to the cuts announced by the RBI has been muted. We believe that expectations of benefits to local cyclicals from lower rates, if any, will come with a lag. There appears to be limited fiscal and monetary space to simulate growth in the near term,” Iyer wrote in a note last week.