More Qs Than As

You can count on Union finance minister Palaniappan Chidambaram to deliver an upbeat speech, full of enthusiasm and laced with good news. But even this die-hard optimist was uncharacteristically sombre during the inaugural address at cii's annual session last week. He talked at length about the negative impact of rising crude prices: "If oil prices remain high, it'll rob developing countries (like India) of some valuable (economic) growth percentage points." What he forgot was that there could be a further impact due to inflation, sluggish demand, poor agricultural growth and, of course, the spectre of rising interest rates.

Largely unknown to him, and to many others, India Inc is already beginning to feel the heat. In their corner-room offices, CEOs are busy reworking figures; more often than not, they are downgrading them. A recent survey by ncaer found that most business leaders were not too sure about the corporate results for the next two quarters, and the think tank's business confidence index slipped several notches. "Last year, analysts were predicting high growth rates (for companies across sectors)—around 35-50 per cent—and those were coming true. But I think that is behind us now," predicts Andrew Holland, executive VP, DSP Merrill Lynch. Adds Dharmesh Mehta, head (broking), Enam Securities, "I think the next quarter will be crucial because that's when the impact of factors like rising oil prices and patchy monsoons will be felt."

But, contrary to common belief, the Q2 results for this fiscal have been a kind of "mixed bag." While most market leaders have done well—sometimes even going beyond expectations—there have been a number of laggards who seem to be grappling with both top- and bottomlines. Within the same sector too, often the financials have been inconsistent (see 'Size Matters' on Page 76). "Last year, growth was on a smaller base. Now, it'll be harder for firms to grow at the same pace," explains Jayesh Seth of Kantilal Chaganlal securities. That, when discounting the danger signals that are flashing in several boardrooms.

Rising fuel prices, and their multiplier effect on inflation, is a clear dampener. Admits Brijmohan Lal Munjal, chairman, Hero Honda, "This is a big concern not merely because motorcycles run on petrol. Oil has an impact on everything and something needs to be done." Taking this logic another step forward, Dilip Chenoy, director general, Society of Indian Automobile Manufacturers, contends that, beginning March next year, "we expect the sector's growth to slow down". And he's talking of the auto sector, which has witnessed scorching growth in the past couple of years. Even in Q2 this year, firms like Maruti, Hero Honda and Hyundai have posted exceptional results.

Apart from dependent segments, higher crude prices are not good for some oil companies either—at least not at this stage. Since the government is cagey about raising the domestic fuel prices in line with global ones, oil firms are being forced to absorb the losses on the marketing front. That explains why Indian Oil showed a 31 per cent dip in its net profits in Q2, 2004-05, compared to the same period last year. But exploration firms like ONGC are reaping the benefits of higher global prices.

What's crucial is that if the government raises domestic prices, as it will have to do in the near future, inflation may only rise further. An RBI estimate indicates the figure will be 9.3 per cent, rather than the current 7.1 per cent, if domestic fuel prices are hiked to match global rates. And that will wreak havoc on all calculations—micro (at the corporate level) and macro (at the economy level).

It's common sense that higher inflation implies a rise in input prices, and that has happened in the recent past.Firms that have done badly in Q2 have been hit by a hike in prices of raw materials like metals, rubber and plastics. Ashok Leyland announced a drop of 20 per cent in net profits, largely because cost of raw materials, as a percentage of sales, went up from 62 per cent to 64.6 per cent. Even companies that have done well, like Maruti, have admitted an upward pressure on the cost side. "Prices of steel and other commodities are up now and we'll see margin pressures kicking in," explains Holland. He adds that some sectors will certainly be downgraded by investors, who'll also be rather too cagey to upgrade others.

Prices have also been moving northwards because of global demand-supply mismatches. In case of metals like copper, steel and aluminium, international prices have skyrocketed. That has had a similar impact domestically and, obviously, these sectors are booming. For instance, Jindal Vijaynagar Steel registered a whopping 252 per cent increase in net profits this Q2 and its sister concern, Jisco, a 33 per cent rise. Steel firms are also riding an export wave, as demand from nations like China and the US is surging. They might suffer if China manages to cool down its growth from double-digit levels to 7 per cent, as it proposes to do this year. The reason: if the Chinese demand is sucked out, global commodity prices may fall. On the positive side, it may provide relief to users of these raw materials.

The fortunes of some companies are being influenced by factors that are unique to their sectors. Pharma is a prime example where the big boys like Ranbaxy and Dr Reddy's Lab haven't done so well in Q2 this year, but smaller firms like Cadilla have posted excellent results. Experts say the reason for this is that most pharma companies are eyeing the lucrative US market, especially in the post-WTO regime in 2005, and are investing huge sums in R&D and employees. But the concurrent revenues are not flowing in. Shahina Mukadam of hdfc Securities told CNBC that she expects sectoral financials to be unsatisfactory for the next two quarters.

Banks too have been hit by factors beyond their control. The increase in yields of various government bonds in recent times have impacted their trading incomes. Therefore, banks like Vijaya Bank, UCO Bank, Bank of Rajasthan and UTI Bank have reported lower profits this Q2. Even a giant like ICICI Bank witnessed only a 10 per cent increase in net profits, despite a 25 per cent growth in its loan portfolio. Anyway, ICICI's Q2 financials were way below Dalal Street's expectations.

So, hold your breath and prepare yourself for a bumpy corporate ride. Don't think that the corporates will continue to do well; you may well find certain sectors doing badly across the board. And while some firms in a sector may continue to do well, others will find the going both rough and tough. Predicts Amitabh Chakraborty, head (research), Kotak Mahindra Securities, "I think we have seen the peak growth for the year in the second quarter. The next quarter will definitely be slower."

If that happens, Chidambaram will have a difficult time ahead ensuring high economic growth, raising revenues as estimated in the last budget and managing the fiscal deficit.