Recession Equals Bonanza

Officially, the Indian economy is in recession, which is defined as negative growth in two consecutive quarters. This was indeed the case in April-June and July-September this year. But what we forget is that while crises like the present one hurt a majority of families and firms, they result in super-normal profits for the ones that are able to keep their heads above the water. Economic shocks can positively energise sectors and segments in many ways.

Even if this realisation sinks in, you will not believe this. In the July-September quarter, the combined profits of 4,076 companies, which are listed on the stock exchanges, were the “highest... made by all the listed companies in any quarter”. According to CMIE, the total profit-after-tax (PAT) of these firms in the quarter was almost 31 per cent higher than the previous best record, which was witnessed by a larger set of 4,854 companies in Q4 (January-March) 2013-14. One can argue that the 778 extra firms in the latter set were possibly loss-making ones, which pulled down the returns. It may be difficult to compare similar sets since new companies were listed on the exchanges, and some delisted, since March 2014. Let’s compare figures for the list of 4,076 companies. In the July-September this year, contends CMIE, their combined profits were an unimaginable 171 per cent higher than what they earned in the same quarter in 2019.

This seems impossible. In the quarter under scrutiny, the GDP contracted by 7.5 per cent, after a debacle in the previous April-June one, when growth tumbled by an unbelievable 23.9 per cent. Between July and September, the economy limped unsteadily out of a series of complete and partial lockdowns. In fact, the various corporate databases show that total sales of the 4,000-odd listed companies fell by 5-7 per cent during these three months. How can profits shoot up in such situations?

Welcome to the counterintuitive world of corporate earnings, where disruptions can lead to bumper profits. “For many, COVID-19 was a great opportunity, which comes once in a lifetime. People exploited the crisis to make more money. I would not put it beyond the corporate world to do the same. While the economy slipped, wealth went up,” says Jagdeep Chhokkar, a former professor in IIM(A). In this case, however, the reasons went beyond unbridled greed.

Four factors were responsible for this upside-down turn of events. The first is distorted sales–lower volumes led to larger profit margins as prices per unit went up. The second is a huge dip in costs under several heads. The third includes the efficiency gains due to strategic changes. Finally, don’t underestimate the impact of external issues like the deliberate and knee-jerk policies initiated during a crisis.

Sales slide and soar

As expected, sales slumped as the economy dived. But the impact was surprisingly lower-than-expected. Ace Equity’s database shows that in the July-September 2020 period, the combined net revenues (net sales plus other operating incomes) of 4,000 listed firms were 7 per cent lower than the figure in the same period in the previous year. They had tanked by 29 per cent in the April-June 2020 quarter. A CMIE executive agrees that the total turnover in Q2 2020-21 “just got a little worse”.

One of the reasons was that the demand for certain goods rose during the ‘unlock’ phases. Deven Choksey, MD, KRChoksey Group, says, “The (July-September) quarter was favourable to firms that were beneficiaries of normal unlocked situations or found takers for their products.” Adds Adi Godrej, chairman, Godrej Group, “There was good demand in the soaps and household insecticides segments. Apart from Covid, buyers were worried about other diseases like dengue and malaria.”

What helped, and was completely unexpected, was that even as volumes went down, the per unit prices in many cases moved in the opposite direction. This dented the drop in revenues in value terms, improved margins, and added to the profit numbers. It reflected in retail inflation, or the prices paid by the consumers, which was a high 7.61 per cent in October this year. Food inflation jumped from 7.87 per cent in June to over 11 per cent in October.

Costs crash, salaries sink

Profitability surged further because expenditures plunged. According to the CMIE analysis, “(for the 4,000-plus firms) expenses fell more sharply than sales did” in the July-September quarter. One of the major savings was in the purchases of raw materials (and components), and finished goods for resale purposes. Manufacturers generally resort to the former, and services firms largely opt for the latter. But these are crucial for non-financial companies, which do not include banks and NBFCs.

In July-September 2020, these two heads accounted for 50 per cent of the net sales of non-financial firms, which was the second-lowest since April-June 2008. The lowest was in April-June 2020, the worst-affected period due to lockdowns. In a piece, Mahesh Vyas, MD and CEO, CMIE, wrote that the “fall in expenses on raw materials and finished goods was significantly greater than the fall in the top-line. The profits, therefore, did not shrink and in fact grew even though the business shrank.”

Sackings, salary cuts, and part-closures reduced the outgo on workers. “Our study of 2,000 NSE-listed firms shows that wage bills in some cases declined drastically. Since March, firms slashed salaries, and reduced the variable payouts,” says Pranav Haldea, MD, Prime Database. “There were lower overheads and operational costs due to WFH, travel curbs, and lesser maintenance,” adds a senior manager in an IT firm, which saved $4 million on account of air-conditioning in its offices.

Strategy shifts, tactical tricks

Firms that faced major upheavals resorted to innovative instruments, both strategic and tactical, to counter the crisis. A few used their factories to produce items like PPE kits (personal protective equipment), which had attractive sales potential. Others managed their cash better to earn extra bucks. Some hiked productivity through the use of less raw materials and manpower. As Vyas wrote in his article, “Efficiency gains are obtained by companies engineering structural changes....”

One of the ways to achieve this objective is through effective inventory management. During the lockdowns and unlock periods, the logistics of buying raw materials is decimated and goes haywire, and pushes up costs and risks. This forces management to use existing stocks, and delay purchases. While this reduces expenses, it enables companies to inculcate long-term strategies that are based on how to run operations efficiently with lower purchases.

Experiences prove that lessons learnt during crises are embedded in corporate cultures. They are not lost, and firms don’t return to original practices. According to Vyas, “Business managers do not waste a crisis easily.” He is confident that companies will continue to “manage with lower stocks”, and the ratio of raw materials to net sales “will structurally fall further as companies worry about the increased risks and uncertainties of the post-pandemic world”.

Surprising shocks, policy plots

Despite lower volumes, firms witnessed increases in selling prices and cuts in costs, and took decisions to drive efficiencies. Obviously, this isn’t true. There were wild variations at several levels. The organised sector stood on firmer ground, even as the earth shattered under the feet of the unorganised. Thus, the profitability of listed lot may present an unfair picture.

“There is pain among the unlisted and smaller companies. Their plight isn’t reflected in the figures,” explains Haldea. Experts contend that the official data about the unorganised segment will be available after a lag of a few months due to COVID, and other reasons. Thus, the complete story about corporate earnings and corporate health will be known only by March 2021. If there are major shutdowns among firms in this sector, GDP recovery will be delayed until 2022.

Within the universe of listed companies, the non-financial ones did better than the financial services counterparts (banks and NBFCs). While the profits of the former zoomed by 215 per cent in the July-September quarter, those of the latter were up by 100.5 per cent. However, the figure for the banks was a whopping 297 per cent. There were several laggards such as mining (quarterly profits plummeted by almost 50 per cent), electricity (grew by a negligible 0.5 per cent), and NBFCs (rise of 8 per cent).

According to CMIE, the manufacturing firms, which accounted for 47 per cent of the PAT of 4,076 firms, “made a killing in operating profits” largely due to “lower spends on raw materials and (purchase of) finished goods”. But the increase in PAT, which deducts the expenditures on interest and depreciation, and provision for taxes, was a minimal 15.2 per cent. “Yet, they made record profits” which were 16.7 per cent higher than the previous best performance in April-June 2018.

Photograph by Soumik Kar

Construction was hit by “stressful” and “extraordinary” circumstances. An upsurge in “extraordinary expenses” of the 208 listed companies led to an “aggregate loss of Rs 25 billion (Rs 2,500 crore)” in the July-September quarter this year. But larger surpluses due to extraordinary profits from “discontinued operations” enabled the segment to be in the black. In essence, the existing business suffered and, in the near future, the sustainability of the gains remains questionable.

In a similar vein, the lack of extraordinary expenses helped the non-financial firms (different from financial services ones). In July-September 2019, they incurred cumulative losses because of the telecom companies. The latter were forced to make provisions for unpaid payments on account of adjusted gross revenue (AGR) due to a Supreme Court ruling. This vanished in 2020, which enabled them to clock enormous profits.

The positive, but unintended, bang due to policy initiatives was visible in the banking sector. The stimulus packages to revive the economy pushed down interest rates, gave moratoriums to firms and individuals, and allowed the banks not to show their bad loans on the profit-and-loss accounts. The combined effect was that their revenues went up in the July-September period, and interest costs (banks borrow too) grew marginally. The result: an enormous jump in profits. In fact, this was a sector, whose salary costs shot up by almost 23 per cent.

Of course, the questions on everyone’s mind are whether the profitable trends are sustainable, and can they inflict the sectors that haven’t benefited till now? Deven Choksey feels that margins will be under pressure in the near future. Sales volumes can taper off, after spikes during the festive season, and per unit prices may come down as inflationary pressures ease. The prices of raw materials, especially commodities and metals, may move northwards.

Don’t be shocked if the corporate profits in July-September this year, and the ongoing October-December one that may turn out to be impressive too, disappear like minor, but bright, blips.

Even if, as RBI predicted, GDP growth becomes positive in this quarter (0.1 per cent) and the next one (0.7 per cent).

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How Profits Rose