A 7% decline in revenue but a 17% jump in profits is not an earnings scenario that you see often. We are talking of the September 2020 quarter numbers over a year ago for a universe of 1,122 companies. But then, abnormal times throw up abnormal results. How did India Inc achieve these profitability numbers and are they here to stay? Let’s dig into the numbers.
In a scenario where companies cannot grow revenues, the next best thing is to curb costs to keep profitability up. And this India Inc did extraordinarily well in the past two quarters. Raw material costs, obviously, are one key area where companies saved significantly. However, was this uniform across sectors? How about the service sector, where production and material costs have a smaller role to play?
To get a better understanding on the earnings for the listed universe, we explored costs for the listed universe for the September quarter. Here are the key trends:
- Raw material costs weren’t the only front on which companies managed better margins. For manufacturing companies especially, the primary infrastructure and production costs were other areas of savings.
- Cost savings were felt much more in some sectors than others; while the listed universe as a whole saw operating and net margin expansion thanks to lower costs, there were sectors where margins have not seen such a cost-driven boost.
- The total interest outgo for companies is lower for the listed universe in the September 2020 quarter against both the June 2020 and the September 2019 quarters, companies did not economize much on this cost front.
We have explored these trends, as well as company-specific examples, below. We’ll be coming up with separate trends in the overall results, where we look at revenue and earnings growth.
Overall cost and profitability picture
Consider the 1,122 NSE-listed stocks where September 2020 quarter results were available at the time of this analysis. This list excludes banks and financial institutions, both because they’re structurally very different and because the moratoriums would anyway distort the picture. We have also excluded Bharti Airtel and Vodafone Idea, as the size and nature of their numbers skew the overall trends.
For these companies, aggregate revenues shrunk by 7.8% for the September 20 quarter over the September 2019 quarter. This is better than the 34% revenue fall in the June 20 quarter over the year-ago period. But even as sales declined, operating profits (including other income) rose 10.3%.
This growth is thanks to costs falling much more than the decline in sales. Aggregate raw material costs, for example, were 15% lower in the September 2020 quarter over the year-ago quarter. As a proportion of sales, input costs were 45.4% in the recent September quarter. This is well below levels these costs normally are at; between the June 2019 and the March 2020 quarters, raw material costs were at or above the 50% mark.
The table below shows the trends in costs as a percentage of sales in the past 6 quarters.
As you can see, it isn’t just input cost savings that helped profitability. Companies also rationalized spending on actual running and infrastructure costs. Power and fuel outgo, key in many manufacturing sectors, dipped sharply by 13% for the September 20 quarter over the year ago. The WPI indices for fuel and electricity show a steep drop during the lockdown months; these costs are only just rising. The WPI indices are yet to reach the levels at the start of this year, indicating that costs are still on the lower side. Similarly, basic production costs also dropped.
Staff costs, for most sectors, have remained stable even on an absolute basis. Although this doesn’t help margins, it certainly provides comfort on the jobs front! As a result, EBITDA margins stood at 16.9% for the September 20 quarter against the 14.6% in the 2019 quarter (excluding other income). But most of these costs are related to company activity and are variable to an extent; other costs, such as interest aren’t that flexible. Therefore, though interest costs dropped on an absolute basis, they remain steady as a proportion of sales. Interest outgo has not fallen as much as other operating costs, either.
Combined with other costs such as depreciation and taxes, the net profit margin expansion is not as much as the operating margin expansion. Aggregate net profit margins expanded to 8.2% in the September 20 quarter against 6.5% in the year-ago period.
Who managed better?
The overall cost picture provides comfort. Breaking it down into specific sectors shows three trends:
One, a lower cost structure was dominant in some sectors more than others.
One reason is that costs did not uniformly fall across the board. And therefore, some sectors benefited far more than others. Fertilizer stocks such as Coromandel International and GSFC saw cheaper inputs as did gas transmission players Gujarat State Petronet and Mahangar Gas. FMCG companies, on the other hand, as well as a few textile sectors and agri-based sectors saw limited room on the raw material front.
Where power costs play a big factor, those sectors have gained well. Cement companies are an example. Lower prices here saw manufacturing costs and power costs shrink by 2 percentage points as a proportion of sales in the September quarter. ACC saw power costs drop by 4.5 percentage points, while Ambuja Cements dropped 3.2 percentage points. Infrastructure companies and logistics players such as saw similar costs savings as well. Several auto stocks, such as Escorts, Eicher Motors, TVS Motor Company as well as ancillaries such as Amara Raja Batteries saw lower manufacturing expenses; not all these companies saw cheaper inputs.
A second reason could be that some sectors had more variable costs linked to production activity than others. For example, a sector such as retailing – which is service oriented but has input costs in terms of merchandise – was unable to rationalize these costs by much even as store reopenings picked up. Input costs for Shoppers’ Stop, for example, accounted for 67% of sales in the September 20 quarter which is far higher than the sub-60% it has been in previous quarters. Realty companies too saw a higher share of basic materials costs.
Two, companies used other cost rationalizations to keep margins up.
FMCG companies, for example, cut back on adspends to maintain margins. Gillette India, Hindustan Unilever and Colgate Palmolive, for example, saw big drops of 5.7 percentage points, 2.1 percentage points and 1.6 percentage points in the proportion of sales that went into adspends. Durables maker Whirlpool of India, while seeing higher raw material costs managed to keep staff costs in check to maintain profitability.
Sectors such as IT, where manpower is the primary cost, also kept margins stable through lower general running costs and some savings on staff costs as well. Infosys, for example, cut its travel expenses by a good 71% in the September quarter over the year ago. Meanwhile, TCS effected a 43% cut in equipment and license costs while also cutting down consultant costs.
Three, in some sectors, significant drops in costs as a percentage of sales came about simply due to a lack of activity.
An example here are sectors such as aviation and hospitality which took a heavy hit on the revenue front. For example, both SpiceJet and Interglobe Aviation had revenues 60% below that of the September 2019 quarter. A lower proportion of fuel and staff costs could be more due to the lower activity than real costs savings. As a result, cost savings may not sustain once normal activity picks up.
This excel sheet lists the Nifty 500 companies along with the main cost heads as a proportion to sales for the June and September quarters for 2020 and 2019. You can sift through this sheet to see how companies have made savings on the cost front.
For a good many sectors and companies, savings and profitability appear to have come about due to cheaper operational costs. In others, companies have tried to rationalize costs even without help on the input or production front.
From here, as normality resumes across sectors, two points will matter.
- First, bringing revenue growth back up. Sustained profit expansion can come about only when topline improves, no matter how much costs are controlled. Besides, for sectors where margin expansion came in due to marked fall in production costs and lower activity levels, how costs pan out once production picks back up needs to be seen.
- Two, especially in companies in the service sector, the extent and impact of a structural shift in the way of doing business and costs. In two main sectors here, finance and IT, there is a possibility of a permanent reduction in both travel and execution, which can bring a shift in margins. Reduction in travel for IT companies through virtual sales and delivery and digitally driven products in the finance space are examples.
The market appears to be already factoring margin expansion, uptick in sales numbers of key sectors, and improvement in high-frequency economic indicators into stock prices. However, there may yet be opportunity to sift through the ones that will make a permanent shift in their cost base when they move to a post-Covid world and those that won’t.