Nothing to cheer

IT'S NOT JUST THE economy that affects the 500. Ownership matters. This year, 83 companies on the list are government-owned, 370 are from the private sector, and 47 are foreign-owned. The revenue of government-owned companies, which account for nearly 40% of the total revenue of the 500, grew 26.75%. Their profits, which account for nearly 42% of the total profits, rose 8.54%. Private sector outfits, which account for nearly 56% in revenue and over 52% of profits, grew 22.6% in revenue, while profits declined 9.82%. For the 47 foreign companies, which account for 4.5% and 5.9% of revenues and profits respectively, revenue increased 13.7%, while profits declined 9.64%. Clearly, for government-owned companies, protection pays.

And where do these companies come from? Delhi and its suburbs are the headquarters for 98 companies, which accounted for 25% share of revenue and 27% of profits. Mumbai houses the head offices of 185 firms, which accounted for 48% revenue and 43% profits.

THE SLOWDOWN DOES NOT seem to have affected companies much, judging by this list. Despite GDP growth slowing to 5.3% in the last quarter of FY12 from 9.2% in the same period in FY11, the latest Fortune India 500 shows that India’s largest corporations have grown 23.76% over the last year. But don’t uncork the bubbly just yet: The vibrant top line growth (21.4% last year) is coupled with a negative growth in net profits. While net profit grew 21.6% last year, this year it’s -2.98%. Even median profits, which grew at a decent 6.4% last year, have shrunk by 2.5%. Exclude banks, non-banking financial services, and oil and gas companies (90 companies), which have heavy revenues and tend to skew the distribution of financial parameters such as profits and interest, and the picture gets grimmer; for the remaining 410 companies, growth in revenue stands at 19.24% coupled with a 10.98% decline in net profit.

The bad news just keeps increasing. The cash and bank balances of the Fortune India 500 grew by a paltry 0.5% compared with the previous year. Total debt grew 18.59%, while for the 410 companies it was higher at 26.94%. Mukesh Agarwal, president of Crisil Research, says sectors such as construction, infrastructure, textiles, hotels, shipping, and aviation were worse off because of high debt and a weak business environment.

Raamdeo Agrawal, joint managing director of Motilal Oswal Financial Services, says that such times test the real competitive advantage of companies. Compare Bharti Airtel and Reliance Communications. Bharti, which moved up two ranks to 11 this year, boasted a 19.7% increase in revenue though profits fell 26%. Reliance Communications, which slipped 16 ranks to 51, saw revenue fall by 12.05% and profits by 31%. The reason: Bharti has invested in attracting customers who spend more.

There was little cheer for shareholders as dividends slumped. Against a 15.4% increase in dividend payouts in 2011, the growth in 2012 is a muted 9.48%. Government companies, which account for over 45% of all dividend payout, registered a 15%-plus growth in 2012. That’s substantially higher than the 4.62% dividend growth of private companies (which account for 48% of dividend payout) and the 9.22% growth of foreign-owned firms (7% of the total).

There are multiple reasons behind the increase in top lines. Some sectors—oil-linked products, metals, agri-commodities, etc.—saw rising prices, thanks to higher input costs. The sharp depreciation of currency, especially in the second half of FY12, helped others in export-oriented industries.

The larger companies fared better than the ones lower down the list; companies that earned above Rs 10,000 crore showed a higher increase in revenue than the full 500. Ditto for profit growth, except for 14 companies with revenues between Rs 15,000 crore and Rs 20,000 crore, whose profits fell 13%. The smaller companies (under Rs 5,000 crore), suffered the most. These companies lack pricing as well as negotiating power, and have been badly hit by the slowdown.

Though revenues seem encouraging when weighed against moderate GDP growth, a large part of it was because of high inflation, says Bharat Iyer, executive director and head of India equity research at J.P. Morgan. “The number of units sold instead of the rupee value of sales would have led to a different conclusion.” Average inflation was 8.96% in FY12. Between April and October this fiscal, it was 7.63%—well above the Reserve Bank’s comfort level. Add the negative trend in the index of industrial production—from an average of 3.05% during FY12 it has dipped to 2.91% in the current fiscal (April to September)—and a gloomy picture emerges.

Inflation is also responsible for lower profits. For the 500, the cost of raw material went up by 29.44%, employee costs up 15.28%, energy by 24.81%, and financing costs rose by 43.3%. Sunil Singhania, head of equity investments at Reliance Mutual Fund, says interest costs accounted for 50% to 60% of earnings before interest, depreciation, tax, and amortisation for many companies. “But we have seen the peak, and chances of interest rates moving down are higher now,” he says. Not all these increases could be passed on to the consumer, resulting in a direct hit on profits. The rise in these costs is highlighted by the stark variance between operating profits and net profit. Even though operating profits grew 18.25% over the previous year, net profits fell 2.98%.

The slowdown is an outcome of a weak investment cycle coupled with wobbly sentiments, both here and abroad. The MSCI (Morgan Stanley Capital International) Asia index points to corporate debt-equity ratios at 15-year highs. “You need higher profits for the situation to improve,” says Iyer.

Weak consumer sentiment and high interest rates have caused increases in working capital. For this reason, liquidity for some sectors will remain tight, though Ridham Desai, strategist and head of India equity research, Morgan Stanley, thinks the worst is over. The last two quarters have begun showing improved asset utilisation, with reduced costs of capital, and an improved outlook for growth, which may improve returns. The overarching worry, though, is the continuing lull in capital expenditure.

Quarterly disclosures around the proportion of promoters’ holdings pledged is an indication of what’s going on. Data available for 170 companies of the Fortune India 500 show that the market value of all promoter holdings pledged, as on Nov. 19, was Rs 1.18 lakh crore ($21.5 billion), 95% of which was by Indian promoters. Kingfisher Airlines, which fell in the rankings from 130 in 2011 to 176 in 2012, has its entire 32.3% Indian promoter holding pledged as of September 2012. Then there’s Orchid Chemicals & Pharmaceuticals (down to 408 from 371): Of the 32.4% shares held by Indian promoters as of September 2012, 77.4% is pledged.

However, this tactic is riskier for mid- and small-sized companies. In a volatile market, if the falling share price pulls down the value of the pledge, once trigger levels are reached the promoter will need to pledge more or stump up other collateral.

Performance by sectors also shows how the slowdown is unfolding. Shipbuilding, health care, and infrastructure development witnessed high growth in revenue, but profit growth slowed. There were a few outperformers—non-banking financial services, banking, IT, and consumer goods all posted double-digit growth in revenue and profits. Sectors such as sugar and telecom, meanwhile, saw a slide in both revenue and profit. Going forward, Morgan Stanley’s Desai is betting that cyclical sectors, including financial, consumer, and industrial will perform better.

It’s not been all bad, however. Gross margins have started improving this fiscal. Raw material costs are now rising slower than output prices and there are signs of margin expansions after several quarters of compression. Desai sees the trend continuing in 2013.“We are in the process of consolidation over the next two quarters, but GDP growth will take four to six quarters to reach respectable levels again,” adds Iyer. “A full blown recovery is contingent on the right policy decisions.”