Moneycontrol Pro Panorama | A squeeze in profitability on the horizon?

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That’s a real possibility for Indian companies, even if it’s a near term risk. They have just come from an incredible run in FY21, when despite the pandemic hitting hard in the first half, they reported a 57 percent increase in profit over a year ago. Much of that was due to cost savings and better efficiency, translating to fat gains in operating profit, as we recently noted.

But FY22 has started off on a dull note even if not as bad as a year ago. There’s no national lockdown this year but a string of localised lockdowns have hurt the income of businesses and individuals. Still, these lockdowns may have a lower impact on sales growth compared to the national lockdown. We will know when the June quarter results are out. ​But concerns on the profitability front are mounting.

The IHS Markit Services PMI number for May came in at 46.4 compared to 54 in April, a sharp fall and also the lowest since August. This was not surprising because people movement has become restricted and places such as malls, restaurants (for dining-in) and theatres are shut. As lockdowns ease this will improve.

But, what catches attention is that service providers did not pass on cost increases in the face of lower demand. That poses a risk for margins. Thankfully, manufacturing PMI responses, reported on June 1, had shown that firms did hike prices though the pace was softer compared to April. That companies are feeling the need to absorb cost increases reflects a difficult demand environment.

One way they can gain confidence is if demand snaps back. States have indeed begun to ease restrictions but are doing so gradually so that cases don’t spike again. Demand could remain subdued for longer even as rising costs crimp margins.

One way to boost sales growth when domestic demand is weak is to export more. That is visible in the data for May too, which shows a healthy jump even over May 2019 levels, as seen in our Chart of the Day. Higher exports can help companies grow their sales but typically domestic sales earn higher margins than exports do, due to competitive pressures in overseas markets.

A dip in margins may not be such a bad thing if it were accompanied by a substantial jump in sales in FY22, as expected before the second wave struck. But a dip in margins and a slowing of sales growth may not be the scenario anticipated by gung-ho investors. Keep a watch for this risk in the coming quarters.

Investing insights from our research team:

Muthoot Finance: A golden road ahead

Value innerwear: Is the steam still left in stocks, post the stellar run-up?

Motherson Sumi: Strong show, accumulate on dips

AC companies: How cool are they as investment bets?

What else are we reading today?

Interview | L&T revenues should double in five years without compromising on profitability: CFO R Shankar Raman

Unemployment in South Asia will remain higher in 2022 than in 2019, says ILO

The noise around CEO salaries in India is highly misplaced

Chart of the Day: Real policy rate is negative in India

The revolution in DIY testing that will outlive the pandemic (republished from the FT)

Technical picks: Punjab National Bank, L&T Finance Holdings, Apollo Tyres and Motherson Sumi (These are published every trading day before markets open and can be read on the app)

Ravi Ananthanarayanan

Moneycontrol Pro