India Inc: Navigating a Challenging Q2 with Resilience in ROCE

The Indian economy is currently grappling with discussions of a slowdown, with many attributing the lackluster performance in corporate profits to untimely and severe rains as well as the impact of an astrologically inauspicious period during Q2 FY24. These factors have reportedly led to deferred large purchases and a general postponement of new ventures. While some consider this slowdown temporary, the data reveals that Q2 was indeed challenging for corporate India.

The Centre for Monitoring Indian Economy (CMIE) data, encompassing 3,291 listed non-financial companies, reveals a 9% year-on-year (YoY) decline in net profits after adjusting for exceptional items. This sharp drop highlights the hurdles faced by corporate India in maintaining profitability during this quarter.

Manufacturing: A Sector Under Pressure
Manufacturing companies, which form the backbone of the economy, witnessed significant stress. Their net profits plunged by approximately 20% YoY in aggregate terms, indicating the challenges brought about by higher costs and demand constraints. Even when excluding petroleum products, the sector’s net profits grew by a modest 5.3% YoY, which is a stark contrast to the robust 20.8% growth witnessed in Q1 FY24.

The subdued performance can largely be attributed to elevated input costs, erratic rainfall disrupting operations, and weaker-than-expected consumer demand during the festive season. These factors combined to weigh heavily on the manufacturing sector’s profitability.

Non-Financial Services: A Silver Lining
In contrast, the non-financial services sector emerged as a relative outperformer. The sector’s net profits after exceptional items grew by an impressive 22.55% YoY. While this growth represents a deceleration from the 28.2% YoY growth recorded in Q1, it still indicates the sector’s resilience in navigating economic headwinds. Sectors such as IT services, hospitality, and transportation appear to have contributed significantly to this growth, buoyed by sustained demand and improving business conditions.

The Bigger Picture: ROCE Shows Resilience
Despite these challenges, a broader view of India Inc’s financial health reveals a noteworthy silver lining. Data from 3,094 listed non-financial firms shows that the aggregate Return on Capital Employed (ROCE)—a key measure of profitability and efficiency—improved from 8.04% in March 2024 to 8.38% in September 2024.

Interestingly, this improvement in ROCE is primarily driven by the non-financial services sector, which continued to leverage its growth momentum. Manufacturing firms, however, saw a decline in ROCE, reflecting the profit pressures mentioned earlier.

What’s remarkable is that the ROCE of 8.38% is significantly higher than the levels recorded in the pre-COVID era, suggesting that Indian firms have made strides in optimizing capital efficiency in recent years. The financial services sector also showed progress, with its ROCE at 4.74%, a marked improvement from the challenges of the pre-COVID years when bad loans were a major concern for banks and non-banking financial companies (NBFCs).

Earnings Estimates Revised Down
The subdued Q2 performance has prompted analysts to revise down earnings estimates for several companies. Weak consumer sentiment, unpredictable weather patterns, and global uncertainties continue to pose risks to profitability in the near term. However, the resilience shown in ROCE indicates that many firms have been able to adapt to these challenges, leveraging cost efficiencies and maintaining a healthy balance sheet position.

Lessons from the Data
The data paints a mixed picture. On the one hand, the fall in manufacturing profits underscores the challenges of rising costs and fluctuating demand. On the other hand, the strength of non-financial services and the improvement in ROCE reflect the adaptability of Indian companies.

For investors, this dichotomy offers valuable insights. While sectors such as manufacturing might face near-term headwinds, areas like IT, hospitality, and financial services could present growth opportunities. The ROCE metric serves as a reminder that capital efficiency remains a critical factor for evaluating corporate performance, especially in times of economic uncertainty.

Outlook for Corporate India
Looking ahead, the trajectory of the Indian economy and corporate earnings will largely depend on a few key factors:

Macroeconomic Stability: Inflationary pressures and global interest rate movements will play a crucial role in shaping corporate margins.

Policy Support: Government measures to boost infrastructure spending and manufacturing, coupled with sector-specific incentives, could help revitalize growth.

Consumer Demand Recovery: A rebound in consumer sentiment, driven by stable incomes and lower inflation, will be essential for driving volume growth across sectors.

Global Trade Dynamics: Export-oriented sectors will need to navigate the complexities of slowing global demand and supply chain disruptions effectively.

Conclusion
Q2 FY24 may have been challenging for India Inc, but the resilience in ROCE indicates that Indian companies are better equipped to handle economic headwinds than they were in the pre-COVID era. While challenges persist, particularly in the manufacturing sector, the strong performance of non-financial services and the improving efficiency in capital utilization provide hope for a better second half of the financial year.

For investors, the focus should remain on sectors and companies demonstrating robust ROCE and the ability to adapt to evolving economic conditions. With policy support and a potential recovery in demand, corporate India could be poised for a stronger performance in the quarters to come.

As the economy navigates this slowdown, it’s clear that the foundations for sustainable growth remain intact, offering a promising outlook for long-term stakeholders in India’s growth story.

The image added is for representation purposes only