By Sourajit Aiyer
Last week, in an article, I looked at the reasons behind the slow growth of wages in India. They have a lot to do with the slowdown of profit growth. One way to boost profits is to invest, but for this you need to raise capital; so let’s take a look at the background and prospects for capital raising by Indian companies.
In the last 10 years, Return on Equity (ROE) declined from more than 20% to under 10% for all listed companies, while profit margin halved from 10% to 5%.
But Indian companies saw appreciation in PE valuation in the last two years following the 2014 elections. This depicts the change in investor perception between FY15 and FY16. FY15 saw renewed interest in the mid-cap space and several large-cap banking and infrastructure companies were hit; and so PE for all companies went up much higher compared with that of Top-500 companies.
But FY16 saw a return of investor interest to the safer large caps, and PE of companies outside Top-500 saw a drop. However, all companies are yet to declare results for FY16.
The profits of the companies have to pick up if the valuation gap is to re-rate. Otherwise, that might restrict the realistic chances of capital raising by the broader set of companies, since many may see large gaps in valuation vis-a-vis fundamentals.
Since the policy-makers want a broader set of companies to invest in capacity and private sector banks are wary because of legacy asset quality issues, the capital markets will the main source to raise money. Only those companies that can realistically evince investor interest from the capital markets will be the beneficiaries.
The YoY revenue growth of 3% in FY15 was just above the average WPI inflation of 2%. Assuming the difference between WPI inflation and revenue growth is an indicator of the underlying volume-growth, this low of 1% shows the stagnation of demand.
Moreover, the difference between year-on-year growth in profits and year-on-year growth in revenues tapered over the last decade. With most companies tightening the screws on operating efficiencies and cost-rationalization, the pressure on increasing the revenue base is high, and a push to volume-based demand holds key.
The focus of policymakers on Start-Up India, Make in India, etc. will increase the pool of companies. But the actual challenge is the demand base. Even the new companies would hit a wall unless demand picks up, since all of them are playing for the same pool.
Unless underlying demand expands by bringing more people into the organized consumer market, putting disposable income into their hands and ensuring interest rate reductions result in private-sector investment and jobs, we will continue to come back a full-circle to the stagnant demand (and revenue) base issue.
Until then, the profit growth will not occur and profit per company will remain flat or fall.
— Sourajit Aiyer is a finance professional based in Mumbai. Views expressed are entirely personal.