Sectors and companies that have the potential to do well despite tough business environment

The benchmark stock indices in India have reported quick gains in the first six weeks of 2012. Both the Nifty and the Sensex have risen by over 19% and 17%, respectively. The uptick is largely due to the renewed fund flow from foreign institutional investors ( FIIs) who have pumped Rs 22,000 crore in to Indian stocks so far in 2012.

Barring this and the gradual decline in the inflation rate, there are no major signs of a revival in the domestic economy. Rising trade deficit, higher input prices, strengthening international crude oil prices, and lacuna related to policy matters continue to dampen the prospects of economic growth.

In addition, ET Intelligence Group's analysis of the December 2011 quarterly results and that of the previous two quarters reveals that India Inc is finding it difficult to keep up the pace of year-on-year profit growth even though revenues are growing. This shows its inability to pass on incremental costs to end users any further. This week, we bring you a detailed results analysis together with the outlook for various sectors.

WINTER FREEZE: India Inc's top line continued to grow in double digits during the December 2011 quarter, but profitability suffered, shows the aggregate analysis of a sample of 2,290 companies that have declared their financial performance for the quarter. Net sales rose by 19.5% year-on-year, a double-digit growth for the ninth consecutive quarter and faster than the 14.6% recorded in the September quarter. However, a striking fact was the dismal 1.2% growth in operating profit before depreciation and excluding other income, the slowest in any of the quarters in the last two years. This is the third consecutive quarter for which profit growth lagged top line growth. The fall in operating profit notwithstanding the double-digit sales growth shows that India Inc may no more be able to absorb rising input costs without sacrificing profitability.

Operating margin dropped in each of the three quarters ended December 2011. In the latest quarter, it fell by 250 basis points, the sharpest drop in the nine quarters. Net profit skidded for the second quarter in a row. It fell by 13.9% year-on-year over and above the 37.6% drop in the previous quarter. Apart from weakness in operating profit, other reasons for the shrinking bottom line are the gradually rising interest burden and depreciation. In the last three years, companies used debt funding to expand capacities and acquire businesses. This has resulted in higher interest outgo. Finance charges as a proportion of sales have inched up by 110 basis points (bps) to 3.3% from the March 2010 quarter. Also, the new capacities have started coming on stream thereby increasing the depreciation of companies.

FUTURE TENSE : While the equity market shimmers with renewed confidence and positive sentiment, the current buoyancy in stock prices is on account of FII money chasing global assets. The enthusiasm doesn't seem to be fully backed by economic realities. The gross domestic product (GDP), which reflects the growth in economic activities, is expected to drop to 6.9% in FY12 from 8.5% in the last fiscal. Industrial production has not been encouraging either; it grew by a meagre 1.8% in December 2011. India's trade deficit is also likely to burgeon to $160 billion in FY12 from $130 billion in FY11. These factors reflect a sombre view on the macroeconomic front and given the sluggishness in domestic and global demand, the situation may take some more time to improve.

In addition, if the US Federal Reserve pumps more money into the system, there is a chance that the additional liquidity may chase commodities and financial assets thereby fueling inflation, according to some analysts. On the domestic front, a mellowing trend in inflation and a slowing GDP growth may prompt the Reserve Bank of India to reduce interest rates, which could help improve demand from both consumers and industries. But, this will be a gradual process with the real benefit sinking into the system in four-six quarters. The impact of the current economic scenario will vary across sectors. Read on to know more about which sectors have greater ability to withstand the slowdown and which companies look more resilient than others.

AUTO SECTOR

Tata Motors benefited from strong demand for its recently launched Evoque model at its European operations. Its consolidated net profit grew 40.5% yo-y in the third quarter, faster than the first two quarters of the current fiscal. It is expected to post strong volume growth at its JLR operations over the next few quarters.