Margins return

The Indian corporate sector has generated superlative profits in the post pandemic period. Profits during recent times have been nearly thrice the profits corporates earned earlier. The pandemic, it seems, has done good to corporate profits.

Net profits of 4,293 listed companies reached Rs.2.9 trillion in the March 2023 quarter. This is over 3.5 times the average quarterly profit earned by listed companies before the pandemic of 2020. The average net profit of listed companies in the nine quarters of December 2017 through December 2019 was Rs.0.83 trillion. Profits crossed Rs.2 trillion in the March 2021 quarter. In the eight quarters since then, it has averaged at Rs.2.28 trillion per quarter. The March 2023 quarter profits beat this recent average by over 28 percent.

Listed companies are the best representation of India’s larger organised enterprises. This segment has done very well in the post-pandemic period.

One reason for the increase in profits of larger companies could be the formalisation of the Indian economy. As the pandemic struck a fatal blow to smaller enterprises in the unorganised sectors, the larger ones stood to gain. They increased their market share and this shows up in a rapid growth in their topline, the sales. A second reason could be an increase in profit margins. High commodity prices and high inflation helped the increase in both, sales, and profit margins.

If the gains from the formalisation of the economy were the result of a more efficient tax regime under GST and the fatality of the shutdown delivered to the vulnerable, then those gains are now a thing of the past. Similarly, the gains from high commodity prices are also largely behind us. The pandemic and its dividends to the corporate sector are well behind us. But listed companies continue to see their profits gallop. What explains this continued growth? Is it continued growth in sales or is it margins or a mix of the two? We find the contributions of the two below.

Our template of understanding the sources of growth (fall) in profits is as follows: The growth (fall) in profit is an outcome of three contributors. First, it can be attributed to a growth (fall) in sales with constant profit margins. Second, it can be from a growth (fall) in margins with constant sales. And third, it is the outcome of increased (decreased) sales with higher (lower) margins.

Net profits net of prior period and extraordinary transactions (Net Profit net of P&E) of listed companies in the March 2023 quarter were 15.1 percent higher than in the March 2022 quarter. This growth was the result of a combination of a 12.2 percent increase in sales and a 0.95 percentage point increase in net profit margin. The apparently small increase in the profit margin had a big impact on the growth in profits.

Sixty percent of the growth in net profit can be attributed entirely to the increase in profit margin. The increase in sales contributed an additional 36 percent and the rest was a bonus from a combination of the two.

Increase in profit margin has returned as the driver of profits after a gap of five quarters. And, it has arrived with a bang. At a 9.8 percent net profit margin (net profit net of P&E as a percent of net sales and other income) in the March 2023 quarter was at least at a 12-year high. Profit margins had not contributed to the growth in profits in the five quarters preceding the March 2023 quarter. All the growth came from expansion of sales. In the five quarters preceding these, all the growth came from increasing margins. Now, in the March 2023, margins have returned to contribute handsomely to the profits of companies.

Growth in sales and growth in margins have contributed differently in finance and non-finance companies.

Financial services companies saw their profit margins rise from 14.11 percent in the quarter ended March 2022 to 15.15 percent in the quarter ended March 2023. Margins were high in the March 2023 quarter although they were even higher in the previous two quarters. This 1.04 percentage point increase in margins played a minor role in the increase in profits of finance companies. Only 26 percent of the growth in profits of finance companies can be attributed to increase in margins. Increase in operating income and other income contributed nearly 70 percent to the increase in profits.

Margins play a much bigger and dominating role in the growth of profits of non-finance companies. These companies saw their net profit margin rise from 7.5 percent in the quarter ended March 2022 to 8.27 percent in the quarter ended March 2023 an increase of 0.77 percentage points. Sales and other income grew by 9.3 percent. Growth in sales contributed to only 25 percent of the increase in profits while the increase in profit margins contributed a substantial 72 percent to the growth in profits.

Profits of non-finance companies had shrunk in the previous two quarters because profit margins had shrunk. Now, with the return of margins, profits have expanded.