Cost cuts, higher prices spur profit

Profit growth was much sharper than sales growth in the 3 quarters of FY07

Massive cost cuts, buoyant sales and improved price realisations accelerated Corporate India’s profit growth in the first three quarters of 2006-07.

A study of 808 companies (excluding oil & gas, software, banks and non-banking financial companies) shows that profit growth in these quarters was much sharper than sales growth. Further, the growth in bottom line was much higher in those quarters in which sales outpaced the rise in the cost of production.

While sales increased 28.24 per cent during the quarter ended December 2006, the total cost of production rose 25.79 per cent, indicating that the latter rate is 284 basis points (bps) lower than the former. As a result, net profit jumped 53.66 per cent.

In the second quarter, while sales rose 27.9 per cent, the increase in production cost was lower by 112 basis points at 26.8 per cent. Thus, net profit surged 35.7 per cent.

In the first quarter, sales were up 27.39 per cent, while cost of production rose 26.59 per cent, 80 bps lower than the former. Profit shot up 40 per cent. A Business Standard Research Bureau study shows that the share of cost-cutting in bottom line was 16.6 per cent in the first quarter, 25.74 per cent in the second quarter and 40 per cent in the third quarter.

In other words, while net profit, in absolute terms, increased by Rs 7,752 crore in Q3, the total cost of production was lower by Rs 3,100 crore (See ‘Methodology’). In Q2, savings on account of lower growth in the cost of production stood at Rs 1,329 crore compared with Rs 5,163 crore increase in net profit. In Q1, savings amounted to Rs 844 crore vis-a-vis the absolute rise of Rs 5,099 crore in net profit.

The study also attributes the rise in profit to savings in other costs, which include salaries and wages, interest and general administrative expenditures. However, raw material costs, which galloped past the sales growth, remained a major concern.

The increase in input costs was higher by 161 bps compared with the sales growth in the third quarter, 338 bps in the second quarter and 48 bps in the first quarter. As a result, raw material costs were higher by Rs 3,283 crore, Rs 3,340 crore and Rs 879 crore in the first quarter, the second quarter and the third quarter respectively.

The corporate sector saw a rise in tax provision in all the three quarters as profits surged. The tax provision was higher by Rs 210 crore in the third quarter, Rs 172 crore in the second quarter and Rs 194 crore in the first quarter.

More than half of the 808 companies studied managed to save on total costs during all the three quarters. Over 60 per cent of them made saving on other expenditure. And, about 50 per cent firms effected saving on interest and salaries/wages. Only 40 per cent of the companies saved on raw material tax provision.

One-fourth of the sample or 197 companies registered decline in net profits largely because of higher cost of production. Of this, the total cost of production was lower for 38 firms, while for 88 companies raw material costs were lower. However, 103 firms managed to save on other expenditure, and another 132 outfits showed a growth in sales income.

Further, of the 45 sectors studied, the sales growth rate of 29 per cent was higher compared with the growth in the total cost of production in the third quarter. The sales growth rate of 24 sectors was higher in the second quarter and of 28 sectors in the first quarter. However, the growth in raw material costs was higher than the sales growth for 26 sectors in the third quarter, for 30 sectors in the second quarter and 22 sectors in the first quarter.

Cement has done well in all the three quarters with net profit growth of 264 per cent in the third quarter, 145 per cent in the second quarter and 244 per cent in the first quarter.

The sales growth rates ranged between 40 per cent and 53 per cent, while cost of production moved between 20 per cent and 25 per cent in the three quarters. This shows that cement companies benefited from cost-cutting and higher price realisations.

Sugar companies suffered a severe setback on account of lower prices with 8 per cent decline in sales in the third quarter and a modest 4 per cent sales growth in the second quarter. However, raw material costs rose 14.5 per cent in the third quarter and 2.08 per cent in the second quarter. The result was obvious: bottom lines of sugar companies declined 17 per cent in the second quarter and slumped 53 per cent in the third quarter.

The first quarter offered a different picture. Net profits of sugar companies zoomed 113 per cent on the back of 33 per cent surge in sales, though there was 30 per cent rise in raw material costs as well. This was because there was buoyancy in prices in that quarter.

Methodology

The study is based on a sample of 808 companies that have posted profits in the last six quarters.

The study excludes the finance, software and services sectors, which do not use raw materials for production purpose. Oil & gas companies have also been excluded as the government controls the pricing power for oil marketing companies. In the third quarter, profits of state-run oil companies increased largely on account of oil bonds.

Savings on cost of production were calculated by applying the cost-to-sales ratio of the previous corresponding quarter to the current quarter. This was done to find out the cost of production for the current quarter based on the cost-to-sales ratio for the previous corresponding quarter. The study shows that the ratio was higher in all the previous quarters and lower in the quarters under review.

Had the cost-to-sales ratio during the quarters under review been higher or the same as the year-ago quarters, the cost of production would have been higher. In such case, bottom lines of these firms would have risen 27.3 per cent in the third quarter, 24.9 per cent in the second and 31.5 per cent in the first. However, they posted net profit growth of 53.7 per cent in the third, 35.7 per cent in the second quarter and 40.1 per cent in the first.

The total cost of production-to-sales ratio was lower at 82.51 per cent (84.11 per cent) in the third quarter, 83.03 per cent (83.76 per cent) in the second and 82.35 per cent (82.87 per cent) in the first.