02 Jul 2012 4:38 PM from Prowess
Mahesh Vyas

Net profit margins rebound handsomely

March 2012 profitability shows India Inc in good health

Net profit margin of listed companies bounced back handsomely to 8.4 per cent in the quarter ended March 2012. It had fallen to 5.3 per cent in the quarter ended September 2011. This was its lowest level in nearly a decade. During the first three quarters of 2011-12, net profit margin languished in the 5.3 to 6.8 per cent range. Compared to the recent past, these margins are considered low.

From March 1999 (which is the begining of quarterly financial statements) through June 2002, net profit margins were mostly in the 4-5 per cent range. Since then, margins have climbed steadily and they peaked in 2007 when they were close to 10 per cent. The global financial crisis brought these down momentarily to 6 per cent for a couple of quarters; but, they bounced back quickly to 8-9 per cent. In 2011, they fell to around 6 per cent again.

In the context of this historical trend, the return to over-8 per cent net profit margin in the quarter ended March 2012 betrays claims of an economic slowdown. In fact, high profit margins and high inflation strengthen the argument that demand is robust enough for corporates to reap handsome margins.

The fall in margins seen in the quarters ended September and December 2011 is largely because of the sharp depreciation of the rupee which not only raised the cost of imported raw materials but also raised the mark-to-market value of external debt whose impact was reflected in the profit and loss statement. The corporate sector absorbed these shocks easily during these two quarters and has returned back to high profitability in the March 2012 quarter.

The net profit margin we speak of here is the net profit after tax net of prior period and extra-ordinary transactions as a per cent of sales and other income. Prior period and extra-ordinary transactions are excluded from both, the numerator and the denominator.

Net profit margins look healthier if we do not make the adjustments described above. Sometimes the difference is small - such as in the quarter ended March 2012. However, these differences can be large such as in September 2010 when the unadjusted margin was 10.57 per cent while the adjusted margin was much lower at 8.73 per cent.

These are aggregate net profit margin of all listed companies. Variations would be much larger at the level of individual companies or even sectors. It is advisable to use the adjusted net profit margin - ie after removing the effects of prior period and extra-ordinary transactions - as these are more sustainable over time compared to the unadjusted profit margins.

Historically, we see that at the aggregate level, the unadjusted net profit margin overstated the margin by over 2 per cent in half of the 53 quarter observations.