Slower revenue growth will hit India Inc: Morgan Stanley

MUMBAI: Indian companies’ revenue growth may slow down in the coming quarters due to higher proportion of variable costs or low operating leverage amid lack of significant capex. “Operating leverage has been falling and is at an eight-year low. Given the lack of big capex, the sensitivity of earnings to macro growth is likely to be lower than history,” said Morgan Stanley’s India strategy report.

Operating leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A business that has a higher proportion of fixed costs and a lower proportion of variable costs is said to have used more operating leverage.

Those businesses with lower fixed costs and higher variable costs are said to employ less operating leverage. Low operating leverage signifies a lower sensitivity to the slower economic growth suggesting a downside protection. Among sectors, IT, telecoms and banks saw high operating leverage while energy, realty and utilities have seen lower operating leverage.

“In trailing four quarters, sectors like consumer staples (ex-sugar), realty and industrials have fallen the most in operating leverage whereas utilities and telecom have added the most,” the report said. Investors should look to buy in sectors which have seen a fall in operating leverage and gross margins as a combination of these indicates EBIT will be protected in a slowdown.

“Gross margins will likely play a greater role in determining where earnings head in the foreseeable future,” the report said. There is an upside earnings risk in sectors which have seen the sharpest fall in gross margins over the past four quarters along with a negative delta on operating leverage.