NewsEarningsQ3 Earnings Analysis: Expense Growth Outpaces Revenue as Labour Code Changes Impact ProfitabilityQ3 Earnings Analysis: Expense Growth Outpaces Revenue as Labour Code Changes Impact Profitability
Analysis of 189 early Q3 earnings shows Indian companies facing margin pressure as expenses grew 14% year-on-year - the fastest pace in two years - while revenue increased 9% and net profits rose only 4%. New labour codes requiring basic pay to be 50% of compensation drove higher provident fund contributions and statutory benefits. The IT sector's top five companies saw profits fall 5% despite 8% revenue growth due to 7% employee cost increases. Analysts debate whether cost pressures will persist through FY26 or represent one-time adjustments, marking a shift from margin-led to revenue-driven profit growth.
*this image is generated using AI for illustrative purposes only.
Indian companies are experiencing a significant shift in their profit dynamics as early Q3 earnings reveal expenses growing faster than revenues for the first time in three years. An analysis of 189 early results shows this trend marking a departure from the margin-led profit cycle that characterized the previous year.
Overall Financial Performance
The aggregate financial performance presents a mixed picture for corporate India. Revenue growth remained healthy at approximately 9% year-on-year, but profitability took a hit as net profits managed only 4% growth. The primary culprit was a sharp 14% jump in total expenses - the steepest increase witnessed in two years.
| Metric | Q3 Performance | Growth Rate |
|---|---|---|
| Revenue Growth | Year-on-year | ~9% |
| Net Profit Growth | Year-on-year | 4% |
| Total Expenses Growth | Year-on-year | 14% |
Labour Code Impact Drives Cost Surge
The expense surge stems primarily from new labour code implementations that took effect in November. These regulations mandate that basic pay must account for at least 50% of total compensation, significantly impacting payroll structures across industries. This change has pushed up contributions towards provident fund, gratuity, and other statutory benefits, creating both one-time adjustments for past liabilities and ongoing higher monthly payouts.
Employee costs have become a particular pressure point, with companies in labour-intensive sectors experiencing the sharpest impact. The IT sector exemplifies this trend, where the big five companies - TCS, Infosys, Wipro, HCL Tech, and Tech Mahindra - saw employee costs rise 7%, the highest increase in two years.
Sector-Specific Performance Analysis
IT Sector Challenges
The information technology sector presents a stark illustration of the current earnings dynamics. Despite achieving revenue growth of nearly 8% - a six-quarter high - the combined profits of the five major IT companies declined almost 5%. This performance pushed sector profits to a three-year low, demonstrating how rising costs can erode the benefits of improved top-line growth.
| IT Sector Metrics | Performance |
|---|---|
| Revenue Growth | ~8% (six-quarter high) |
| Combined Profit Change | -5% |
| Employee Cost Increase | 7% (two-year high) |
| Profit Level | Three-year low |
Non-Financial Sector Trends
When financial firms are excluded from the analysis, the underlying economic trends become clearer. Non-financial companies achieved nearly 5% revenue growth year-on-year after five sluggish quarters, suggesting improving demand conditions. However, their total expenses rose around 7% to a one-year high, resulting in a 3% decline in net profits to their lowest level in three years.
Notable Exception: Reliance Industries
Reliance Industries bucked the broader trend with its standalone performance. The conglomerate experienced a 2% drop in total income due to lower volumes, but benefited from declining overall expenses as raw material costs fell for the sixth consecutive quarter amid softer crude oil prices. This cost advantage enabled Reliance to deliver 8% profit growth year-on-year in Q3.
Analyst Perspectives on Future Outlook
Market experts offer varying views on the sustainability of current cost pressures. Some analysts characterize the expense surge as a temporary adjustment, with Ashwini Shami of OmniScience Capital describing it as "a one-time payroll adjustment under the new labour laws." He estimates that provident fund adjustments will add 1-2% to payroll costs, creating mild impact on labour-intensive sectors without materially altering broader margin trajectories.
Conversely, other analysts anticipate more persistent challenges. Vinod Nair of Geojit Financial Services expects labour code-related adjustments to continue through FY26 as companies implement new norms by the March quarter. Additionally, concerns about raw material cost inflation, particularly in silver, aluminium, and copper, could pose ongoing margin risks for sectors like electric vehicles and consumer durables.
Market Implications and Strategic Shift
The December quarter results signal a fundamental shift in corporate earnings drivers. The analysis indicates that net profit growth has begun lagging revenue growth, marking the end of the margin-led profit cycle that characterized recent periods. This transition suggests that companies will need to focus more heavily on top-line growth rather than margin defense to sustain earnings momentum going forward.
The early earnings print reveals an uneven impact across sectors, with disrupted cost structures affecting companies differently even as signs of top-line recovery begin to emerge. This mixed performance underscores the challenges facing corporate India as it navigates the transition from margin expansion to revenue-driven growth strategies.
16
