How sales growth converts into profit
Defence-electronics company Apollo Micro Systems increased net profit by 53.7 per cent in its second fiscal quarter ended 30 September. Revenue growth of 72.3 per cent outpaced that gain. Consolidated revenue rose from 225.26 crore rupees a year earlier to 388.15 crore rupees, while net profit increased from 30.03 crore rupees to 46.15 crore rupees. Expanding sales generated more total profit for the company, alongside a smaller share of each sales rupee converting into net earnings. That conversion rate is the sensitive input in a valuation built on the growing revenue.[1]
I start the calculation by dividing net profit by revenue. Using the disclosed figures on the same consolidated basis gives a net margin of approximately 13.3 per cent a year earlier and approximately 11.9 per cent in the latest quarter. Net margin measures the profit left from sales after financing, taxes and other items. It is sensitive to those items as well as production expenses. Temporary delivery mix or tax effects could have changed the ratio. The observed decline in the conversion of revenue into profit anchors the calculation; explaining its cause requires tracing the contributions of expenses and tax.[1]
A calculation at unchanged revenue
To put an amount on the old margin, I hold revenue at the latest quarter’s level. Multiplying 388.15 by 30.03 and dividing by 225.26 produces hypothetical net profit of approximately 51.7 crore rupees. The gap against reported profit of 46.15 crore rupees is approximately 5.6 crore rupees. Only the applied margin changes in this calculation. A valuation carrying the old ratio into current sales assumes that much additional earnings. Choosing a margin therefore gives a concrete amount to an assumption easily absorbed into the growth story.[1]
A calculation starting from the latest quarter’s margin converts expanding revenue into profit at the current rate. Assuming a return to the old margin requires the same revenue to yield more earnings. Anyone adding that recovery to the growth case needs an explanation of the conditions improving profitability. The prior-year ratio could have been unusually high; the latest quarter’s lower ratio could also be temporary. The comparison leaves those possibilities open. The amount carried by the assumption can nevertheless be calculated, making its contribution to the value assigned to revenue growth visible.[1]
The direction over the first half
Revenue also grew faster than profit in the first-half results. Six-month revenue increased from 358.85 crore rupees to 639.44 crore rupees, while net profit rose from 47.71 crore rupees to 71.37 crore rupees. The same direction thus appears over a longer comparison period. These amounts support a calculation of net profit as a share of sales. Assessing the conversion of earnings into cash requires tracing collections, working capital and capital expenditure. Extending the calculation to free cash flow brings in the cash-flow statement and balance-sheet items; the sensitivity used here measures reported net profit.[1]
The margin I choose when valuing Apollo’s revenue growth directly changes the earnings side of the calculation. A higher ratio yields more profit from the same sales; a lower ratio yields less. The joint movement of revenue and net profit in comparable results provides a concrete measure for assessing that choice. A margin recovery means a larger share of sales remaining as profit; a persistently lower level means revenue growth converting into earnings at a smaller share. That conversion rate is where I look for the economic burden carried by the model of Apollo’s expansion.[1]