Profit margins are under siege

“Rising input prices are a cause for concern for seven sectors (auto, consumer staples, discretionary, industries, pharma, cement and chemicals), which account for 24% of the Nifty’s weight, said analysts at Jefferies India Pvt Ltd. Report on March 3. Jefferies analysts built 50-250 basis points (bps) EBITDA margin expansion across these sectors in FY23. According to the brokerage firm, it can be deducted. Ebitda is earnings before interest, taxes, depreciation and amortization. One basis point is 0.01%.

The longer the conflict lasts, the greater the devastation and economic pain. Against this background, there remain incremental risks to global supply chain disruption. In addition, longer shipping delivery timelines will add to the cost of importing raw materials. Therefore, some near-term cushion in margins can be expected for companies that have raised prices in the December quarter.

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Clearly, the stock markets are worried. Since Russia invaded Ukraine in the early hours of February 24, the Nifty 50 index is down 4.8%. Among the sectoral indices, Nifty Auto Index has fallen the most with a fall of 12.5 per cent. Simultaneously, the Nifty Metal Index has gained 7% on an anticipated rise in price realizations.

The road has become difficult for the auto sector. An analysis by Kotak Institutional Equities shows that the prices of Automotive OEM (Original Equipment Manufacturer) raw material basket has increased by 90-160 bps in Q4FYTD22 and by 170-360 bps at current spot prices, which is a mix of aluminum and precious metals. The reason for the sharp jump in prices is from Q3FY22 levels. , Kotak expects the biggest impact on the gross margins of Maruti Suzuki India Ltd and the two-wheeler makers.

Already, price hikes by OEMs to fight cost inflation and higher retail fuel prices have increased the cost of ownership for consumers. “Total cost of ownership for two-wheeler consumers has grown by 15-16% year-on-year in FY2022,” said Kotak analysts.

Besides, retail fuel prices are expected to rise after the assembly elections, which may further impact the demand. However, the extent to which the retail fuel prices are hiked remains to be seen, with some expecting the government to cut excise duty to lessen the blow on consumers. On Friday, the price of Brent crude closed at $ 123.5 per barrel.

For the fast-growing consumer goods sector, higher crude oil prices drive up packaging costs. A sharp rise in palm oil prices does not bode well for many consumer firms.

International coal prices have also risen. Petroleum coke (petcoke) and coal derived from crude oil for manufacturing of cement are the major inputs, which is not good news for the sector. ICICI Securities Ltd. reported, “Imported coal/petcoke prices are up 40% from December 2021 exit due to current geopolitical tensions, while domestic petcoke prices have also increased by around 24% month-on-month ” Power and fuel costs are estimated to be 25-30% of the total operating cost of the sector.

Meanwhile, Coal India Limited (CIL) is expected to benefit from the hike in e-auction premium on fuel supply agreement (FSA) prices. In addition, the FSA price hike is expected. Overall, however, rising coal prices will have an impact on the power sector. “India is already reeling under coal shortage as the supply of CIL is less than the demand due to spurt in industrial activity. In addition, high global coal prices make imports inaccessible for many power companies. Rohit Natarajan, an analyst at Antique Stock Broking Ltd, said, “It is a difficult situation as we are in peak power demand during the summer season.

In addition, the increase in global gas prices is expected to push up domestic gas prices in FY13. This will reduce margins of city gas distribution companies and may also hurt volumes. In addition, high spot liquefied natural gas prices will make imports expensive.

True, companies can raise prices and pass on the increased operating costs to end-consumers, but a weak demand environment has made it challenging to do so.

Cement companies have tried to hike prices several times in the last two quarters, but on most occasions they have to withdraw on poor demand.

Therefore, the overall jump in energy prices is a matter of serious concern. “We struggle to settle and maintain prices at those levels (Newcastle coal at $260/t, spot LNG at +$25 mmBtu or Brent + $110/bb). Ultimately, end demand for prices at such levels. Pinakin Parekh, an analyst at JP Morgan India Pvt Ltd, wrote in a report on March 2, he said, “However, we see that the issue is that energy prices are likely to fall very quickly from here. Not likely and it could be normal for new prices to stay close to current levels. The issue for Indian policy makers is not just limited to oil and retail fuel prices, though it attracts the most investor attention, but also applies to gas and coal.”

Even before Russia invaded Ukraine, oil prices had risen by 50% in the 12 months leading up to February 23. The approach is firm. “Even if the Russia-Ukraine conflict subsides soon, high oil prices are here to stay. Decarbonization and the push towards clean energy mean companies have invested less in capex to boost production since 2019. This will limit supply in the global market, which is slowly recovering from the COVID-19 pandemic, adding pressure to prices. Ritesh Jain, global macro investor and former executive of BNP Paribas Asset Management India Pvt Ltd, said.

For now, uncertainty in global geopolitics makes it difficult to know for sure how long commodity prices will continue to rise.

However, the near-term outlook will be largely driven by the news flow generated by the ongoing conflict. Some developments should focus on the kind of sanctions imposed on Russia, whether the Organization of the Petroleum Exporting Countries accelerates oil production, and whether China comes to Russia’s aid.

That said, fears of lower profits and increased uncertainty have dampened investor sentiment. “We have recently lowered our Nifty target for December’22 to 17,500,” he said. The growing threat of double losses, rising rates and low global liquidity suggest that returns are likely to remain low in the near term, the Jefferies report said.