Inflationary Pressures Weigh Down Earnings Of Companies Across Sectors

Since 2020, the Covid-19 pandemic has been the greatest threat to businesses worldwide. But now, companies are facing another problem — inflation. Commodity prices have been on the boil for months.

Commodity Prices Are On The Boil

Energy costs have gone through the roof as the world struggles with an energy shortage. Crude oil is currently trading at the highest point in the last three years. Coal price have been on the rise as well. Just as gas becomes costlier, several countries have brought back their coal plants into operation. Just last year, oil prices had slipped into negative territory as traders were unsure about the future of oil.

A similar pattern is visible across key commodity sectors such as metals, vegetable oils, shipping among others, causing raw material and overheads costs for several sectors to rise rapidly. Smelters and steel mills in various areas including China have shut down due to high fuel prices, creating a shortage. Consequently, steel, aluminium, zinc and other industrial metal prices have to continued rising unabated.

Margin Pressures Across Sectors

Hindustan Unilever Limited saw its material costs increase by 144 basis points during the September quarter as compared to the previous quarter. In comparison to the pre-pandemic period, material costs as a percentage of revenues have gone up by more than 300 basis points in recent quarters.

The rise in raw material prices and freight rates was highlighted in the management’s call with analysts. Prices of key commodities such as tea, crude palm oil, polyethylene and fuel went by anywhere between 50 per cent and 80 per cent over the last one year.

In addition, the management highlighted that the ocean freight charges have gone up by five times since the March quarter of financial year 2020. While some segments have recovered, other segments are yet to recover in terms of customer confidence, making it difficult for the company to continually increase prices. Nestle India’s results indicate a similar trend of rising cost pressure.

Similarly, results of companies in the auto sector indicated that the sector is undergoing pain due to weak consumer sentiment and increasing material costs. Eicher Motors has seen its operating margins drop to 16 per cent from 26 per cent in the pre-pandemic term. Other companies in the space like Maruti, Hero Motocorp and Tata Motors have seen a similar downward margin pressure in the recent quarters as well.

The increase in steel prices has squeezed the margins of sectors that depend on steel as a raw material. The ex-chief financial officer (CFO) of Bajaj Auto, Soumen Ray, had commented that the rapid price increase in key commodities was unprecedented and declined to give a guidance for the future quarters.

The cement sector which is highly energy-intensive has seen margins fall with the rise in expenses. Ultratech Cement saw its profits decline by 23 per cent for the quarter on a sequential basis. Operating margins have also come down from 28 per cent in the previous quarter to 23 per cent in the current quarter.

An analysis by Business Standard shows that the cumulative net profits of 1,305 manufacturing and domestic service sector companies declined by 21 per cent quarter-on-quarter to their lowest levels during the first quarter of financial year 2022 (FY22).

In addition, the raw material costs as a percentage of total sales stood at 50.1 per cent — the highest in the last five years.

The auto, consumer durables and capital goods segment showed the highest decline in margins, whereas sectors like fast moving consumer goods (FMCG) and pharmaceutical managed to maintain stable margins. FMCG and pharmaceutical companies generally have greater pricing power compared to other sectors, allowing them to maintain margins. Nevertheless, companies have been careful to not price themselves out of the consumer’s reach.

Festival Season Might Offer Relief

As the festival season begins, companies are expecting an improvement in consumer sentiment, and an opportunity to improve margins. All sectors have been preparing for the festive season by stocking up on inventory, bolstering distribution networks, and adding new staff members in order to cope with the demand. Consumer durables and auto sectors hope to make a comeback as consumer sentiment improves during the auspicious period.

As the threat of Covid abates and local-level restrictions ease, consumers are expected to step out and increase spending. In contrast to commodity consumers, energy and metal production companies are on a roll.

Several steel stocks have multiplied in value within the period of a year, giving handsome returns to investors. Other companies in the aluminium, oil, steel, power and real estate space that had been underperforming for the past few years have now created wealth for their investors.