A steep and sustained fall in crude palm oil prices is good news for Indian companies that use palm-based derivatives to make soap. In the past few years, soap makers had been hit by a combination of rising prices of crude palm oil and chemicals as well as plastic packaging material. Left with little choice, they hiked prices and that has resulted in volume growth moderating, while sales growth and margins have improved chiefly due to the price increases.
The concern is that volume growth can take a severe hit, hurting consumer companies in the longer run. But current price trends yield room for optimism for soap makers. Crude palm oil prices have fallen, with spot prices having declined by 29.7% in dollar terms year-on-year, according to data from the Malaysian Palm Oil Board obtained from Bloomberg. Average prices in the current quarter so far are down by 25% y-o-y and by 21.4% sequentially.
Godrej Consumer Products Ltd’s stand-alone financials show that oils and fats as a percentage of raw materials consumed was 36%, and soaps contributed to 35% of stand-alone sales.
Thus, the decline in palm oil prices should see the soaps business of consumer goods makers such as Hindustan Unilever Ltd and Godrej Consumer Products benefit immensely. They have hiked prices substantially, and the decline in raw material prices should see gross margin improve substantially (after deducting raw material costs from sales, but before considering other operating costs).
The spoilsport is the depreciating rupee, which had negated the decline in palm oil prices. In the December quarter, the damage has not been as severe, with the average dollar-rupee rate declining 6% y-o-y, and even appreciating 2.1% sequentially. This apparently pleasant state of affairs can be rocked in no time, which is a risk. But till that happens, after adjusting for currency movement also, soap makers should benefit from falling palm oil prices.
The soap segment’s margins are likely to improve in the near to medium term, but the longer term poses a by-now-familiar question: Will producers keep prices constant, soaking up all the cost benefits, and in turn spend more on advertising to push sales, or will they go in for promotions such as volume discounts, or even cut prices to pass on the benefit to consumers?
The past few years have seen small companies get pushed into a corner by rising input costs and as a result lose market share to larger rivals. Falling costs work in their favour, however, and they can pass on cost reductions much earlier if they want to win back market share. The past has shown how large companies have lost out when a sizeable price difference develops. They may soon find themselves in a situation where they may have to revisit the trade-off between profit margins and sales growth.