BackDemand slump offsets benefits of falling commodity prices
The sharp decline in prices of commodities has not translated into an improvement in operating performance for companies using these raw materials
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The sharp fall in prices of commodities like crude oil and copper has not translated into an improvement in operating performance for firms that consume these raw materials.
An analysis of top commodity companies—excluding banks, information technology services providers, commodity producers, intermediaries such as auto ancillaries, tyre makers and heavy equipment suppliers—showed that operating profit growth has slowed to 1.3% year-on-year, the lowest in two years. Operating margins declined by 92 basis points from a year ago to 12.3% in the quarter ended December due to slower net sales growth. A basis point is 0.01%.
In an environment when demand is weak and inflation is slowing, firms do not have pricing power. Both volume and pricing growth slowdown was seen in the December quarter, said Anish Damania, co-chief executive and head of institutional equities, IDFC Securities.
While raw material costs as a percentage of net sales dropped 1.1 percentage points to 62.6% from a year ago on the back of lower commodity prices, it did not translate into improvement in the margins. Sales weakened because companies also had raw material which they bought earlier at higher prices in their inventories and there could have been some de-stocking. Also, after the elections, there was an expectation things would change dramatically, but there isn’t much tangible improvement being witnessed in the real economy yet, which may have dampened confidence and hence demand, said Gaurav Mehta, head and strategist (institutional equities) at Ambit Capital Pvt. Ltd. Of course, there are exceptions, but the bulk of commodity-using companies show this negative trend.
Another reason could be populist schemes being reined in by the National Democratic Alliance government. This could have reduced rural demand, which had otherwise been buoyant over the last few years, added Mehta. Besides, freight costs have not really come down despite the plunge in crude oil prices because the truckers have not passed on the benefit. Also, while petrol and diesel prices have come down, consumers have not benefited significantly due to the excise duty hike, according to Damania. With raw material prices coming down and demand softening, companies may be forced to reduce selling prices in the coming quarter; hence, the full benefit on operating margins may not be seen unless demand improves.
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