Rising costs pinch Indian companies5 min read . Updated: 29 Aug 2010, 09:40 PM IST
Rising costs pinch Indian companies
Mumbai: Rising raw material costs, wage increases and higher interest expenses dented corporate profitability across sectors in the last quarter, negating the impact of strong demand that shored up sales growth in an expanding economy.
Sales growth of 31 Nifty firms, excluding banks and oil companies, remained robust at 15.3%, the second fastest pace in seven quarters, in the three months ended June.
Also See Escalating Expenses (PDF)
Yet stand-alone profit of these firms was down by an average 7%, the worst performance since the December 2008 quarter, following the collapse of Wall Street investment bank Lehman Brothers Holdings Inc. at the height of the global financial crisis.
“It is a volume-led growth that we are seeing now, while the rise in earnings that we saw in the immediate aftermath of the crisis was largely driven by lower manpower costs owing to wage cuts and lower commodity costs," said Ravindra Nath, vice-president of institutional equities at Asit C. Mehta Investment Intermediates Ltd. “The operating margins we saw at those times could not have been sustainable."
Rising input costs, led by increased prices of raw materials, wage increases and higher interest charges have contributed to a decline in operating profit margins, hitting earnings growth in most sectors. For the 31 Nifty firms, the rise in employee expenses at 19% and interest costs at 64% was the highest in six quarters. Raw material costs for these companies increased by 17% after growing by over 19% in the preceding two quarters.
A Mint analysis of 313 firms in the BSE 500 index (excluding banks and oil companies) shows that both raw material costs and wage expenses have grown at the fastest rates in the past two quarters since the slowdown.
Also See Restricted Growth (PDF)
While raw material costs have grown by over 22% in the past two quarters, employee expenses have risen by 18.6% after an increase of 21% in the March quarter. The increase in interest costs at 21.5% was the highest in five quarter.
Fifty of the most liquid stocks traded on the National Stock Exchange constitute the Nifty 50 index. The BSE 500 accounts for 93% of market capitalization on the Bombay Stock Exchange (BSE).
Most analysts aren’t worried by the cost inflation, given that sales growth has remained robust in most sectors. As a proportion of total sales, the rise in raw material costs, employee expenses and interest costs has been limited to a range of 1-3%.
The rise in costs should not be a major cause for concern as long as economic growth is healthy and companies are able to pass on the costs to consumers, says Ajay Parmar, head of institutional equities at Emkay Global Financial Services Ltd.
“The spike in wages and rise in other input costs is natural in an economy that is reviving," Nath said. “We can see it as a positive development as it indicates that demand for personnel and inputs is growing, after remaining muted earlier."
While moderate inflation is widely acknowledged to be a sign of a robust recovery, there seems to be a general consensus that over-heating can hurt producers.
Many firms in competitive sectors find it difficult to pass on the cost increases to consumers in an environment where inflation is in double digits. While auto firms have found it easy to raise prices, analysts point out that makers of home and personal care products might find it difficult to do so because of the intense competition.
“Profit growth during 2010-11 will be much lower than that in 2009-10 (for manufacturing companies)," the latest monthly review of the Centre for Monitoring Indian Economy (CMIE) says.
This is because raw material costs are estimated to go up by 24.2% due to a likely rise in commodity prices.
“We do not expect the manufacturing companies to completely pass on the burden of the rising raw material prices to the consumers. This will restrict the growth in profits," the report says.
A 15 June research note by Ritika Mankar, an economist at the Indian arm of UK-based investment advisory firm Execution Noble, shows that even historically, high inflation hammers stock market returns across the broader market as well as sectoral indices. The study, based on stock returns over the past 10 years, finds that most episodes of high returns in India’s equities market have occurred during periods of low inflation.
The Sensex return since the start of this year has been a measly 3.5%, the same rate a savings account offers. Double-digit inflation over the same period means that real returns offered by the benchmark index have actually been negative.
It comes as no surprise that domestic investors have not found buying attractive in a range-bound market even as foreign institutional investors, or FIIs, have found these returns quite attractive compared with the returns available in developed markets.
FIIs have already pumped in over $11 billion (Rs51,590 crore) this year and a belief in the India growth story should ensure that FIIs would continue to remain net buyers for the next few quarters, as developed markets struggle to recover, analysts say. The International Monetary Fund has projected India’s gross domestic product growth at 9.4% this year.
Yet, that alone is unlikely to lead to a major market rally unless corporate earnings growth accelerates. While mid-cap companies have out-performed the broader market over the past year or so, they could run out of steam now. “A rise in interest costs and wage inflation would tend to hurt the mid- and small-cap companies more," Mankar says.
While a good monsoon and the base effect might lead to an easing of food inflation, inflation in the prices of manufactured goods might continue to remain a cause for concern. “Inflation in manufactured goods is projected to remain higher at 6.4% in 2010-11, as compared to 3.2% in 2009-10," the CMIE review says.
“Margin pressure for most companies would remain till the end of this year and it is only in the fourth quarter that we might expect some easing off," Siddhartha Roy, economic adviser to the Tata group said.