Threat to profit margins and earnings from higher crude oil prices
Oil refiners, airlines, paint makers, lubricant manufacturers and firms that make tyres and FMCG are expected to bear the brunt of rising oil prices
Brent crude oil prices flirting with $80 a barrel cannot be taken lightly. Among other macro worries such as a rising import bill and higher inflation, there is a threat to operating profit margins of companies that use oil, oil-based derivatives or fuel as inputs.
Oil refiners, airlines, paint makers, lubricants manufacturers and firms that make tyres and fast-moving consumer goods (FMCG) are expected to bear the brunt of rising oil prices.
Indian companies should see some adverse impact of rising oil prices for the June quarter, says Ritesh Jain, chief investment officer at BNP Paribas Asset Management India Pvt. Ltd.
“Things should get worse in the September quarter, considering that there is a lag effect in rising prices and the impact on input costs, plus, companies also have some inventory,” added Jain.
Of course, the impact on margins will depend on the extent to which companies are able to pass higher costs on to consumers. On this front, some firms are better placed than others, as they enjoy better pricing power.
FMCG companies seem to be in a relatively good position to increase prices. Companies in this sector had cut prices of many products after the introduction of the goods and services tax in July.
The government’s vigil on anti-profiteering also meant price hikes were kept in check. This leaves some headroom to increase prices without affecting demand to pass on the impact of rising crude prices. The main impact will be on packaging costs. Some inputs used in the home and personal care segment too will be affected.
For airlines, fuel costs eat into a major portion of revenues and better yields are necessary to compensate for that.
For the March quarter, SpiceJet Ltd saw an increase in yields, whereas IndiGo (run by InterGlobe Aviation Ltd) reported a decline in the measure. Still, earnings before interest, taxes, depreciation and amortization, or Ebitda, for both wasn’t enough to cover depreciation and interest costs, indicating that pricing has to improve if these companies have to be more profitable. For aviation firms, if incremental capacity is limited, then the pricing environment is likely to be better.
The paints sector feels the pain too, as inputs used in manufacturing paints comprise monomers and crude oil derivatives, forming about 30-35% of total raw material costs.
State-run refiners and marketers would definitely be better off when they take commensurate increases in petrol and diesel, but as we have seen, that is not always the case when elections are in the offing.
For tyre makers, high demand from steadily rising vehicle sales has helped pass on costs through price hikes, albeit partially.
Higher duties on imported tyres have improved sales of domestic manufacturers.
Therefore, operating leverage benefits along with softening rubber prices should offset rise in price of crude derivatives.
Firms will be able to pass on rising costs initially, says Jain of BNP Paribas, adding, “But after some time, stagflation will set in and it will be challenging to pass on the impact of rising crude oil prices then.”
“What this means is that the earnings recovery that everyone is anticipating to take place in FY19 will be pushed further by a few quarters,” said Deepak Jasani, head, retail research, HDFC Securities. Of course, much depends on whether crude oil prices remain higher on a consistent basis.