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Home / Markets / Mark To Market /  Cost pressures a key threat to high Nifty earnings growth forecast

A penny saved is a penny earned. This mantra of cost rationalization has been a saviour for corporate earnings since the covid outbreak.

Companies have tried to curtail the adverse impact of the pandemic on their financials through a series of cost cuts. Benign raw material prices were also a favourable contributor. However, with the ongoing commodity inflation, the risks to operating margins will keep rising fast unless companies resort to price hikes.

“So far, companies have been able to tackle rising cost inflation through cost rationalization, but their ability to pass on cost pressure is a key monitorable," said Rahul Singh, chief investment off-icer, equities, Tata Mutual Fund.

An analysis by BofA Securities shows that raw materials comprise 22-57% of sales for Nifty50 companies excluding services sectors
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An analysis by BofA Securities shows that raw materials comprise 22-57% of sales for Nifty50 companies excluding services sectors

Prices of commodities, including steel, coal, copper, aluminium and palm oil, which are used as key inputs across sectors, are heading north. Crude prices, too, are on an uptrend. Companies in the paints, cement and tyre sectors, among others, use crude-based derivatives as raw material.

Management commentaries of key companies across sectors indicate that low-cost inventory and cost controls have aided margin expansion despite input cost inflation.

About 31 corporates, comprising 46% of free-float weighted market cap within Nifty50, are exposed to commodity risks, according to a bottom-up analysis by BofA Securities Ltd. “Among the sectors with high exposure, raw materials comprise 57% of sales for the discretionary sector, followed by 36% of sales for materials, 31% for staples, 29% for energy, 28% for industrials, 27% for utilities and 22% of sales for the healthcare sectors," it said in a report on 22 February.

Companies in the consumer durables, automobile and tyre sectors have announced price hikes in January. Management commentaries point to further price hikes. However, those hinge on the pace of demand recovery.

However, analysts at BofA Securities said though most firms are pushing for cost curtailments to avert cost push, margin pressures cannot be ruled out.

“There has been a sequential recovery in key earnings parameters such as revenue, profit and margin growth in the December quarter. For the earnings recovery to continue, improvement in demand has to continue. Apart from the risk from rising cost inflation, a key monitorable would be the high ask rate," said Arshad Perwez, vice president, JM Financial Institutional Securities Ltd. It estimates an earnings growth of 32% for Nifty50 companies in FY22. According to Bloomberg data, currently, FY22 consensus earnings per share estimate for Nifty50 firms is 528.

While a low base of Q4FY20 could aid earnings performance, analysts still caution about significant downside to margins from cost inflation.

The Nifty 50 index fell by more than 4% on Friday primarily because of worries about rising bond yields globally, but investors should keep an eye on earnings recovery as well.

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