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In the June quarter, a large part of the savings was on the raw material front.
In the June quarter, a large part of the savings was on the raw material front.

India Inc may see a decline in cost savings from Q2

  • In Q2, companies are expected to have continued with the tight leash on costs

Money saved is money earned. India Inc. has followed this mantra resolutely during the pandemic, as was evident in the June quarter earnings season. Of course, some economists had pointed out that the sharp cost cuts result in a so-called paradox of thrift. When everyone is busy saving, this may come back to bite companies in terms of lower demand for their goods.

In Q2, companies are expected to have continued with the tight leash on costs. “Cost rationalization is likely to remain the focus in the September quarter as well. Companies will continue to aim to keep a curb on costs," said Sanjay Mookim, head of India research at JP Morgan.

But a repeat of cost-led margin growth is unlikely in the September quarter, and expenses are expected to rise on various fronts in the quarters to come.

Raw material prices for some sectors have started inching up. Besides, as economic activity picks up pace and business resumes, some variable costs are bound to increase.

“If prices of raw material increase, there isn’t much that companies can do about it. Overall, they are still left with some more room to save costs. However, the cost-savings led improvement in margins, which we saw in the last quarter, may not go higher from where they currently are," said Mookim.

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In the June quarter, a large part of the savings was on the raw material front. In the case of Nifty50 companies, raw material costs fell to 23% of total expenditure, from 36% in the year-ago period, analysts at Phillip Capital India Pvt. Ltd said in a note.

But prices of crude-based derivatives such as petroleum coke, monomers and coal have risen in recent months.

A reduction in advertisement and promotional expenses was another key contributor to cost savings. Had the sector’s advertisement spends remained at pre-covid levels, Ebitda would have declined by 12%, instead of recording modest growth, JM Financial Institutional Securities Ltd said in a report on 28 September.

Ebitda—earnings before interest, taxes, depreciation and amortization—is a measure of profitability.

But companies are expected to begin loosening their purse strings. Fast-moving consumer goods, retail and consumer discretionary firms will have to eventually shell out money for promotions. “In the quarters to come, ad spends will make a sharp comeback. This bodes well for media firms but will erase savings for consumer companies. Variable costs, which are mostly linked to volumes, will also rise going ahead. Net-net, margin growth, which was prompted largely by cost rationalization in the June quarter, is unlikely to sustain for many sectors," said Jitendra Gohil, head, India equity research, Credit Suisse Wealth Management.

Ad spends are also expected to rise owing to the festive season and the ongoing Indian Premier League tournament.

Cost savings on account of work-from-home may continue. “For banks and IT companies, a reduction in fixed costs due to faster adoption of work-from-home would continue. Our interactions with the management of banks suggest there is a disconnect between market expectations and on-the-ground business of banks. We expect some private banks to surprise positively," Gohil said. Sector-wise, IT and banks may post decent earnings. Both are seen as key beneficiaries of adopting the work-from-home model. Tata Consultancy Services Ltd, the first to announce September quarter results, has already reported margins at an eight-quarter high.

Other areas of cost savings have been on wages, travel and rentals. Based on a study of more than 160 listed companies, analysts at JM Financials found that at least one-third of these firms made salary cuts/variable pay rationalization, one-fifth undertook headcount rationalization, and one-fourth re-negotiated rentals. “While growth revival is likely to reduce the focus on costs (as seen in previous cycles), nonetheless, (a) lower rental expenses (ex. of institutionally owned business parks), (b) savings on advertising/marketing spends, and (c) lower discretionary cost structures are likely to provide sustainable margin benefits going forward," JM’s analysts said.

While holding on to some necessary cost cuts may be helpful, loosening the purse strings would be essential at a macro level for demand to improve.

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