A penny saved is a penny earned. This mantra of cost rationalisation has been a saviour for corporates earnings since the peak of covid-19 in March 2020. Companies have tried to curtail the adverse impact of the pandemic on their financials via a series of cost cuts. Benign raw material prices were also a favourable contributor. But with the commodity inflation, the risks to operating margins is fast rising unless companies resort to price hikes.
“So far companies have been able to tackle rising cost inflation via cost rationalization but going ahead, the ability of companies to pass-on cost pressure is a key monitorable,” Rahul Singh, chief investment officer-equities at Tata Mutual Fund.
Also Read | The limits to India’s privatization push
Prices of commodities including steel, coal, copper aluminium, palm oil, which are used as key inputs across sectors, are heading northward. Crude prices too are on an uptrend. Companies in the paints, cement and tyre sectors, among others, use crude-based derivatives as raw materials. Management commentaries of key companies across sectors indicate that low-cost inventory and cost controls have aided margin expansion despite input cost inflation.
A bottom-up analysis by BofA Securities Ltd shows that 31 corporates, comprising 46% of free-float weighted market cap within Nifty50, are exposed to commodity risks. “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 & 22% of sales for the Healthcare sectors,” it said in a report on 22 February.
To be sure, companies in the consumer durables, automobile and tyre sector have announced price hikes in January. Management commentaries point to further price hikes, however that hinges on pace of demand recovery. However, analysts at Bofa Securities feel that even 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 sustain, improvement in demand has to continue. Apart from risk from rising cost inflation, a key monitorable would be the high ask rate,” Arshad Perwez, vice president at JM Financial Institutional Securities Ltd said. JM Financial estimates an earnings growth of 32% for Nifty50 companies in FY22. According to Bloomberg data, currently, FY22 consensus earnings per share estimate for Nifty50 companies is at Rs528.
While a low base of Q4FY20 could aid earnings performance, analysts still caution of significant downside to margins from cost inflation.
The Nifty 50 index fell by nearly 4% on Friday mainly owing to worries about rising bond yields globally; but investors should keep an eye on earnings recovery as well.