In Commodity News 09/06/2015
Despite dismal earnings in the March quarter and FY15 as a whole, falling raw material costs provided some respite for Indian companies. Raw material costs as a percentage of sales fell to 12-year low in the March quarter at 46.6% of the sales. This is the lowest since December 2002, when it was 45.3% of the sales.
The fall is largely attributable to lower crude oil prices and its derivatives. Brent crude averaged $53.9 per barrel in the March quarter, a level unseen in many years.
Coal, copper, iron ore, steel, rubber, cotton and almost every industrial commodity and fuel was lower, which helped Indian companies keep raw material costs low. But the big problem was that demand stayed low, with new projects not taking off, and hence the revenues stayed muted.
However, going forward raw material costs are expected to remain soft. And with finance costs starting to come down, operating margins could improve.
Mahesh Nandurkar, India Strategist, CLSA said, “Due to falling input costs India Inc.’s EBIDTA margins have seen some improvement in last few quarters. Fall in raw material cost has more than offset the adverse impact of operating leverage as revenue growth has diminished. However going forward, the benefits of falling raw material cost is expected to continue and potential improvement in revenue growth will drive up operating margins. Further, the expected fall in interest costs should boost net profit margins and returns on equities (ROE) should go up.”
Commodities other than crude oil, copper and zinc have continued their slide in the June quarter.
Nic Brown, head of commodities research at Natixis, a London-based research house said, “Crude oil, coal, iron ore are expected remain soft while in metals fundamentals have improved for copper and zinc which may strengthen.”
According to Brown, crude oil will remain oversupplied and Natixis estimates Brent prices to remain in the mid-$60s per barrel both in the second half of 2015 and throughout 2016.
As structural changes in China continue to depress global coal prices, both coking coal and metallurgical coal will be in surplus. In India, coal prices will also be affected by the availability (and auction price) of coal blocks. A similar story will keep iron ore prices depressed.
For metals, Nic said, “Nickel and aluminium currently exhibit excess supply, hence the recent decline in prices. However, with the price of refined metal now trading below the costs of production for many higher-cost producers around the world, a mild rebound in nickel and aluminium prices would not be unexpected. In contrast, copper and zinc fundamentals are more robust, suggesting that prices may push higher over the coming year.”
But the benefit of lower raw material costs may get diluted if the rupee weakens. However, Brown says even this may not be an issue as “with fall in gold imports, with soft crude oil prices, current account deficit will be under control which will limit rupee’s weakness.”
Ajay Srinivasan, Director, CRISIL Research said, “With prices of most commodities expected to remain subdued, we expect Indian corporates to continue to profit from lower raw material costs in fiscal 2016. For example, we expect crude oil prices (Brent) to average around $60 per barrel in 2015, which will benefit companies whose raw material costs are linked to the crude chain. Similarly, companies consuming steel will gain from tepid steel prices; average international prices are forecast to be in the range of $380-400 per tonne in 2015. However, demand growth and the competitive scenario will influence the extent to which these gains on the raw material front flow into the bottom-line.”
Continued lower demand and poor monsoon can, however, upset India Inc’s margins. If monsoon remains poor as per the IMD forecast, rural demand may be low for sometime.
Several industries have also seen cheaper Chinese imports flooding Indian markets, which include manmade fibers, paper and steel among others. While cheap imports keep domestic prices under control, it hurts the pricing power of Indian companies. The steel industry is an example.
With the RBI signalling a pause to further rate cuts and banks not passing on the cuts, the profitability of India Inc may be impacted.
“It is clear that given the RBI’s stance on monetary policy, it does not look as if the cost of borrowing will fall further in FY16. However we focus on operating margins which in the the medium to long run will be driven not so much by raw material prices but by the competitive position of the companies concerned. I reckon that if you look at operating margins for the Sensex over long periods of time, you will not find them to be correlated to raw material prices,” said Saurabh Mukherjea, CEO, Institutional Equities, Ambit Capital.
