Cost pressures rising anew for India Inc

After a welcome drop in March, corporate India felt cost pressures mount in the quarter ended June. The cost-to-sales ratio of BSE 500 companies, excluding banks and non-banking finance companies (NBFCs), increased to 82.3% in the quarter ended June from 81.8% the previous quarter, a DNA Money analysis shows.

Banks and NBFCs were excluded due to the non-manufacturing nature of their business.
Operating profit margins fell 60 basis points sequentially to 17.7%, due mainly to the sharp fall in the margins of oil marketing companies, as crude oil prices increased to around $70 per barrel in June from $50 per barrel in March.

Global crises led to a steep rise in raw material costs last year, resulting in very high cost-to-sales ratio (total expenditure expressed as a percentage of a company’s sales). In 2008, the cost-to-sales ratio was 86.5% for the quarter ended March, 88% for June and September, and 87.1% for December.

Operating margin performance has been in keeping with the cost-to-sales ratio. Margins have been lower when cost-to-sales ratio was higher and vice versa.A declining cost-to-sales ratio indicates higher efficiency.

In the recent past, costs have again started moving upwards. Crude oil and commodity prices have shown an increasing trend lately. “There are signs that the sharp decline in core inflation has been arrested and prices have started to inch higher,” says Sonal Verma of Nomura Financial Advisory and Securities.

“Our estimate of pipeline inflation, WPI-input prices, which collapsed in August 2008, bottomed out between June and July this year and started rising in August,” wrote Verma of Nomura in a note to clients on September 3, 2009.  So what happens to the cost-to-sales ratio and operating margins now?

While some experts anticipate margins to be more or less stable, others see an improvement. While some experts anticipate margins to be more or less stable, others see an improvement. Manish Sonthalia, portfolio manager at Motilal Oswal Financial Services, feels the cost-to-sales ratio in the September quarter would be similar to that witnessed in the June quarter.

“This is because the rise in raw material costs would be visible with a lag effect. Companies would be keeping inventory with them,” said Sonthalia. Gaurav Dua, head of research at Sharekhan Securities, agrees that operating profit margins in September are likely to remain stable. “This is because the impact of higher raw material costs would be largely offset by scale benefits,” said Dua.

While Dua and Sonthalia maintain that margins would be more or less stable, Harsha Upadhyay, fund manager at UTI Mutual Fund says, “First quarter is generally the weakest in terms of margins of all the quarters. The remaining quarters tend to do well in terms of margins,”

“Margins in September have started going up. I am very much confident that margins would be higher because selling prices have gone up,” said a fund manager who did not wish to be named.

Largely, it looks like margins could be stable to slightly better in September. It looks like the December quarter would witness pressure on the cost-to-sales ratio and accordingly the margins.  “Expect cost-to-sales ratio to rise in December 2009 quarter,” says Sonthalia of Motilal Oswal.

Anand Shah, head - equities at Canara Robeco MF said, “If consumer price index goes up, then it would have to pay higher wages to its employees sooner or later.” This means companies would have to shell out more.

Another fund manager, who did not wish to be named, said the cost-to-sales ratio might increase with a marginal pressure on margins, most likely from December 2009 quarter.

“Profitability though would increase in absolute numbers, as demand increases. The declining trend in cost-to-sales ratio in the last six quarters was on account of a fall in commodity and crude oil prices and it is for these same reasons that it will move up again,” he said.