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The recent spike in crude oil prices will lead to a sharp fall in India Inc’s margins and profitability in the forthcoming quarter.
Historically there is negative correlation between international crude oil prices and the earnings before interest, tax, depreciation, and amortisation, or the operating margins of listed companies.
The biggest impact is expected to be felt by manufacturing companies and those that rely on petroleum-based raw materials.
The numbers suggest an across-the-board impact, including banks and financials, and oil and gas companies.
Banks and non-bank lenders, on the other hand, take a hit on margins as higher crude oil prices lead to a rise in bond yields and a fall in bond prices.
The trend was visible in the first nine months of FY22. The operating margin of all listed companies was down by 100 basis points to 25.1 per cent during April-December 2021 as the Brent crude oil price jumped from an average of $45.5 a barrel in FY21 to $74.7 during the first nine months of FY22.
Manufacturing companies, however, reported a margin expansion during April-December 2021 over FY21.
Analysts attribute this to a jump in revenues and the profitability of metals and mining companies despite a steady rise in energy costs. The quarterly results suggest a decline in operating margins for manufacturing companies in Q3 of FY22. For example, the operating margin for FMCG companies was down 60 basis points in Q3FY22 over Q2FY22 while the margins in the auto component space hit a five-quarter low in Q3FY22.
Analysts see the biggest decline in corporate margins to happen in the next few quarters. This is because the sharpest rise in crude oil prices has happened in the last three months. The Brent crude oil was trading at around $70 a barrel at the end of November 2021, up just 7.7 per cent from $65 at the end of March 2021. For comparison, the crude oil price crossed $100 on Thursday, for the first time since 2014, after Russia invaded Ukraine.
“I see a big downgrade in corporate earnings in FY23 and FY24 as a combination of higher crude oil prices and interest rates compresses margins across the board. There is now a strong likelihood of little or no growth in the overall earnings of Nifty 50 companies compared to the previous estimate of around 20 per cent growth over FY22,” said Dhananjay Sinha, managing director and chief strategist JM Institutional Equity.
“The biggest impact will be on the earnings of public sector oil-marketing companies if the government doesn’t allow a full pass through of higher oil prices. We have seen a sequential decline in the margins of paints and other FMCG companies and this could get worse if oil stays above $100 for long,” said Shailendra Kumar, chief investment officer, Narnolia Securities.
A similar decline in corporate margins had occurred between FY12 and FY14, when crude oil crossed $100 for the first time in history. Conversely there was a steady expansion in corporate margins from FY15 to FY17, when oil prices declined to an average low of $47.8 in FY17 from a high of $115 in FY12.
India Inc faces the challenge from a potential decline in consumer demand as households are forced to spend a bigger portion of their income on fuel and energy. “There could be a bigger negative impact on consumer demand this time than in the past. There is little or no fuel subsidy now and oil companies have the freedom to fully pass on higher prices to consumers,” added Sinha.
This will worsen the negative impact of higher oil prices on corporate earnings in the forthcoming quarters.
“Consumer demand has weakened in the third quarter and there could be a further decline in demand if the oil-marketing companies raise retail fuel prices in line with the recent spike in crude oil price,” said Shailendra Kumar.
