Rising crude oil prices can pull down profit margins of Indian companies

Rising crude oil prices always cause a spell of gloom in India, a country that regularly imports about 85% of its requirements and the immediate impact in the public mind of surging prices is inflation that puts severe stress on the common man’s wallet. But experts have pointed out to a decline in the profit margins of Indian companies that have had a good season in the past quarters.

Riding production cuts by Saudi Arabia and Russia, crude prices are rising globally and have reached close to $95 a barrel. Calculations show that for every 10% rise in crude prices, retail inflation can climb up by 20 basis points if the impact is passed on to the market.

To compound the woes in the country, the price rise is taking place against the backdrop of weak consumer demand in the domestic market and slowdown in developed economies including the biggest ones.

While the crude prices could eat into the bottom lines, weak consumer demand can depress the topline growth, subjecting Indian companies to a pincer attack. The revenue growth of listed companies in April-June of FY24 was the lowest in the past nine quarters. There was also a deceleration in India’s nominal gross domestic product (GDP) growth in this time window. The report said that the slowdown won’t be reversing quickly.

“The pricing power of companies has weakened in recent quarters due to a slowdown in sales and revenue growth. They will be forced to absorb most of the rise in their input and finance cost from higher crude oil prices, resulting in lower margins in the next few quarters,” Dhananjay Sinha, head of research and equity strategy at Systematix Institutional Equity, told the Business Standard.

The price of Brent crude oil has gone up nearly 24% in the past three months. Now it stands at $92 a barrel, a far cry from $74.9 a barrel at the end of June this year. It sprung a nasty surprise on the country that was cosily placed in a situation where prices were going down for almost a year. At the end of May 2023, it was ruling at $72.6 a barrel, down from a high of $122.8 a barrel at the end of May 2022.

In fact, the fall in crude prices in large parts of 2022 and 2023 pushed up the operating profit margins of Indian companies. As a result most companies reported a rise in their bottom lines in three successive quarters – from Q3 of FY23 to Q1 of FY24. Most interestingly, it came against a backdrop of lukewarm revenue growth.

Data from 2,936 listed that the Business Standard crunched revealed that cumulative operating profit rose (year-on-year) a whopping 33.9% in April-June FY24 compared to 8.2% growth in total revenues during the period.

The earnings before interest, taxes, depreciation, and amortisation margin rose by 500 basis points in the period. The rise, claimed the report, was fuelled by the nearly 35% drop in Brent on crude oil price. The average price of crude had gone down from $115.5 a barrel in April-June 2022 quarter to an average of $75.7 a barrel in April-June 2023.

One of the very few sectors that higher crude oil prices could benefit was companies such as ONGC that price its products according to global benchmarks. Any fall in crude prices benefits India Inc by paving the way for lower raw material and energy prices and a possible decline in interest rates.

Historically, there has been a negative correlation between the price of Brent crude oil and operating profit margins of companies (listed on the stock exchanges) in the country. There is also a positive correlation between crude prices and the yield on the 10-year GoI bond.

Higher oil prices indicate higher yields on the 10-year government securities. These mean higher lending rates for corporates and individual borrowers. If interest rates are lower, it also implies higher consumption in most sectors of the economy, indicating topline growth.

The report also mentioned that the connection between the crude prices and profit margins of companies, and between crude oil prices and bond yields, seem to have become stronger in the past three years.

E(NDS)