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  • How do price movements of raw materials impact a company’s profitability?

    Publish Date: September 07, 2018

    In accounting, there is a principle of ‘going concern’. This is an assumption that a company shall remain in business for the foreseeable future. Every company conducts its operations on this principle. However, for a company to be successful and remain in business for the long term, it needs to have growth and profitability. Generally, the two most common ways for a company to increase its profits is to increase its revenues or decrease its input costs.

    In this article, let’s examine how a rise in input costs can impact the profits of companies in different sectors.

    FMCG sector

    Guess what: your favourite shampoo or toothpaste can cost you a lot more if there is a spike in crude oil prices. Wait, how is that possible? Well, crude linked derivatives such as High Density Polyethylene (HDPE) and Linear Alkyl Benzene (LAB) are important input items for Fast Moving Consumer Goods companies. HDPE is used in packing materials for goods like shampoos, soaps, oils and other essential items. Similarly, LAB is a key ingredient in manufacturing detergents. So a rise in crude oil means that the price tags on your everyday items can change for the worse.

    Related read: Find out the 6 effects of rising crude oil prices on the Indian economy

    Battery sector

    Lead is probably the most important raw material in the manufacturing of batteries. It constitutes around 60% of the total cost of batteries according to a report by the Hindu Business Line. The margins for companies like Amara Raja Batteries or Exide Industries is dependent on after-market sales and replacement sale units. And since lead is such a major input component, any volatility in the metal’s price impacts the sector’s profitability.

    Aviation industry

    Aviation Turbine Fuel (ATF) is a specialised petroleum product that is used to power aircrafts. Crude oil is a major input ingredient used to create this fuel. Currently, ATF constitutes around 35-40% of the total operational cost of an airline in India according to a report by the Economic Times. Any price jump in crude oil prices can inflate input costs for this sector.

    This was clearly evident by the fall in share price of aviations stocks when crude oil prices breached the $80/barrel mark in May 2018. One way to mitigate these costs is to pass on the price rise to the customer. However, this puts aviation companies in a really sticky spot because profitability could be adversely affected if passenger growth slows down due to rise in ticket prices.

    Related read: 7 things to know about the aviation industry

    Paper sector

    Pulp is a raw material used to make paper. It is a fibrous material that is made from wood fibre, recycled newspapers, rags and even vegetable matter. A constraint in the supply of domestic wood pulp in the recent times means that many companies import pulp from other countries. And when imported pulp prices are on a high, the profitability of paper manufacturers is severely impacted.

    Paint sector

    Titanium dioxide (TiO2) is one of the key ingredients required to manufacture paint. Most Indian paint firms including Asian Paints and Berger Paints import TiO2 from China and other countries. Rise in the cost of TiO2 means that paint companies are forced to hike prices. This results in lower margins because sales volumes take a knock.

    Related read: Kansai Nerolac Paints: Q1 earnings update

    Conclusion

    Rise in input costs not only affect a company’s profits, it also has a big impact on the company’s stock price. Most airline stocks in India plunged overnight after a rise in crude oil prices in May. As a participant in the stock market, it is very important to keep track of input prices so that you can make better decisions when it comes to stock trading.

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