Scientists predict 1.2 million deaths by the end of August, hospitals are running out of beds and oxygen, and bodies are being dumped in the Ganges, but the Nifty 50 Index is trading at a price / ratio. profit of 31. Even after softening somewhat since February, valuations are still rich. In the Asia-Pacific region, only Australia, New Zealand and Singapore are more expensive.
Colgate offers brilliant clues to the mystery. For the year as a whole, the Indian unit of the American multinational saw a rise of just over 7% in its net sales, but since that increase reached 1.2% in the 12 months previous years, the two-year average is less than 5%. This is a company that only once increased its annual revenue by less than 13% in the nine years leading up to 2015. But then came the challenge of its domination of a guru. yoga and his local Ayurveda society, followed by Prime Minister Narendra Modi’s bizarre ban on 86% cash in 2016, a banking crisis, a sharp economic downturn, and finally two waves of Covid-19. Colgate hasn’t once achieved double-digit growth in the past six years under Modi.
Then there is this surprise: the margin of the Colgate-Palmolive India Ltd. unit. listed in Mumbai. Earnings before interest, taxes, depreciation and amortization in the March quarter increased by more than 8 percentage points to almost 33%. How does a company that puts certain chemicals in tubes pass the pressure of rising commodity prices to consumers in the midst of a raging pandemic?
According to economists, this should not happen. Wholesale prices in India, an indicator of rising costs, jumped 10.5% last month, the highest level in 11 years. Consumer price inflation, for its part, slowed to 4.3% from 5.5% in March. Leaving aside the differences in the makeup of the two indices, this divergence could be “an early indicator of future margin pressures as companies struggle to pass on higher raw material costs due to weak demand.” , Jay Shankar, economist at InCred Capital in Mumbai, wrote in a note to clients.
Sure enough, analysts at brokerage firm Motilal Oswal don’t believe Colgate India’s record profit margin – achieved by cutting advertising, manpower and other costs – will last. Product inflation will eventually make a dent.
Is it okay? I plotted the evolution, compared to the previous year, of the company’s margins compared to a measure of the pressure on the prices: the annual variation of the difference between the inflation of the wholesale prices and that consumer prices. A higher number indicates costs are rising, but in an environment with low revenue growth – like the pandemic – businesses are struggling to pass them on. Profitability suffers.
This logic used to hold. Until 2018, expanding margins and price pressures were negatively correlated, but since then they are more likely to move in parallel. And that’s not just true for Colgate. The Indian unit of Unilever Plc, the country’s largest consumer goods company, is working hard not to behave like a commodity processor. Its margins respond less to price pressures. But where the two once moved in opposite directions, they are now more likely to follow each other.
One interpretation of this unlikely convergence is that the pandemic has changed habits. By purchasing from a store, shoppers can put smaller toothpastes in their shopping cart. Buying online during last year’s nationwide lockdown, they might have preferred larger quantities to avoid ordering too frequently. The bigger the pack, the higher the producer’s margin.
But not anymore. In the second wave of infections, consumers behave differently. Although mobility restrictions have been quite tight in metropolitan centers, prompting people to buy more essential supplies online, personal care price inflation is plummeting. As with many other products. If companies find it difficult to pass on the prices of raw materials at this delicate moment, households will find it difficult to absorb them: heavily taxed gasoline, which costs 45% more than in the United States, is already weighing down on consumers. budgets. Yet in the past three months, the only large stock of non-durable consumer goods to have fallen in India is cigarette maker ITC Ltd.
Are investors overconfident in profit margins? The second wave of the pandemic is different from the first. It spread like wildfire and overwhelmed the healthcare system. Last year’s epidemic posed a greater threat to livelihoods. This year, the biggest fear people have is losing loved ones. According to calculations by economists at the State Bank of India, personal health spending and loss of income due to illness will cause families to shrink by 660 billion rupees ($ 9 billion). This is six times larger than the total toothpaste market in India. Consumers won’t stop brushing their teeth, but they will look for cheaper ways to do it.
This will force producers to tighten up once more to satisfy investors, even though, at the aggregate level, cost reduction is a zero-sum game. Business expenses are the income of households. If consumers don’t earn enough, bland demand will prompt India Inc. to make deeper cuts, making things worse for everyone. Developed countries have offered generous income support to households to break this vicious circle. There is none of that in India. Instead, New Delhi inexplicably cut the corporate tax rate six months before the pandemic hit.
Even with depressed purchasing power, there can be an illusion of asset price prosperity. When more than 5% of gross domestic product shifts in a year from labor’s share of corporate income, as a recent study from Azim Premji University in Bangalore showed, the stock market gains new legs. Especially when the central bank – like its counterparts elsewhere – keeps interest rates low and abundant liquidity. Under current policies, this year could happen again: Listed companies will win at the expense of families and small businesses.
Investors may have to settle for this unhealthy balance until demand conditions normalize. But in the absence of a credible vaccination plan, when will it be? The smiles lost due to the pandemic will take a long time to return. Without Modi’s bold income support program, even the increased profit margins might not last.
Andy Mukherjee is a Bloomberg opinion columnist covering industrial companies and financial services. He was previously a columnist for Reuters Breakingviews. He has also worked for The Straits Times, ET NOW and Bloomberg News.
This story was posted from an agency feed with no text editing. Only the title has been changed.
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