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Impact of higher input costs is much steeper than expected

When the third quarter results started coming out, it was well accepted that input costs would put pressure. In fact, the pressure has been much broader and also deeper than originally thought. Here is what is impacting the quarterly numbers in Q3 on the operating front.

5 mins read   |   29 - Jan - 2022   |  
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written by Shashank Gupta

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Operating profits are falling

One clear trend that is emerging in the Q3 results is that the top line is robust in most cases but the operating profits are under pressure. If you look at the Q3 results announced, FMCG players have been under strain due to higher crude prices and other input costs. Even in the case of pharma companies, the operating profits have taken a hit due to higher input costs and the supply chain factors. In the case of pharma, top line has also been hit by weak US markets. Among the other sectors that bore the brunt of the spike in input costs are the IT sector, cement and infrastructure names. Most infra names have been hit by high construction, labour as well as material costs. In the case of cement, it is not so much about the input costs but the cost of freight, transport and power that has put pressure on these names. But the big surprise package was the IT sector where pressure on operating margins has ranged between 200 bps to 400 bps. The reason has been a sharp spike in manpower costs in the midst of historically high levels of attrition. This is despite the strong top line growth. 

Warning signals were there

The input cost syndrome was never in doubt. With the WPI inflation sustaining in double digits for more than 6 months, it was always obvious that there would be a kicker effect on input costs. Most of the Indian companies had already warned about the likely impact on the operating profits in Q3. The global supply chains were still under strain and the Omicron variant had only worsened the situation. What was surprising was that the problem of higher input costs is much more endemic than imagined. It is also hitting sectors across the board and we have to still assess the full impact on sectors like oil, metals and telecom. 

Watch out for borrowing costs

What does the road ahead look like on the cost front. For now, it looks like the input cost pressures may have flattened out, although there are no indications of input costs receding. But the biggest problem is going to be the cost of funds. With bond yields likely to scale up fast in line with rising interest rates, one can expect greater pressure on the cost of borrowings for Indian corporates. That means; the safer bets in the coming few months will be the zero-debt companies or at least the low debt names. Flat input costs and rising borrowing costs could put a lot of pressure and we could see the impact in the coming months. Profit growth would be the casualty if companies don’t take a quick relook!