Falling prices of crude oil ? now at $93 per barrel ? together with a decline in prices of a host of other commodities should provide Indian companies with some much-needed succour, at a time when regulatory restrictions have made key natural resources like iron ore and coal difficult to source. Since the start of 2014, prices of essential commodities, including iron ore, coal, crude, rubber and palm oil, have been on a downward spiral. Global coal prices, for instance, are ruling at $78 per tonne, sharply down from $100 per tonne 30 months ago, with the slump attributed mainly to declining demand from China, a dominant player in international coal trade.
Raw material costs for the BSE 500 companies (excluding banks and IT firms) stood at R6.37 lakh crore for the quarter ended June 30, the lowest in three quarters and 1.03% lower than in the quarter ended December 31. With an aggregate turnover of R10.33 lakh crore in the April-June period, 1.4% higher than in the October-December period, raw material costs as a percentage sales came down by 150 basis points to 61.68%.
The drop in prices of palm oil, used in a wide array of consumer products ranging from soaps and cosmetic products to cereals and snacks, will bring cheer to retail households. The spot price of Malaysian crude palm oil stands at around $626 per tonne in September, declining by close to 13% since January.
?We use derivatives of palm oil in the soaps we make and the prices of these derivatives have also started to reduce,? said Adi Godrej, chairman of Godrej Consumer Products. ?It will help our company?s operations and we hope to recover our Ebit (earnings before interest and tax margins), which were coming down.?
Subdued demand for products across categories around the world, owing to a weaker-than-expected revival in economic growth in regions like China and Europe, has been the main reason for declining commodity prices. For instance, the spot price of China Import Iron Ore Fines with 62% Fe content has declined as much as 40.5% since January to around $80 per tonne at present.
The international prices of iron ore have crashed due to a slowdown in the demand for steel in China.
Meanwhile, regulatory restrictions on mining in states like Odisha, Jharkhand and Karnataka have led to a severe shortage of iron ore in the country, forcing steelmakers to procure the key raw material from the spot market at a very expensive price. To take advantage of declining iron ore prices globally, steel producers are looking to step up imports of the commodity ? JSW Steel has been importing around 0.5 million tonnes a month of iron ore for its steel plants. Seshagiri Rao, joint managing director and group chief financial officer at JSW Steel, said his company had decided to hike the quantity of iron ore it imports to around 0.9 million tonnes per month.
?With iron ore prices in India reaching all-time highs, a fall in international prices is a boon in disguise,? Rao said. ?The international trend in iron ore prices, along with a stable domestic currency, is a good thing for India.?
Rao explained that the economics of using imported iron ore for steel plants in India, vis-a-vis using domestic iron ore, depended on the location of the plant. For instance, using imported iron ore at JSW Steel?s plant in Dolvi, Maharashtra (which is close to the port) is actually proving to be cheaper for the company than using locally mined ore. But at its Vijayanagar plant in Karnataka, using imported iron ore is still a costly proposition, Rao said, after factoring in transportation costs.
Analysts believe the fall in iron ore and coking coal prices will mostly benefit non-integrated steel players like JSW Steel that can retain and possibly improve operating margins, whereas integrated steel players like Tata Steel and Steel Authority of India (SAIL) will continue to face margin pressures. ?As steel prices come under pressure, the margins for integrated steel producers will come under pressure. Integrated steel producers (Tata Steel and SAIL) are unlikely to benefit from fall in iron ore prices,? a September 15 report by Motilal Oswal said. ?Instead, increased royalty and closure of iron ore mines in Jharkhand will add to costs.?
Similar regulatory restrictions have been imposed on the mining of coal as well after the Supreme Court cancelled the allocation of 214 coal mines to Indian companies on September 24, terming such allocations as illegal. These mines, awarded since 1993, were supposed to serve as captive fuel linkage for power and steel companies.
In a coal-deficit country, procuring additional coal may prove to be a challenge for these companies, increasing the likelihood of these companies resorting to imported coal. It helps that global prices of coal have corrected sharply in the last few months. While imported coal is still going to be more expensive than the cost of captive coal that they enjoyed earlier, the situation could have been much worse if coal had been trading in the range of $100 per tonne and had the rupee not appreciated considerably against the dollar.
For oil and gas companies, a drop in global prices of crude oil will help bring down the under-recovery for state-run oil marketers that were selling these products below cost. It would also benefit upstream oil producers who were made to fund a sizeable portion of these under-recoveries. In the past, net realisations of state-run oil producer Oil and Natural Gas Corporation (ONGC) has suffered due to the burden of subsidies that it had to bear. With fuel prices in India getting more market-linked, ONGC?s earnings could grow around 20% annually, the Motilal Oswal report stated, adding that for every $10 per barrel increase in ONGC?s net realisation, its earnings will improve by Rs 6 per share. ONGC?s earnings per share stood at Rs 31 in FY14.
The need for higher borrowings to fund under-recoveries and an often delayed and ad-hoc subsidy sharing mechanism has also impacted the financials of oil marketing companies (OMCs) like Hindustan Petroleum, Bharat Petroleum and Indian Oil in the past. While the combined debt and interest cost of these three OMCs rose around 22% and 27% annually over the last 10 years, their profitability has remained mostly flat. ?We estimate OMCs? debt to reduce by 15-25% leading to 8-16% EPS (earnings per share) benefit, with HPCL at 16%, followed by BPCL at 9% and IOC at 8%,? the Motilal Oswal report said.
Another set of companies that are looking forward to better times ahead are tyre makers who hope to benefit from falling natural rubber prices and the early signs of a revival in auto demand, ahead of the crucial festive season. Rubber prices in India have declined by around 24.6% since the beginning of the calendar year to $1.99 per kg.
?The reduction in rubber prices should help in improving the operating margins of tyre companies since prices of the final product are unlikely to fall in tandem with rubber prices,? said A Subba Rao, chief financial officer of tyre manufacturer Ceat, a part of RPG Enterprises.
Retail buyers who purchase new tyres as replacement for old and worn-out ones do so out of necessity, and this helps tyre makers maintain firm pricing, Subba Rao said.