Crude oil spike could pinch FMCGs hard; operating margins likely to suffer

Operating margins are likely to suffer as crude-linked derivatives act as key inputs for consumer goods companies

Your favourite toothpaste or detergent bar could cost more if crude oil prices continue to rally the way they have in the past month. Between March 9 and now, crude oil has spiked to levels of about $72 a barrel, a jump of 10 per cent. The expectation is that it could cross the $75-mark in the near term as geopolitical issues (the on-going war of words between the US and Russia), and a demand-supply mismatch push up prices, analysts tracking the market said.

Among companies that are affected significantly because of rising crude prices are fast-moving consumer goods (FMCG) players. Crude-linked derivatives such as Linear alkyl benzene (LAB) and high density polyethylene (HDPE) act as crucial inputs for consumer goods companies.

An increase in price of these inputs, says G Chokkalingam, founder, Equinomics Research & Advisory, will mean that production costs will increase putting pressure on companies to raise product prices. “In the event they do not raise product prices, as they could suffer an impact on their margins, notably, operating margins,” says Chokkalingam.

LAB, for instance, is used in making detergents and constitutes almost 60-70 per cent of the latter’s input cost. HDPE is used in packaging material for all essential consumer items from soaps to detergents, hair oils, creams, shampoos and toothpastes. Packaging costs of these products constitute 15-20 per cent of overall production cost for companies.

So, rising crude prices are not the best of scenarios for consumer goods companies, explains Sachin Bobade, senior research analyst at brokerage Dolat Capital. “The pressure to pass on the input price hike is high and while price-led growth will show improvement, volume growth will be impacted, spooking investors and allied stakeholders,” he says.

Investors anticipated these concerns on Thursday pushing the FMCG Index down 0.16 per cent on the BSE to 10,663. It remained volatile through the day even as the broader Sensex was up 0.47 per cent to touch 34,101.

While consumer goods companies are not indicating anything yet in terms of their pricing strategy, some say the picture will become clearer in the coming weeks. “Companies will tweak pricing if crude breaches the $75-mark,” Bobade says.

Sunil Duggal, chief executive officer, Dabur India, said that price changes would be effected keeping in mind competitive intensity. “The strategy will be to take judicious price hikes without hurting volume growth,” Duggal says.

Crude’s FMCG Connection
| Key inputs used by consumer goods companies are derivatives of crude oil

| This includes linear alkyl benzene (LAB) and high density polyethylene (HDPE)

| LAB goes into making detergents and HDPE is used as packaging material 

| Any increase in the price of crude oil will mean prices of these inputs will move up

| This puts pressure on companies to raise prices or take a hit on margins

While the fourth quarter of the 2017-18 financial year will see consumer goods companies gain from a low-base effect in the year-ago period, that window may not be able in the coming quarters, sector analysts said. “It will mean that they will have to move cautiously on pricing if they wish to minimise the impact on volume growth,” an FMCG analyst with a Mumbai-based brokerage said.

Rising input costs also reduces the window for companies to spend heavily on advertising and sales promotions, sector experts said, which is an important lever for them. The rise in crude oil prices has clearly come at an inopportune time.