Rising crude oil prices could eat into the festive profit of Indian companies

In an interaction with CNBC-TV18, Harsha Upadhyaya, Chief Investment Officer at Kotak Mahindra Asset Management Co. pointed out that while overall sentiment for the Indian market continues to remain positive from a medium-term perspective, investors should keep an eye on crude oil.

“Crude has moved up and there could be some pressure on margins,” he said, adding that there could be further pressure on oil prices if the Israel-Hamas conflict escalates and is no longer a local conflict.

“We have seen a 30% rise in crude prices over the last 3 months, from $70 to $90 a barrel. So there has already been an increase. This will flow into margins over the next 1-2 quarters with a lag,” he said.

Can stocks keep rallying with the rise in oil prices?

Crude oil prices have risen nearly 6% since the Israel-Hamas conflict first began ten days ago. Analysts back home are in a wait-and-watch mode as any escalation of the conflict can lead to a significant impact on margin across oil-dependent sectors such as auto, aviation, and paints, among others.

In a report released on October 9, Axis Capital noted that oil marketing companies are likely to be worst affected due to a spike in oil prices. Auto-fuel gross marketing margin has already dropped from a strong Rs 10.2 per litre in the first quarter of FY24 to Rs 2.1 a litre in the second quarter and to Rs 0.8 a litre on a spot basis. Axis expects this to adversely impact the earnings of oil marketing companies in the second half of the current financial year.

“Airlines like Indigo lose 20% of their earnings, and paints and tyres manufacturers may lose 4-7%, if oil prices rise $5 a barrel. FMCG companies are also likely to be affected (through detergents and via packaging) and are likely to pass on price increase but at the cost of volumes,” the Axis report stated.

Source: Company, Axis Capital Estimates

Crude prices have impacted the price of Styrene, a crude oil byproduct and a solvent used in making reinforced plastic fabrications, pipes and automobile body parts. Prices of Styrene have risen nearly 26% over the last three months.

The prices of daily-use items such as soaps, toothpaste, hair oil, etc. have also been on a steady uptrend over the past couple of months.

Nomura estimates that every 10% increase in oil prices can raise the fiscal cost by 0.2% of GDP in India, assuming the government bears the entire loss.

Upadhyaya said that earnings delivery remains an important factor that will drive market sentiment. He expects earnings for large caps to grow in the mid-teens. However, small- and mid-cap stocks could be at more risk of a correction if things don’t pan out as expected, he said.

“In large caps, we do not see too much earnings risk. Over the next 2 years, we expect about 16-17% earnings CAGR. Even in a worst-case scenario, there is not so much valuation discomfort in that basket. However, in small and mid-caps the earnings CAGR is about 25% for the next 2 years and valuations are at a premium to large caps as well as the segment’s historical average. If at all there are risks to earnings delivery it will be in mid- and small-caps,” he noted.