BOTTOMLINE: Supply pangs can spoil the earnings picture

The global logistics picture has also got muddled with ships and containers not being available where they ought to be. The trade distortions and clogged ports have upset shipping schedules and broken the well-oiled supply chains, hitherto focused on delivering just-in time.

Then there’s also the energy picture: oil, gas, coal and power supply disruptions, some self-imposed, leading to a surge in energy prices. So, we have a predicament of rising prices, read inflation, and a supply situation that doesn’t look like its mending swiftly. And that should be a worry for investors in equities.

Commodity prices have surged to their highest since 2014. The S&P GSCI index that tracks the most liquid commodities—crude, metals and even soft commodities—scaled to 590 in October from just about 400 at the end of calendar 2020, that’s a 50 percent surge. The gains on a year-to-date basis are a steeper 63 percent. Such a steep escalation is bound to impact overall inflation and pinch businesses and/or consumers.

What’s also important to note is that the index has mostly ranged between 300 to 450 over the past 7 years. And few, therefore, would have anticipated such a sharp spike beyond.

A look at the commodity price trend and inflation data historically suggests only a moderate but positive correlation of 0.6 for the S&P-GSCI and US CPI (consumer price inflation). A similar study of the S&P-500 and S&P-GSCI indicates almost no correlation. So equities may not collectively react to the surge. However, there is bound to be an impact in affected sectors.

 

A study of the early bird results of 161 non-financial sector companies listed on NSE reveals that 75 of them saw an operating profit (EBIDTA) margin decline quarter-on-quarter for the September ended quarter, while 78 witnessed a year-on-year decline. That’s a good 46-48 percent of the sample set.

Some of the notable names that witnessed margin pressure quarter-on-quarter include Asian Paints, Havells and Ultratech Cement. Even services players like Infosys and Wipro have seen cost pressures, though these seem driven by the shortage of manpower, not goods.

What we need to be cognizant of, is that given these early signs, the impact of such input cost pressures and supply disruptions can get accentuated in the coming quarters. This, because the supply chain issues in many sectors like electronics and automobiles and chemicals hasn’t shown any significant signs of easing yet, and many expect the problems to linger till well into 2022. If this is correct, expect sales to get capped by supplies and input costs to stay elevated. The key question, therefore, is whether the cost escalation can be passed on. My wager is, not entirely. And, if that’s so, expect both sales and margins to get dented going ahead.

The new supply headwinds could well send analysts back to rework their numbers once this earnings season is done. And the revisions would likely be downward. The only thing that could keep the sentiment upbeat is a belief that this supply imbroglio and surging prices are transient and won’t impact estimates for the next fiscal, FY23, materially. And with most analysts rolling over price targets based on next fiscal’s earnings now, stock price tends may just skip this patch. That’s the optimistic view.

The pessimistic argument is that this inflation will not be as transitory as some imagine and that the Federal Reserve will need to start tapering and raising rates sooner than expected, and for longer than expected.

Whichever side you place your bets on, what you cannot ignore today is the pain the supply side is likely to inflict on businesses. How significant that will be, the jury is still out on.