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White goods & durables: Inflation in crude oil prices- Transitory impact on margins

We note expenses amounting to ~10% of net sales are directly impacted by change in crude oil prices for white goods and durable companies. There is negative correlation between change in crude oil prices and EBITDA margins of Durable companies. Historically higher crude oil prices have impacted margins for 2-3 quarters but we also note the durable companies have managed to pass on the inflation via pricing actions. In-spite of volatile crude oil prices over past 15 years, EBITDA margin of Havells has steadily improved from 10.4% in FY06 to 15% in FY21. We also note the organized players are likely to gain market shares during these tough times from smaller/ unorganized players as these companies are likely to suffer more. We maintain our positive stance on the sector and top picks are Havells (BUY) and Crompton Greaves (BUY).

  • Crude oil at $100/bbl and historical impact on earnings: Ongoing geopolitical tensions between Ukraine and Russia have likely resulted in increase in crude oil prices. We note, EBITDA margins of the white goods and durables sector have been negatively correlated with crude oil prices historically.
  • Crude oil derivatives and related cost heads as % of net sales: We have analyzed the cost structure of Havells and note expenses amounting to ~10% of net sales are directly impacted by a change in crude oil prices. Key expenses include power & fuel, logistics, plastic, packaging material and paints. Distributors also incur freight cost ~2% of net sales.
  • Transitory impact of higher costs: While increase in crude oil prices impacts the profitability, we note the Durable companies have passed on the increase in costs with a lag of 2-3 quarters. Also, there is sharp recovery in margins whenever crude oil prices have declined in subsequent years.
  • Bigger impact on unorganized sector; large players gain market share: The impact of increase in crude oil prices will be higher for smaller / unorganized sector. While there will profitability impact for all companies, larger players are likely to gain market shares in case of steep inflationary environment.
  • Sector view & top picks: Considering the strong return ratios, healthy growth potential and low penetration levels, we remain structurally positive on the white goods and durables sector. We also expect the migration from unorganised to organised sector to steadily generate value. Havells India and Crompton Greaves are our top picks. Key risks: Higher-than-expected rise in crude oil prices, any delay in price hikes to protect margins, and irrational competition.

Valuation summary

TVJ Bureau

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