Consumer companies stare at margin pressures in Q3 COMMODITIES AND RUPEE MOVEMENTS OVER THE LAST ONE MONTH How Ratan Tata’s strategies panned out for Tata Steel
Top line, margins could fall due to spike in crude oil prices and depreciation of rupee
Demonetisation is not the only worry for consumer companies in the December quarter. Operating profit margins could come under pressure as a spike in crude oil prices and depreciation of the rupee push up cost of goods sold for companies.
In the past month, the price of crude oil has jumped nearly 13 per cent to $53 a barrel, while the rupee has depreciated to levels of about ~68.23 a dollar from ~66.72 in the same time. It hasn’t helped that the price of agri-commodities such as palm oil and copra has also increased by 12 per cent and six per cent in the past month. Palm oil, for the record, is used in making soaps, while copra is a key input in hair oils.
As G Chokkalingam, founder, Equinomics Research & Advisory, says: “What companies are staring at is a double whammy, where the top line will remain subdued due to demonetisation and margins will squeeze owing to a crude oil spike and rupee depreciation. This hardly bodes well for them.”
Companies are already beginning to articulate these concerns not only in fast-moving consumer goods (FMCG) but also consumer durables and retail.
In a presentation last week, the country’s largest consumer goods company, Hindustan Unilever Ltd (HUL), said its near-term performance was under pressure and that market growth would be adversely impacted due to demonetisation. While HUL did not specify the pressure on margins, analysts expect at least a 80-100 basis-point impact on margins of FMCG firms in the third quarter.
Dabur’s CEO Sunil Duggal has already said it is cutting ad spends in view of the market environment this quarter. Duggal also said that demonetisation had resulted in massive trade destocking, which had hit primary sales in the third quarter.
In consumer durables, Eric Braganza, president, Haier Appliances India, says the pressure of raising prices is growing as input prices shoot up because of rupee depreciation. “With the demand having slowed in the wake of demonetisation, raising prices could only hit sentiment further.”
Both white and brown goods have a high degree of import component in them. Even a 100-basispoint depreciation in the rupee will mean that consumer durable and electronic makers will have to increase prices by at least 1-2 per cent, industry executives said.
“The rupee has slid 2.2 per cent against the dollar in the past one month, which is sharp. Prices will have to increase by 3-4 per cent if firms have to ride out of this,” said C M Singh, chief operating officer at Videocon Industries.
But, most firms seem reluctant to do this as consumer durables sales have been hit by 30-40 per cent in cities and 60-70 per cent in rural areas owing to demonetisation.
In a concall on Friday, jewellery and watch maker-cum-retailer Titan said that it expected the third quarter to be weak as consumers cut back on discretionary spends. “Because of a cash crunch and the general mood itself, discretionary purchases are not on the minds of people. There will be an impact on Q3 as a result,” said C K Venkataraman, chief executive officer of Titan’s jewellery division. In the first quarter of 1992-93, when Ratan Tata was still new to his role of Tata Steel chairman, the company had posted a meagre profit. If it continued, the year would end with a loss of ~180 crore. Over a sombre dinner meeting with some senior executives and the board of directors at Taj Chambers of Taj Mahal hotel in Mumbai, a goal was set. Tata Steel would have to reduce cost by ~500 a tonne, which translated into 7.5 per cent of the cost at that point in time.
At that time, Tata Steel ran in three different well-defined watertight silos: The raw materials division, the marketing and sales division, and the works. But, all the divisions had to come together to achieve the target.
“The target sounded impossible. It was so stiff that only a cohesive team could achieve it. Everyone had to innovate, break away from the past and come up with a new way of thinking. It required determination to achieve the impossible,” a former senior executive recalled.
In less than six months, Tata Steel executives conveyed that they had managed a cost reduction of ~350 a tonne. At a cost meeting that stretched till two in the morning, a disappointed Tata said, “Your promise is with me; you don’t have to make another promise. What is at stake is your prestige and reputation.” It took Tata Steel less than three months to bring down the cost to ~500 a tonne. The resultant impact: 1992-93 was a profitable year for Tata Steel with profit before tax of ~127 crore on revenues of ~3,423 crore.
“Ratan Tata transformed Tata Steel. The late 1990s were a difficult time for the company. But by 2001, Tata Steel became the lowest cost producer in the world,” the executive added.
In 2001, Tata Steel topped the World Steel Dynamics chart of lowest cost steel producers in the world, a position it retained for five years.
In keeping with Tata’s dream of having global manufacturing facilities, in 2007, Tata Steel acquired Corus in a $12-billion acquisition, in what was the biggest foreign acquisitions by an Indian company.
The strategy, as chalked out by Tata, was to have one virtual organisation with two legal entities. But, Tata Steel and Corus remained as two separate entities, officials close to the development explained.
The existing Corus management was given a freehand to decide the course of the company. Decisions were made by the Corus board, only if there was a note of dissent, was it referred back to the Tata Steel board. The idea was not to conquer the company but partner it.
If Tata was able to bring about cohesion in Tata Steel and make it one integrated company, in Corus, just the reverse happened.
The fact that Corus had a quick change of CEOs, did not help matters either.
In any acquisition, it is important to look at the cultural, social and location issues that are much broader than just business aspects, explained Malay Mukherjee, who has handled several acquisitions as a board member of ArcelorMittal till 2008. ArcelorMittal has a team of 2530 people to handle such issues.
“It is also important to gauge the attitude of the current management,” he said.
Corus had legacy issues, which had pulled down the company prior to the acquisition. “To make it work, a complete overhaul of the way it operated was required,” said officials close to the development.
The Corus group was formed out of a merger between British Steel and Koninklijke Hoogovens in 1999. To say that there was a cultural mismatch would be stating it mildly. Reports indicated that Corus group's market value in 1999 stood at $6 billion (at the time of the merger) and fell to $230 million in 2003. Integration was the major stumbling block.