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Corporate margins to rise from the ashes

* India Inc’s operating profitability has seen a sharp contraction with 2QFY23 and 1HFY23 EBITDA margins of MOFSL Coverage companies (ex-financials) being down 540bp and 510bp to 12.8% and 13.5%, respectively in 2QFY23

* The gross and EBITDA margins for MOFSL Universe are expected to come in at multiyear lows of 29.4% and 14.7% in FY23, a compression of 520bp and 270bp YoY, respectively.

* However, the recent commodity price correction will drive the margin pick-up sequentially in 2HFY23E and FY24E, in our view. We expect the MOFSL Universe to post 190bp and 220bp expansions in gross and operating margins to 31.3% and 16.9%, respectively, in FY24.

* We forecast the following sectors to lead the gross margin recovery in FY24: Cement (+430bp), Consumer (+250bp), Metals (+240bp), O&G (+150bp), and Auto (+130bp).

* We project the following sectors to lead the EBITDA margin recovery in FY24: Cement (+310bp), O&G (+230bp), Metals (+190bp), and Auto (+180bp).

Waning commodity inflation to fuel margin expansion

* After witnessing the peak and trough…: Corporate Inc. margins have seen acute volatility since the start of the pandemic. Post-clocking multi-year highs in FY22, corporate gross and operating margins are expected to contract to multi-year lows in FY23 due to a spike in commodity prices led by global macro headwinds. Sectors reliant on global commodities would see maximum pain led by significant price volatility that will have a cascading effect on corporate India’s margins.

* …margin recovery to be driven by lower input costs: After creating an adverse impact during 1HFY23, commodity prices have finally started to correct sharply from their peaks. The benefits of lower input costs should trickle down to corporate profitability going forward. The sectors severely affecting the FY23E margins will be the key drivers for FY24E margin expansion. Among the key sectors – Cement, Metals, O&G, Consumer, Auto, and Specialty Chemicals will drive margin expansion, in our opinion.

The peak Margin story (FY21-FY22)

* In FY22, corporate India’s profitability surged notably to multi-year highs driven by a sharp drop in global commodity costs due to fall in demand during the pandemic along with strict cost-efficiency measures undertaken by corporates.

* Gross margin for the MOFSL Universe stood at 34.6% in FY22 (driven by O&G but dragged by Metals, Cement, and Consumer). However, gross margin for the Universe (ex-Commodities) contracted to 42.4% in FY22 from 44.7% in FY21.

* EBITDA margin for the MOFSL Universe expanded to a 15-year high of 18.7% in FY21 driven by cost-efficiency measures; whereas (ex-Commodities), the margin scaled a four-year high of 25.4% in FY21. However, from the beginning of FY22, companies started to witness margin pressure owing to rising commodity costs. Thus, EBITDA margin moderated to 17.4% in FY22 led by O&G and Cement.

Margins to hit multi-year lows in FY23E despite a gradual revival

* Global excess liquidity, geopolitical challenges, supply-led disruptions and depreciating INR led to extreme volatility in commodity costs and pushed the same to multi-year highs.

* During the pandemic, companies were not able to pass on the entire cost inflation to consumers due to modest demand. Subsequently, in FY22 and as of 1HFY23, corporate India continued to face significant gross margin pressure in spite of taking sound cost-efficiency measures and multiple price hikes.

* In FY23, gross margin of MOFSL Universe (ex-Financials) is expected to drop to a decadal low of 29.4% and EBITDA margin is likely to plunge to an eight-year low of 14.7%.

* Metals, Cement, Oil & Gas (O&G) sectors’ margins are likely to be impacted adversely in FY23.

Key sector-wide findings

* In FY23E, the entire MOFSL Universe would witness notable gross margin pressure. The gross margin of the Universe is likely to contract 520bp YoY to 29.4%; whereas, gross margin (ex-Commodities) would report a contraction of 130bp to 41.1% during the same period. Further, in FY23E, EBITDA margin is likely to contract 270bp to 14.7% and (ex-Commodities), it would fall ~90bp to 22.9%.

* In FY23E, gross margins of Metals/Cement /O&G are projected to contract 1,230bp/630bp/350bp YoY, respectively; whereas, the same for Retail and Consumer are likely to expand 90bp and 100bp, respectively.

* EBITDA margins of Metals/Cement/O&G/Tech are forecasted to contract 510bp/ 480bp/260bp/140bp YoY; whereas, the same for Consumer/Auto/RE/Retail are likely to expand 20bp/80bp/110bp/150bp, respectively, in FY23E.

The story unfolding in FY24E: past inhibitors to drive margin recovery

* As the benefit of the recent moderation in commodity costs starts accruing in 2HFY23, we expect several sectors to be positively impacted. Going forward, we project some improvement in overall costs as the macro headwinds cool off and other overheads return gradually.

* All the sectors within our coverage universe (barring Retail) are likely to benefit from gross margin expansions. For the MOFSL Universe, gross margin is likely to expand in Cement (+430bp), Consumer (+250bp), Metals (+240bp), Specialty chemicals (+170bp), O&G (+150bp), and Auto (+130bp).

* Most of the Nifty companies are likely to report gross margin expansion in FY24E, with 12 companies to clock over 150bp YoY expansion.

* All the sectors within our coverage universe (barring Infra) are likely to benefit from EBITDA margin expansions. For the MOFSL Universe, EBITDA margin is likely to expand 220bp YoY to 16.9% in FY24E. This is likely to be driven by Cement (+310bp), Specialty Chemicals (+230bp), O&G (+230bp), Metals (+190bp), Auto (+180bp) and Consumer (+160bp)

Most of the Nifty-50/MOFSL Universe stocks to see margin expansion in FY24E

In FY23E, 11 of the 33 Nifty-50 companies (ex-Financials, ex-TAMO) would see gross margin contraction of over 200bp; whereas, Auto and Healthcare to cushion this steep margin decline. Conversely in FY24E, 27 of the 33 companies under consideration are expected to report gross margin expansion (with 10 companies to witness margin expansion of more than 200bp YoY).

* Further, 17 of the 34 Nifty-50 companies (ex-Financials, ex-TAMO) would post EBITDA margin contraction in FY23E (with 9 companies to witness margin contraction of over 200bp). However, most of the Nifty-50 companies would see EBITDA margin expansion in FY24E, with eight companies to report expansion of more than 200bp YoY.

Margins to hit multi-year lows in FY23E

* Gross margin for the MOFSL Universe stood at 34.6% in FY22 (driven by O&G but dragged by Metals, Cement, and Consumer). However, gross margin for the Universe (ex-Commodities) contracted to 42.4% in FY22 from 44.7% in FY21.

* EBITDA margin for the MOFSL Universe expanded to a 15-year high of 18.7% in FY21 driven by cost-efficiency measures; whereas (ex-Commodities), the margin scaled a four-year high of 25.4% in FY21.

* In FY23, gross margin of MOFSL Universe (ex-Financials) is expected to drop to a decadal low of 29.4% and EBITDA margin is likely to plunge to an eight-year low of 14.7%.

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