Crude palm oil prices have declined by 31.5% in dollar terms in the past 12 months. Photo: AFP

29/03/2013 (Livemint) - Falling palm oil prices have brought some relief to consumer companies in India. This commodity is a key cost component for soap companies as its derivative is used in the soap manufacturing process. Palm oil prices also figure in the input cost of packaged food companies. Their impact on soap companies is significant. In 2011-12, oils and fats contributed 36.2% to Godrej Consumer Products Ltd’s stand-alone raw material costs.

Crude palm oil prices have declined by 31.5% in dollar terms in the past 12 months and that has seen soap makers enjoy a healthy increase in gross margins, especially in recent quarters. The rupee’s depreciation against the dollar had been a dampener, but a relatively stable rupee in recent quarters has helped.

In earlier years, when palm oil prices shot through the roof, companies hiked prices to compensate for the increased cost. Falling prices are resulting in fatter margins, and rather than cutting product prices, companies are stepping up advertising and promotional spends, and allowing what remains to flow to profits. That’s why soap makers are not unduly depressed despite a perceptible slowdown in volume growth, as improved margins are allowing them to grow profits.

The party spoiler at such a time is obviously the risk of a bounce in palm oil prices. Since end of December, palm oil prices have risen by 12.5%. Though they are still a long way from the highs they have fallen off from (see chart), the risk for soap makers is that rising prices will feed into higher input costs and hurt margins. As volume growth is trending down, a squeeze on margins that will result in a price hike is the last thing they would want at this stage.

However, the outlook for palm oil prices is not suggesting a strong uptrend. Dorab Mistry, director, Godrej International Ltd, presented his outlook on global vegetable oil prices in a recent conference. He expects palm oil to trade at 2,400-2,700 ringgits per tonne up to the end of May (at present, it trades at 2,380 ringgits). However, post-June, he expects prices to come under pressure and after August-September, once the low cycle phase of the production stage gets over, he expects them to come under further pressure.

In a recent research report, Macquarie reassessed its demand-supply estimates for palm oil and expects an increase in palm oil inventories from what it had forecast earlier. It has, therefore, cut its palm oil price forecast for 2013 by 12.5% from its earlier forecast, and by 9.2% for 2014. A change in any of the factors that affect global vegetable oil prices is a risk to these predictions of lower palm oil prices.

The prognosis for soap makers, as a result of these forecasts, is good and it appears they may continue to enjoy better margins for some more time to come. Though prices are expected to increase in the short term, companies such as Godrej Consumer and Hindustan Unilever Ltd are adept commodity buyers and should not get affected by a short-term jump in prices. Therefore, one can expect their soap business to keep benefiting from a benign palm oil price scenario.

A risk for them is if the rupee were to depreciate significantly versus the dollar from current levels. That can undo the good that comes from lower international palm oil prices.