Retaining gross margins (GM) happens with a lag for B2B business, even if it is very well established.
- Customers resist price hike, and start looking for alternative sources if terms are not lucrative.
- Key raw material costs keep increasing with inflation and dynamic supply situation.
Operating Margin (OPM) expansion possibility can be sensed by focusing on:
- Gap b/w capacity and production: Management commentary about the expected sales growth ++ type of products to be launched.
- Operating Leverage: Contribution of fixed operating costs (Manufacturing, Employee, and Others) in overall expenses.
If sales growth materializes and fixed operating costs do not increase to a similar extent, OPM increase would be inevitable.
In my opinion, past margins provide a solid anchor to base valuation since most management do their best to avoid lowering the established levels. Even maintaining consistent level of OPM is a good performance in my view. It’s like running on a treadmill, one needs to do a lot to stay at the same place.
P.S: Open to hear views from far thinking or well read minds on VP around this topic.
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