Tepid rural demand a dull spot for FMCG cos

But the bigger problem for most FMCG companies in Q3 would perhaps be the impact of subdued rural demand. Elevated inflation levels continued to hit consumer sentiment. In their respective pre-quarter updates, Dabur, Marico Ltd and Godrej Consumer Products Ltd have pointed out that rural markets remained muted last quarter. Even so, there could be a small respite on a year-on-year (y-o-y) basis, due to the base effect, as rural demand was also weak in Q3FY22.

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Mihir Shah, an analyst at Nomura Financial Advisory and Securities (India), estimates Q3 volumes of consumer staple companies to grow in low-to-mid single digit y-o-y. This would be because of inflationary pressures, downsizing from larger pack sizes to smaller packs and calibrated consumption in some non-essential categories, Shah said in a report.

Akin to the trend seen in the previous quarters, FMCG companies’ Q3 revenue growth would be driven by pricing gains.

The bright spot in the quarter would be the sequential expansion in gross margins, aided by softening prices of commodities such as palm oil and crude oil derivatives. Nomura estimates the aggregate gross margin of consumer staples companies under its coverage to rise by 110 basis points sequentially in Q3.

ITC Ltd is expected to be an outlier in Q3 results in terms of volume growth. Various broking firms estimate the company’s mainstay cigarette business volumes to grow in high single-digit to low double digits. Recall that shares of ITC surged by as much as 52% in 2022, led by strong performance in the cigarette portfolio. However, it remains to be seen if this performance continues, given the high base hereon. Also, investors in the stock should watch out for any tax hikes on cigarettes in the upcoming budget.

Across companies, lower input prices would lead to price cuts, and that may restrict downtrading and also aid in volume growth. Recently, Hindustan Unilever Ltd (HUL) took price cuts in select stock-keeping units of soaps. On comparing product prices in December versus October levels, the price of Ayush and Hamam soap was lower by 13% and 2%, respectively, said analysts at Kotak Institutional Equities in a 9 January report. Other soap brands, such as Dettol and Santoor, have also seen price cuts, they added.

Hereon, gross margins of FMCG companies are expected to rise, but how much of this expansion translates into a rise in their Ebitda margins needs to be watched. This is because new product launches and brand investments could lead to higher advertising and promotion spending.

To be sure, a rebound in rural demand holds the key for any meaningful upside in FMCG stocks. But the recovery here is likely to be gradual. “Investors would need to read into management’s commentary on rural markets – whether they are calling out any signs of improvement or not. Expectations are riding high on this front, along with the anticipated announcements in the upcoming full budget before elections,” said Alok Shah, an analyst at Ambit Capital.

Nevertheless, the valuations of FMCG companies are expensive. According to Bloomberg data, HUL, Dabur, Marico and Britannia Industries Ltd trade at 41-52 times their respective FY24 earnings. This poses a hindrance to sharp upside moves.

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