Softening raw material prices boosted the profit margins of Indian listed fast-moving consumer goods companies in the September quarter (Q2FY24), as was expected. Aggregate gross margin expansion for FMCG companies under Nomura’s coverage stood at 505 basis points year-on-year, rising to 51.6%–the highest in at least nine quarters.
This left room for companies to step up their advertising budgets. Accordingly, Ebitda margin expansion was comparatively slower than the gain at the gross margin level.
But while these have helped with profitability, the revenue and volume performances of these companies are nothing to write home about, in contrast with the overall industry performance.
“While overall FMCG market volume growth improved marginally quarter-on-quarter (8.6% year-on-year in Q2FY24 versus 7.5% in Q1FY24) the demand was slower than expected for organised players (2.2% year-on-year in Q2FY24 versus 4.1% in Q1FY24),” wrote Mihir Shah, analyst at Nomura Financial Advisory and Securities (India) in a report dated 20 November.
This, he said, was due to softening raw material prices making the products of unorganised players “more affordable for value-seeking consumers”.
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Demand in urban markets was decent. But this was not enough as rural demand was subdued owing to an uneven monsoon, the shift in the festive season this year, and elevated inflation levels. Plus, pricing-led tailwinds have diminished for companies with the base becoming larger. Cumulatively, this took a toll on revenue growth. Hindustan Unilever Ltd (HUL) and Britannia Industries Ltd saw year-on-year Q2 revenue growth in the range of 1-4%, while for Marico Ltd it was down by nearly 1%.
What’s more, there are not enough tailwinds for significant revenue growth as this has to be majorly volume-led. HUL has said that if commodity prices remain stable, pricing growth can be expected to be slightly negative in the near-term. Q3 could get a boost from the shift in the festive season, but post that the picture is blurry.
“Unorganised players may continue to gain strength, especially in highly penetrated categories such as tea, soaps and detergents, until there is a sufficient price pass-on by organised players,” said Sachin Bobade, an analyst at Dolat Capital. This could lead to a loss of market share for listed companies.
Further, the pick-up in rural demand could be gradual at best. While companies seem optimistic on a revival in rural demand, the pace of recovery remains to be seen. Dabur India Ltd expects rural markets to gain traction with hikes in minimum support price, good rabi crop sowing, and the likelihood of more government measures ahead of elections.
The lack of clarity is captured to some extent in stock performances. Shares of companies with vast exposure to rural markets, such as HUL and Dabur, are down 2-4% so far this year. Marico’s stock rose by a mere 3%, significantly lagging the Nifty FMCG index.
On the profitability front, while gross margin is likely to remain elevated, companies are expected to invest those gains towards marketing to tackle increased competition. This will weigh on Ebitda margin outlook. “There were more earnings cuts than upgrades for FY2024-26E due to a weak growth outlook (delayed rural recovery) in staples,” Kotak Institutional Equities said in a Q2 review report on consumer staples.
The valuations of key FMCG stocks hardly offer comfort. Shares of HUL, Marico and Britannia trade at 40-48 times their FY25 estimated earnings, according to Bloomberg data. These multiples are not exactly cheap given the risks.