Softening prices of raw materials boosted the profit margins of Indian listed fast-moving consumer goods companies in the September quarter (Q2FY24), as was expected. Overall 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 expand their advertising budgets. Consequently, Ebitda margin expansion was relatively slower than the gain at the gross margin level.
But while these have helped with profitability, the revenue and volume actions of these companies are nothing to write home about, in contrast to the overall performance of the industry.
“While overall FMCG market volume growth improved marginally quarter-on-quarter (8.6% y-o-y in Q2FY24 vs 7.5% in Q1FY24), demand was slower than expected for organized players (2.2% y-o-y in Q2FY24 vs 7.5% in Q1FY24). 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 prices of raw materials making the products of unorganized players “more affordable for value-seeking consumers”.
Demand in urban markets was decent. But this was not enough as rural demand was subdued due to uneven monsoon, the change in the festive season this year and elevated inflation levels. Moreover, price-led tailwinds decreased for companies with the base becoming larger. Cumulatively, this has led to 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 declined by nearly 1%.
In addition, there are not enough tailwinds for significant revenue growth, as this must be primarily volume-based. HUL said that if commodity prices remain stable, price 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 the picture is murky.
“Unorganized players may continue to gain strength, especially in highly penetrated categories like tea, soaps and detergents, until there is sufficient price pass-through from organized players,” said Sachin Bobade, 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 about a revival in rural demand, the pace of recovery remains to be seen. Dabur India Ltd expects rural markets to gain traction with increases in minimum support price, good sowing of rabi crops and the likelihood of more government measures ahead of elections.
The lack of clarity is captured to some extent in stock presentations. Shares of companies with extensive exposure to rural markets, such as HUL and Dabur, have declined 2-4% so far this year. Marico shares rose by a mere 3%, significantly lagging the Nifty FMCG index.
On the profit front, while gross margin is likely to remain elevated, companies are expected to invest those gains into marketing to deal with increased competition. This will weigh on Ebitda margin outlook. “There were more revenue cuts than upgrades for FY2024-26E due to weak growth outlook (lagged 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 are trading at 40-48 times their estimated FY25 earnings, according to Bloomberg data. These multiples aren’t exactly cheap because of the risks.