FMCG companies eye improved margins as raw material costs ease

Besides palm oil, other key inputs such as crude-based derivatives and edible oil have seen a drop in their prices. “After two years of sharp inflation, we are seeing commodity cost inflation coming down,” Vishal Punmiya, an analyst at Yes Securities (India), said. “Our internal consumer staples raw material inflation index, which tracks movement of key commodity prices at a basket level, has now actually entered negative territory after almost 30 months (1.4% decline in May 2023 vs May 2022),” he said in a 22 June report.

Thus, investors will keep a close eye on how gross margins shape up when the June quarter results (Q1FY24) are announced. However, expansion at gross-margin level may be curtailed at Ebitda level owing to increase in advertisement and promotional expenses with rising competitive intensity. To be sure, prices of some commodities such as wheat, milk and sugar are elevated, which could impact companies like Britannia Industries Ltd.

As such, benefit of price hikes is expected to diminish, and growth would have to be driven by an uptick in volume. “Deflationary/stable input costs with no/ limited new price increase in Q1FY24 should support volume growth recovery. Only handful of categories like edible oil, hair oil, soap, detergent and tea have taken price cuts to protect volumes, given higher saliency of unorganized players in those categories,” Nomura Financial Advisory and Securities (India) analysts say.

In upcoming Q1 earnings calls of FMCG companies, management’s comments on rural demand would also be key as recovery has been underwhelming. Stocks of companies with relatively high rural exposure such as Dabur India Ltd and Hindustan Unilever Ltd (HUL) appear to be factoring this with shares up by only 2% and 5%, respectively, in 2023 so far.

But, this has not had a bearing on the Nifty FMCG index, which has sharply outperformed the Nifty 50 index so far in 2023, gaining by 18%. In comparison, Nifty 50 index has risen by 6%.

A significant contributor here has been ITC Ltd, shares of which have continued the strong run seen last year. The stock is hovering near its all-time highs and has appreciated by 36% so far in 2023. ITC’s mainstay cigarette business is on a strong footing with robust volume growth expectations.

Shares of Godrej Consumer Products Ltd (GCPL) too have fared well, appreciating by nearly 24%. Investors seem excited about GCPL’s margin outlook given lower palm oil prices. GCPL’s raw material basket has shown the sharpest moderation year-on-year; and softening of palm oil prices will likely lead to meaningful margin expansion in Q1FY24, according to Nomura.

To be sure, valuations of many FMCG stocks are on the higher side. Shares of HUL, Dabur and Britannia trade at 51-55 times their FY24 estimated earnings, showed Bloomberg data. “We think the FMCG sector seems well poised in H1FY24 with raw material cost tailwind. However, in H1FY24 we expect revenue growth to moderate as pricing benefits should fade and growth would have to be volume-led,” said Kunal Vora, head of India equity research at BNP Paribas in a report on 27 June. The brokerage expects a time correction in the FMCG sector.

Updated: 02 Jul 2023, 10:26 PM IST