2 major factors that will weigh on demand and margins of FMCG

Irregular rainfall and a pick-up in commodity costs are expected to weigh on the demand and margins of fast-moving consumer goods (FMCG) companies.

Most companies reported a sharp expansion in gross margins in the April-June quarter (first quarter, or Q1) of 2023-24 (FY24), given the lower prices of key raw materials and earlier price hikes.

Furthermore, there were expectations that cost savings being passed on could reflect in volume growth going forward.

However, these hopes could be dashed if demand recovery, especially in the rural segment, stalls, and gains on the raw material front start to recede.

Antique Stock Broking highlights that for August, rural market demand has not witnessed any significant improvement and has been impacted by inflation in vegetable and food prices and a weak monsoon.

The competitive intensity remains high among unorganised or regional players in categories like detergents and foods, it adds.

The Street is watchful about the uneven rainfall and its impact on rural sentiment.

While rainfall in August was 36 per cent below the long-period average, the shortfall for the current season from June to September 14 is 10 per cent.

Says Ajay Thakur, research analyst at Anand Rathi Institutional Equities, “While the dependence of rural income on agriculture has shrunk, good monsoon rainfall boosts rural sentiment and demand.

“Also, rural demand has been soft for the past two years owing to high inflation and lower disposable incomes.

“With a spotty and poor monsoon, the possibility of a spike in food prices could again curb disposable incomes and hurt rural demand.”

The brokerage has a ‘buy’ rating on Hindustan Unilever (HUL) and Godrej Consumer Products among largecaps and Zydus Wellness and Emami among midcaps. HUL, Emami, Britannia, Dabur, and Colgate  are among the FMCG companies that get a sizeable chunk of their volumes and revenues from the rural segment.

Consumer majors indicated in the June quarter that there are some green shoots in rural demand on the back of falling inflation, with growth being aided by a low base.

A subpar monsoon in one year is unlikely to cause a meaningful dent in major cereal production, a spike in inflation, or a deceleration in FMCG growth, says IIFL Research.

However, it may dampen consumer sentiment, delaying the anticipated recovery in volume growth, according to the brokerage.

The other concern going ahead would be the impact on margins as higher raw material prices, amid price cuts and increased spending on advertising, take a toll on margins.

Crude oil prices, which are currently trading at $95 per barrel, are up 26 per cent over the past three months.

Lower prices of the commodity and other inputs in Q1FY24 had helped the FMCG majors clock gross margin gains of up to 750 basis points compared to the year-ago quarter.

This could reverse as the spike in crude oil prices is leading to increased prices of packaging, soda ash, linear alkylbenzene, and titanium dioxide, which could shrink gross margins, points out Antique Stock Broking.

At current valuations, the preferred picks for the brokerage are Godrej Consumer and Jyothy Laboratories.

Some brokerages, however, believe that the impact of rising input costs could weigh on the financials in the second half (H2) of FY24 rather than in the immediate quarter.

Analyst Mihir P Shah of Nomura Research says, “While prices of commodities have inched up month-on-month, most of them are still deflationary both quarter-on-quarter and year-on-year (Y-o-Y) for the second quarter of FY24; and thus are still supportive of Y-o-Y gross margin improvement.

However, as commodity prices have started to rise again, it could pose a risk to margin assumptions in H2FY24.

The brokerage is betting on companies exhibiting pockets of strength and improved execution.

Its top picks are Godrej Consumer, ITC, HUL, and Dabur.

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