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Rough terrain for FMCG cos amid sluggish rural demand

Rural demand remained sluggish, hurting volume growth. This in turn impacted the revenue performance as softening raw material costs restricted further price hikes. For perspective, Hindustan Unilever Ltd (HUL), which derives a significant chunk of revenue from the rural markets, clocked a mere 3.6% year-on-year sales growth in the three months ended September (Q2FY24), the slowest in the past nine quarters at least.

The ongoing quarter (Q3FY24) doesn’t seem to offer much respite for FMCG companies from a demand perspective. The festive season was expected to boost sales, but that did not help. 

“Retail inventory increased due to lower secondary sales compared to primary sales on account of lower than expected off-take growth during the festive season and delayed winter,” said Antique Stock Broking’s recent FMCG dealers channel check.

Additionally, listed FMCG companies are grappling with rising competition from local firms or the unorganized sector, especially in highly used categories such as tea, soaps and detergents. 

Local companies in the sector have made a comeback aided by softening commodity costs which helped their pricing power. To beat this pressure, listed FMCG companies have cut prices to recover market share from local companies, but to what extent this strategy has worked remains to be seen.

“We reckon volumes of most staples companies shall stay muted in Q3, especially in rural India,” said Nuvama Research report dated 21 December. 

For Dabur India Ltd, the broking firm expects low-single-digit volume growth in Q3, which aligns with the 3% year-on-year growth seen last quarter. What’s more, the outlook appears clouded going into 2024 with no significant green shoots visible in the near term. 

It is hardly surprising that investors are treading carefully with FMCG companies having vast rural exposure such as HUL and Marico whose stocks are up only by 1% and 4%, respectively. Dabur shares have lost nearly 6% in 2023 so far. In comparison, the Nifty FMCG index has risen over 25% so far. 

However, it is worth noting that the climb in the index was primarily driven by ITC Ltd, shares of which have risen by 38%. 

A lower-than-expected increase in tax on cigarettes during the Union budget 2023, coupled with improvement in its businesses have aided investor sentiment. However, growth is moderating now in its cigarette business, partly owing to a higher base.

Coming to profitability, most FMCG companies are expected to clock a year-on-year rise in gross margin in FY24 after two consecutive years of decline. This is largely due to benign raw material costs, with prices for commodities like crude oil falling. Even so, caution is warranted as prices of some agricultural commodities have been on the rise with wheat, and sugar prices increasing 6-7% sequentially in Q3 so far. These impact the raw material baskets of food companies such as Dabur, Nestle India Ltd and Britannia Industries Ltd.

According to Motilal Oswal Financial Services, the overall commodity cost basket in Q3 so far is down by 2.4% year-on-year, but is higher sequentially albeit slightly by 0.5%. The increase in the agricultural basket was offset by a drop in the prices of non-agricultural commodities.

In any case, the valuations of most FMCG companies do not offer comfort. Shares of HUL, Dabur, and Britannia trade at higher multiples of 41-51 times their FY25 estimated earnings, according to Bloomberg data. Given the lack of near-term growth levers, these multiples look expensive.