One of the few sectors to have outperformed falling broader market indices has been the consumer non-durables sector. In the past one year, the FMCG index of BSE has risen 9% compared with the benchmark Sensex, which has slipped by 19.5%.
The companies in the sector have kept sales growth healthy, have not passed on the full increase in input costs, but still managed to grow profits. But how long can this performance be sustained is the question investors should be asking.
Stable or falling advertising and promotion costs have been a key highlight in recent quarters. Will rising product prices hit consumer demand, as it has in the past? Will inflation really decline in the coming quarters, as is being predicted? And, if inputs become cheaper, will consumer companies hold on to product prices, or will competition force them to cut prices?
These variables will play a key role in shaping the sector’s performance and valuations in the near to medium term. These questions become more relevant as price hikes are playing a bigger role in growth now. Hindustan Unilever Ltd’s sales, for example, rose by 18.5% in the September quarter, with volume growth at 10%. This does not mean a return in pricing power.
Unable to absorb rising costs any more, companies have passed on some of the increase to consumers. Even now, material costs continue to run ahead of sales growth. In the September quarter, the sector’s sales rose 18.3%, but operating profit increased 20.4%. The higher growth in operating profit is chiefly due to subdued growth in advertising and promotional expenses. Though all firms do not report this figure separately, for those who do, such expenses rose just 3.4%.
In addition, scale benefits have also contributed to better margins. While scale benefits are sustainable, it is doubtful if ad spends can remain subdued, without affecting sales growth at some stage. Product prices have been rising and at some point, they could affect demand. That would be the signal for companies to start investing in advertising and promotions again to push up sales, a move that could affect margins.
A key positive for the sector will be if overall inflation slows and the industry’s inputs become cheaper. That will give the industry adequate room to grow both sales and profits.
In the short to medium term, the timing of these uncertain events could play some havoc with profits, even though the longer-term story for consumer firms remains intact. The industry is still in a relatively better position compared with peers, but there appear enough reasons for investors to tread cautiously.