FMCG: kicking the expectation can down the road
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Retail inflation has been trending down but inflation in input costs of fast-moving consumer goods companies has inched up. That is a challenge no doubt but also an opportunity for consumer companies. In the past, they passed on falling input costs to remain competitive in the face of weak demand. Now prices are being increased or promotions are being withdrawn in select categories such as soaps but that is affecting demand.
Consumer companies are still caught in a tough place but rising inflation may suit them better. The organised sector can usually tide over input cost inflation better, due to their scale and ability to buy forward, giving them a slight edge over smaller competitors. If the price gap is significant, they can win share, aiding volume growth. Buyers of premium products also absorb price increases better. These are the slim hopes that one has to hang on to, as there are no signs of a broad-based demand revival.
Analysts are expecting the sector’s revenues to grow by 8-10% during the September quarter but this could go lower if the impact of price hikes is lower than expected. Hindustan Unilever Ltd’s volume sales is expected to increase by 2-3% from a year ago, with value sales growing a bit more than that. ITC is expected to see volume growth in cigarette sales continue and with pricing also contributing, its overall sales are expected to increase by 7-10%.
The increase in input costs may put some stress on gross margins over the June quarter, as companies may not have passed on all increases in costs. Some of the main commodities that have seen prices increase are wheat flour, sugar and palm oil—which affects both food and personal care companies (who use its derivatives in their products). Although crude oil remains low, it appears to have bottomed out, which is used as an input and is linked to the cost of packaging.
Tight controls over costs, especially over advertising, are expected to keep profit growth higher than sales growth. Some of the sector’s long-awaited triggers such as the pay hikes for the government and a better monsoon have happened. The goods and services tax is set to commence in FY18. Investors may still give the sector a few more quarters to deliver better growth. After that, it may become increasingly difficult to justify the price to earnings ratio of 40 times trailing 12-month earnings that it trades at.