For FMCG firms, rising inflation may be a blessing in disguise
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At one point, packaged consumer goods makers were tipped to benefit immensely from falling prices. That did not happen. Now that inflation is gearing for a comeback, consumer companies (and their investors) may wonder if they can expect a return of good times. The Wholesale Price Index (WPI)-based inflation for April rose by 0.34%, reversing a decline seen for 17 straight months (the decline had tapered in the past six months).
Why did companies not benefit so much when costs declined? This period also coincided with weakening consumption demand, with urban demand initially affected by poor economic growth and then rural demand getting hit by bad weather and falling rural wage growth.
When costs decline in such an environment, larger companies fear they will lose share to smaller ones if they keep prices unchanged. This has happened before. Tough economic conditions unhinge brand loyalty quite easily, as consumers try to make every rupee count. Smaller firms are quick to respond to near-term changes in costs.
Since the larger companies feared they could lose share, they passed on lower costs by way of volume discounts or price cuts. They even spent more on advertising and promotion, and even in this difficult environment endured a substantial increase in salaries (blame that on the hiring boom for e-commerce, perhaps).
Cutting product prices meant that sales growth in value terms and profit growth tapered. They did report having retained customers and market share. But the pain on the profit front has been a drag on valuations. In the past one year, the S&P BSE FMCG index has been almost unchanged.
Therefore, news that deflation may have become history raises the question of whether the adverse situation will neatly reverse. Crude oil prices have come off their lows, which can affect related raw and packaging material costs. Rising vegetable oil and sugar prices can affect packaged food companies. Palm oil prices have been increasing and that could see related costs for soap production rise. Note that inflation is not widespread across categories, and the monsoon rains (if they are as good as predicted) may bring food prices down. But it does seem safe to say that inflation has reversed its declining trend.
So, will the larger companies hike prices now? No. Smaller firms will feel the pinch initially and possibly increase prices as their procurement costs rise. The bigger ones will wait and increase prices only when they are confident it will not affect demand. That should see sales growth exceed volume growth and eventually benefit profit growth. How soon this reflects on their performance depends on how consumers respond to a hike in product prices, when it happens.
Rising inflation may not be good news for some parts of the economy, for interest rates and even disposable income. Given how the past few years have turned out, packaged consumer goods makers may welcome a bit of support from inflation.
The writer does not own shares in the above-mentioned companies.