Home / Market / Mark-to-market /  FMCG stocks back in favour as costs beat a retreat

Shares of fast moving consumer goods (FMCG) companies are making a gentle recovery, after getting pummelled from the highs of end-August. The BSE FMCG index is still down by 9.3% since end-August, but is up by that same rate over its lows of early-October. Some of that is because of the broad market, which is up by 3.4%. There has also been a rotation to defensives—a trend that seems to have caught up in other global markets, too.

While these are external factors, the FMCG sector itself seems to have turned the corner on one troubling event. The reversal in rising crude oil prices and rupee depreciation is a welcome development. Crude oil prices have fallen by a fifth in the past month. Though the September quarter did not see any significant impact from increasing costs, companies had cautioned about rising costs during the fiscal year.

Since the more established companies would have more sophisticated procurement systems, they would have locked into prices early on. Eventually, as higher prices feed into new contracts, costs would have increased. The falling rupee affects the cost of all inputs linked to import-parity prices, chiefly chemicals and packing material. The crude oil spike affects linked inputs. The chart shows how paraffin oil prices (used in hair oils) and HDPE (high-density polyethylene, used to make bottles, among others) have risen in FY19.

The reversal in oil prices and the appreciation of the rupee should bring some relief to companies, although with some lag. Material costs are a fair share of the sales of FMCG companies—47% in the case of market leader Hindustan Unilever Ltd. So, variations in these costs can make a significant difference to margins. When fuel prices also decline, it will yield freight savings, which will reflect in other expenditure.

But the pullback in prices may have one drawback. During the cost push, companies could have increased prices, at least a little over the increase in costs, and see if the market absorbed it. Growth has been largely volume-led in recent quarters, and while that’s good, a higher contribution from price increases would also be welcome.

Importantly, a benign raw material price situation strikes one risk off investors’ minds, assuming it stays down. That largely leaves the rural market as a potential risk. While non-farm income and wages are showing encouraging signs, the chief concern is on the agricultural front. Worries on the output front and of lower crop realizations are being cited as signs of persisting rural distress. What impact that has on consumption will have to be watched. So far, rural consumption of FMCG products is on an uptrend. In the September quarter, retail sales in rural areas rose by 20% compared to 14.5% in urban centres, according to the Nielsen Co.

The jump in shares has also meant that valuations have gone back to looking very expensive, with a price-to-earnings ratio of 50.7 times for the BSE FMCG index. That hinges on an assumption that rising GDP growth will continue to keep the consumption theme going.

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