As raw material prices inch up, FMCG firms brace for margin pressure
- Escalating raw material prices herald a halt in margin expansion for FMCG firms, as they brace for prudent pricing strategies ahead
NEW DELHI : Recent increases in the prices of essential raw materials, including crude oil, palm oil, coffee, and cocoa, could halt the “meaningful" expansion in gross margins that makers of fast-moving consumer goods have witnessed over the last few quarters.
Faced with such cost pressures, companies are poised to tread carefully before transferring these increases to consumers, mindful of the competitive landscape and the imperative to sustain sales volumes.
“We observe that most raw material prices are seeing some inflation and few are largely range bound over the past few quarters," BNP Paribas said in a report on Tuesday. "The cooling of raw material prices had resulted in meaningful gross margin expansion for most companies under our coverage. We see the increase in prices in the current demand environment as a negative development for the sector."
According to BNP Paribas, the phase of margin expansion is now a thing of the past, while revenue growth is expected to remain sluggish.
Analysts at the brokerage track monthly prices of over 150 fast moving consumer goods across 20 categories to ascertain pricing action and its likely impact on sales and margins.
Insights into the price movements of several key commodities reveal the breadth of the inflationary pressures. For instance, crude oil prices rose by 2.0% year-on-year in the March quarter.
Within agricultural commodities, maize saw increases of 3.9% year-on-year and 4.6% quarter-on-quarter, exacerbated by anticipated demand surges and governmental procurement plans for ethanol production, analysts at Motilal Oswal Financial Services said in a separate report released Tuesday.
Coffee prices jumped 15.3% on year in March, with wheat seeing a 2.6% year-on-year increase.
“After cooling off in the past few quarters, raw material prices have turned inflationary. As raw material prices deflated, companies had largely retained the benefits. Considering the competitive intensity, pressure on volumes and strong gross margins, we think companies would be reluctant to hike prices in the near term… This poses a risk to consensus’ margin assumptions," analysts at BNP Paribas said in their note.
Companies have largely maintained that pricing actions are largely behind them and will be on a need basis.
Krishnarao Buddha, senior category head at Parle Products, agreed, saying that price adjustments will be made as necessary, especially in light of soaring cocoa prices impacting products like candies and biscuits.
“We are looking at need based pricing action wherever we feel that suddenly prices have gone up. Cocoa prices are really under stress, there prices have shot up disproportionately. We have candies and biscuits where we use cocoa based products which will have some bearing. Oil prices and sugar have been pretty benign--while we took some slight disproportionate price increases last fiscal that impacted the top-line but improved the profitability," said Buddha.
Similarly, Godrej Consumer Products Ltd (GCPL) is closely monitoring the impact of rising prices of palm oil, commonly used for soap manufacturing, after having implemented price cuts on its Godrej No 1 portfolio between March 2023 and March 2024 to navigate previous inflationary periods.
“It (pricing) tends to follow oil prices. Palm prices this financial year have been soft—though there has been some firming up in the last few weeks. Prior to that it was highly inflationary," said Sudhir Sitapati, managing director and CEO, GCPL.
Over the past two years, manufacturers of fast-moving consumer goods implemented significant price increases as a direct response to the surge in raw material costs. Products within categories such as detergents, oral care, and soaps experienced price adjustments ranging from 15% to over 20% during this period. Notably, the oral care segment witnessed the most substantial hikes, with prices continuing to climb even further.
These adjustments initially contributed to improved margins for consumer goods producers. However, they also led to decreased consumer demand and slowed volume growth due to the higher prices.
Recently, with raw material costs stabilizing, there has been a marked decrease in the frequency of price adjustments over the last three months, with companies opting to lower prices or offer more product per purchase instead.
But inflation in some categories is returning, analysts warned.
Companies are set to announce their March quarter earnings next week. "We expect a weak 4QFY24 for FMCG companies. Pricing contribution is likely to be mostly neutral to negative, while we do not expect any major recovery in volumes. Higher raw material cost is a new headwind and poses a further downside risk to consensus earnings estimates," said analysts at BNP Paribas.
