FMCG stocks have disappointed. Can the big 4 pull off a turnaround?

Investors have historically seen it as a defensive sector, a bastion of stability, even during a market correction when it historically holds firm.

The FMCG sector has long been seen as a barometer of consumer sentiment in India, catering to consumers across income levels with essential products that remain in demand regardless of economic conditions. However, recent years have painted a different picture, with the sector falling short of expectations.

FMCG faces headwinds

Despite a broader market uptrend, the FMCG sector has not only underperformed but has also seen sharper corrections.

The Nifty FMCG index has delivered a modest return of just 1.8% this year, significantly trailing Nifty’s robust 11.7% growth. Moreover, in the last three months, the FMCG index has declined by 7.8%, compared to Nifty’s 2.9% drop.

Individual company performance has been even more disheartening. Industry leaders like Hindustan Unilever (HUL), Dabur, and ITC have grappled with stagnant sales, shrinking volumes, and declining profit margins, further weighing on the sector.

Adding to these challenges is mounting competition from regional players and digital-first brands, which continue to erode market share. The pressing question now is whether this decline marks the beginning of the end for the FMCG sector’s status as a reliable safe haven or simply a temporary setback poised for recovery.

Let’s delve deeper into the factors at play.

First, understand the underlying problem of the FMCG sector.

The FMCG sector's current slowdown stems from several deep-rooted issues that surfaced post-pandemic. While the industry initially benefited from "revenge buying" as life returned to normal, lingering disruptions in the supply chain created availability and distribution challenges. This mismatch between demand and supply drove up prices across essential goods.

Inflation rose sharply to 7.6% in mid-2020 before easing to 4.1% in early 2021. However, the relief was short-lived. The 2022 Russia-Ukraine conflict reignited inflation, peaking at 7.8% due to crude oil price surges and renewed supply chain hurdles.

Inflation’s dual impact

Higher inflation had an adverse effect on demand on one hand, and raw material price inflation hit companies as they had to take price hikes and/or figure out other innovative ways to manage margins (like reducing grammage).

Put both together, and you have a situation that was not very conducive to growth.

Rise of local and private label brands

This led to a significant shift in consumer preference towards local and private label brands such as Flipkart Supermart and Amazon-owned Solimo, which are generally able to offer better value as their costs are more manageable.

These brands offer better value due to lower overheads, such as minimal distributor commissions and lean marketing budgets. This shift isn’t unique to India; it’s a global trend.

An analysis of 13 categories across personal care, home care, and food and beverages showed rising volumes for local players. Between April 2022 and 2023, local brands recorded 12.7% volume growth, outperforming national brands, which grew by 8.5%.

For example, detergent brand Supreme 51 in Madhya Pradesh, Reflect in Maharashtra, and masala brand Teju in Karnataka achieved domestic reach growth of 101%, 109%, and 65%, respectively, during this period.

But the question arises: why?

In times of rising inflation, listed companies raise their prices to maintain margins. This forces customers to move towards value-for-money substitutes offered by local brands. This has helped them gain market share.

Rise of startups

The growing dominance of startups and direct-to-consumer (D2C) brands has intensified competition, eating into the market share of traditional FMCG companies.

These new entrants leverage innovative marketing strategies, such as influencer collaborations, and capitalise on digital platforms like e-commerce to rapidly expand their customer base.

Also read: Q2 results: How urban slump, input costs threw FMCG off gear

For instance, ITC purchased Yoga Bar and invested in Mother Sparsh. Marico acquired Just Herbs, True Elements, and Beardo to expand its personal care portfolio. Dabur took a 51% stake in Badshah Masala. Tata Consumer Products acquired Soulfull and NourishCo Beverages to diversify its offerings.

Rural slowdown

The biggest worry came from the rural market, which contributes 45% to FMCG sector sales. This segment comprises low-wage earners whose income mainly depends on government spending and good monsoons.

This cohort is facing many structural challenges, including high unemployment, low government spending, and poor monsoon, which has forced them to cut back on their spending. Moreover, stagnant real rural wages have made matters worse.

Final nail in the coffin

Even though there was a slowdown, urban consumers were doing the heavy lifting until a few months back. However, judging by their Q2FY25 performance, they have also reduced spending. This has resulted in slowing growth and falling margins.

Also read: Mint Explainer: Why urban India is spending less

Market leaders feel the pinch

Britannia Industries

In its Q2FY25 report, Britannia highlighted that metro cities, which account for 30% of FMCG sales, are leading the decline. The drop in these regions is 2.4 times greater than in other areas.

Britannia highlights two key factors behind the slowdown: First, a rise in housing costs contributes 22% to the urban household budget. This is true as rentals in many cities have increased by up to 50% in a year. Second, inflation, especially in food and essential household goods, has pressured their purses.

However, their incomes have not risen in line with the rise in inflation, further straining their purchasing power. This has led them to cut back on spending on everything from essentials to discretionary purchases.

Also read: Fast Moving Consumer Goods: Time for a strategic pivot

This has led to tepid bottom line and top line growth. Its consolidated revenue grew 5.3% YoY, reaching Rs. 4,668 crores, while adjusted profit after tax (PAT) declined 8.9%, totalling Rs. 535 crores, both below expectations.

Moreover, the operating profit margin (OPM) also fell by 2.9% due to rising input costs.

However, it did achieve a volume growth of 8%, in line with estimates.

Hindustan Unilever

HUL's sales growth has decreased to just 2% and volume growth to 3%. On the other hand, its gross margin reduced by 1.5% to 50.4% and its Ebitda (earnings before interest, taxes, depreciation, and amortization) margin by 0.8% to 23.8%. Even its PAT reduced by 2% sequentially to ₹2,611 crores.

Its volume growth reduced by 1% to 3% sequentially, while it increased by 1% from 2% YoY. Its share price has also collapsed after Q2FY25 earnings.

HUL also said that demand growth remained slow in urban markets while rural demand continued to improve gradually during the quarter. The company aims to strengthen key brands, drive premiumisation, and reshape the portfolio towards high-growth categories.

ITC

The FMCG segment experienced muted growth of 5.4%, reaching ₹5,578 crore, mainly due to challenging demand conditions and inflationary pressures on input costs. Its Ebitda margin also dipped slightly by 0.4%.

According to ITC, continuous rains and floods have adversely impacted discretionary spending and sharp inflation in input costs. However, this has been primarily mitigated by premiumisation, supply chain optimisation, calibrated pricing action, digital initiatives, and strategic cost management.

Dabur

Dabur has highlighted a marked slowdown in urban consumption, exacerbated by heavy floods and natural calamities. These challenges have significantly impacted its portfolio, with Q2FY25 results reflecting sharp declines across key segments.

Its FMCG segment saw an 8% decline in home and personal care sales, a 10% drop in healthcare sales, and a 21% decrease in food and beverages (F&B) sales.

Despite this, secondary sales grew by 6% in home and personal care and 4% in healthcare. However, F&B sales dipped by 11%.

Here, rural demand outpaced urban demand by 1.3% in secondary sales. According to Nielsen data, rural growth was 6.0% higher than urban during the quarter.

Road ahead

Though Inflation dipped in July and August, it has again started surging, led by cereals, pulses, and vegetables. There is no sign of a decline in input costs, which can lead to more price hikes.

The government has also recently increased the import duty on crude and refined edible oil, leading to ~ a 20% surge in edible oil prices. Moreover, the prices of soaps, snacks, and personal care products are also expected to increase.

Besides that, FMCG companies have planned more price hikes on their products if input costs rise. Dabur has taken a 1-1.5% price hike in H1FY25, and HUL intends to take a price hike in the low single digits. Price hikes could impact volumes.

But, there is a good news.

Dabur has expressed optimism that urban consumption may have bottomed out, suggesting potential for recovery. Coupled with the rebound in rural demand, especially after favorable monsoons, this could pave the way for sustained growth.

However, challenges remain. Rising input costs could complicate matters, leading to further price hikes that may impact volume growth and margins.

Valuation outlook

While the NIFTY FMCG index continues to trade at a ~10% premium to its 10-year median valuation, individual stock performance presents varying opportunities:

HUL: Trading at a ~9% discount to its 10-year median valuation, HUL appears to offer the best risk-reward opportunity.

For more such analysis, read Profit Pulse.

Britannia, Dabur, and ITC: These stocks are trading closer to their long-term valuation averages. However, ITC stands out with its stable cigarette business and attractive dividend yield, making it a stock worth keeping an eye on.

Note: Throughout this article, we have relied on data from www.Screener.in and Tijorifinance. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.  

The purpose of this article is only to share interesting charts, data points, and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educative purposes only. 

Madhvendra has been a passionate follower of the equity market for over seven years. He is a seasoned financial content writer. He loves reading and sharing his honest opinion about publicly listed Indian companies and macroeconomics.

Disclosure: The writer does not hold the stocks discussed in this article.