Respite in crude prices a boost for FMCGs, but how long?

After surpassing the $130 per barrel mark, Brent crude prices are now hovering around $110 per barrel
After surpassing the $130 per barrel mark, Brent crude prices are now hovering around $110 per barrel

Summary

  • Margin pressures for the sector were already elevated in the December quarter
  • Price hikes taken by FMCG companies are expected to offer support to their margins in Q4FY22

MUMBAI : Crude oil prices have retreated from their recent peaks seen after the Russia-Ukraine conflict started on 24 February. After surpassing the $130 per barrel mark, Brent crude prices are now hovering around $110 per barrel.

This offers respite to fast-moving consumer goods (FMCG) companies, albeit little, as prices continue to remain elevated compared to last year. Higher oil prices inflate packaging and freight costs for the FMCG sector and are, therefore, not desirable. Prices of another key input, palm oil, are also down from recent peaks but up year-on-year (y-o-y).

Slight relief
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Slight relief

“The correction in Brent crude prices and palm oil prices from their recent highs in 2022 does offer a breather to FMCG companies. Even so, y-o-y, commodity cost pressures continue to exist. Here, companies that have more indexation to palm oil and crude oil would be adversely impacted, such as Hindustan Unilever Ltd (HUL) and Godrej Consumer Products Ltd (GCPL)," said Alok Shah, an analyst at Ambit Capital.

Steps to cope
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Steps to cope

Soaps, shampoo, detergent, biscuits, and edible oil categories are the most impacted because of input cost inflation, pointed out a report by IDBI Capital Markets & Securities Ltd.

For HUL, the soaps and detergents portfolio, which accounts for a large chunk of its revenues, is exposed to risk because of its dependence on palm and crude derivatives. GCPL’s soaps business would be hurt as well. This week, the firm’s shares rose 5%, while those of HUL remained flat. So far in 2022, the stocks have declined by 23% and 11%, respectively.

Dabur India, Marico, Nestlé India, and Britannia Industries are moderately impacted by cost inflation, according to analysts at Kotak.

Margin pressures for the sector were already elevated in the December quarter (Q3FY22). Understandably, for some time now, FMCG companies have been hiking prices to fight cost pressures. These price increases are expected to offer support to margins in Q4FY22. However, depending on how raw material prices behave, there is a threat to margins as we enter FY23, posing a downside risk to earnings estimates for the year. Some analysts have already trimmed expectations.

As such, the timing of the stress because of rising costs assumes significance as current demand conditions are not particularly upbeat. Given the uncertainties, it is difficult to evaluate the exact impact on margins or volumes.

“It is difficult to accurately assess the earnings impact given many moving parts, unprecedented inflation and volatility, weak demand environment constraining further price increases, demand destruction due to broad based inflation across goods/services, and competitive intensity," said analysts from Kotak Institutional Equities in a report on 11 March.

Needless to say, input cost trajectory is important to monitor. It is also critical to follow what happens to demand when companies hike prices further. As such, what the managements say while declaring the Q4 results would be important.

Meanwhile, valuations are comparatively lower. Bloomberg data shows, shares of HUL, GCPL, Britannia, Marico and Dabur trade at 47 times, 36 times, 42 times, 45 times and 46 times estimated FY23 earnings, respectively. But near-term concerns may cap meaningful upsides, unless raw material prices correct significantly.

“Investors await a Goldilocks scenario of higher growth (demand) and lower inflation. On the rural side, a good monsoon season may help. For now, optimism runs low with risks to earnings having risen," Shah said.

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