2023 brings hope for FMCG companies

As we enter 2023, there is hope that these concerns will alleviate. In 2022, as raw material costs spiked in the backdrop of the Russia-Ukraine war, FMCG companies were pushed to take price hikes to cope with the situation. While this supported revenue growth even as volumes were muted, it was not enough to fully offset the rise in input costs. Thus, gross margins came under pressure. The saving grace was that companies cut their advertising & promotion (A&P) spends and that meant the blow to Ebitda margins was relatively lesser.

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“Staples companies have seen 2-3 percentage point (ppt) gross margin compression year-to-date. While it was partly offset by lower ad-spends, Ebitda margin was still >100 basis points lower year-on-year and 1.5ppt lower versus FY20 levels," said analysts from Jefferies India in a recent report. One basis point is 0.01%.

Encouragingly, raw material cost pressures have eased now. Prices of key inputs such as palm oil and crude oil derivatives have moderated. The price of palm oil has dropped by almost 52% from the peak of MYR 8076.5 per tonne seen in March. Even so, the current price is higher versus pre-covid levels (January-February 2020). Moreover, premiumization of products through value-added launches would aid in margin growth. In 2022, premium products fared well.

But as companies increase brand investments, the cushion from lower A&P spends may not be available at the Ebitda margin level. “Competitive intensity can increase with softening raw material prices and may also increase the risk of higher product price cuts and higher A&P spends," said analysts from Nomura Financial Advisory and Securities (India) in a report on 15 December. The brokerage firm sees 2023 as a year of margin recovery as it sees more margin tailwinds than headwinds.

Nomura estimates aggregate Ebitda margin of consumer staples companies under its coverage to rise year-on-year in FY24 after two straight years of decline.

While that augurs well, a rebound in rural demand is crucial for volume uptick. There are expectations that the market is poised to recover on the back of better crop realizations and fall in inflation levels. As such, rural demand recovery necessitates closer tracking.

Further, given that raw material costs have softened, further price hikes are not likely. To be sure, incremental revenue growth would be led by volume. In view of this, price-led growth would be minimal. Therefore, surprises on revenue growth could be low in 2023.

Meanwhile, the Nifty FMCG index staged a good show in 2022, rising by almost 20% so far, while the Nifty 50 index has increased at a slower pace of 4.5%. Despite gloomy business conditions, one factor that drove the performance of Nifty FMCG index is the stellar show put up by ITC Ltd’s shares. The ITC stock rose as much as 52.5% so far in CY22 helped by rising investor preference for value stocks compared to growth stocks during the year. Plus, the company’s mainstay cigarette business has done well on the volumes front in the half year ended September.

Overall, while there are risks to growth momentum, stiff valuations are also a challenge, points out Jefferies. According to Bloomberg data, Hindustan Unilever Ltd, Dabur India Ltd and Britannia Industries Ltd trade at almost 53 times, 45 times, and 50 times their respective FY24 earnings. Hereon, investors will watch the extent of margin recovery.

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