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FMCG investors in a fix on lack of clarity on rural growth outlook

HUL, ITC and Parle have raised prices in select categories of products including soaps and detergents to beat input cost inflation.Premium
HUL, ITC and Parle have raised prices in select categories of products including soaps and detergents to beat input cost inflation.

  • Shares of key FMCG firms such as HUL, Nestle, and Britannia among others, are trading at a one-year forward price-to-earnings multiple of more than 55 times. Also, their valuation multiples are at a steep premium to their 10-year averages

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At the time when urban India was grappling with the first wave of the coronavirus pandemic, rural demand had come to the rescue of makers fast moving consumer goods (FMCG). But after the second wave, things have flipped. There are concerns that the once bouyant rural demand is fading. With FMCG companies continuing to battle severe input cost inflation, muted rural demand adds to investors' discomfort. Further, the management commentaries of large FMCG companies do not provide much clarity on what lies ahead on this front.

For instance, the management of Hindustan Unilever Ltd (HUL) turned a bit cautious on rural demand post the September quarter earnings. This was in sharp contrast to its views at the annual investors meet in August, where the management had said rural demand was resilient and that the company was expecting a satisfactory year.

In its Q2FY22 earnings conference call with analysts, the HUL management said that it was not clear whether some softening of demand is intermittent due to unseasonal rainfall or other factors. So, it indicated that it prefers to closely watch how the rural demand pans out for a few months before reaching a conclusion.

Concurring with HUL, competitor Dabur's management said rural demand was strong in the months of July and August, but September-October saw a slowdown due to liquidity pressures from wholesale channels.

On the other hand, the management of Godrej Consumer Products Ltd (GCPL) does not seem too perturbed by this. They feel that the slowdown in rural markets appears to be an optical illusion, due to the unnatural base of Covid-hit months. GCPL expects rural demand to be a major growth driver on the back of two focus categories − hair colour and insecticides. It should be noted that the rural market currently contributes to less than 30% of the company's sales.

"Slowdown in FMCG markets is a risk highlighted by us as well as a few FMCG companies. However, the picture on the ground is not yet clear, and while the risk remains, we refrain from actually calling out a slowdown till further data is available," analysts at IIFL Securities Ltd said in a report on 24 November.

Speaking of data, an analysis by Motilal Oswal Financial Services Ltd showed that double-digit average growth in 1HCY21, rural consumption finally lost steam last quarter, declining 2.4% year-on-year in 3QCY21/2QFY22. "As many as seven of the 11 indicators used to determine the trends in rural consumption contracted in 2QFY22, with double-digit growth in only one indicator – farm credit," the domestic brokerage house said in a report.

"Some FMCG companies are said to have raised prices, so concerns relating to inflation may begin to recede. But the outlook on rural demand is marred by excess rainfall spoiling crops and muted rural wage growth," said an analyst with a domestic brokerage house requesting anonymity. So, investors in FMCG stocks need to brace for yet another downside risk, which is likely to weigh on valuations and share prices, he added.

Media reports said that HUL, ITC and Parle have raised prices in select categories of products including soaps and detergents to beat input cost inflation.

According to IIFL, the inflationary environment and price hikes are making the picture more complex. "FMCG products have a price elasticity of ~-0.5x per our experience, which means volume growth will be impacted negatively, but value growth will be impacted positively," added the IIFL report.

It is not surprising then that the Nifty FMCG Index is lagging key benchmark index Nifty50. In this calendar year so far, the former has risen 9%, while the latter is up 22%.

As far as valuations are concerned, the shares of key FMCG firms such as HUL, Nestle and Britannia among others, are trading at a one-year forward price-to-earnings multiple of more than 55 times. Also, their valuation multiples are at a steep premium to their 10-year averages. The aforementioned risks could lead to moderation in the valuation multiples of FMCG companies, analysts said.

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