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Margins, the bright spot for FMCG

Companies with higher exposure to palm oil and its derivatives such as Godrej Consumer Products Ltd (GCPL) are expected to benefit more. Palm oil price is down by 51% from the peak seen in March last year.

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While FY24 is expected to be the year of margin expansion for fast-moving consumer goods (FMCG) companies, the extent of recovery would vary. This is because of the different raw material baskets that companies have. For instance, companies with higher exposure to palm oil and its derivatives such as Godrej Consumer Products Ltd (GCPL) are expected to benefit more. Palm oil price is down by 51% from the peak seen in March last year.

Similarly, Brent crude oil is hovering at $72-77 per barrel, the lowest level since the beginning of 2022. This would aid margins of most FMCG companies, given that packaging costs would trend lower.

Graphic: Mint
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Graphic: Mint

“Despite deflationary trends in past few months, inventory covers have delayed full benefit, which we expect will be visible in H1FY24," said analysts at Jefferies India in a 21 March report.

Here, home and personal care companies are relatively better placed. However, for packaged food companies like Nestle India Ltd and Britannia Industries Ltd, high wheat and milk prices are a problem. In March quarter to date, average price of wheat is up by 20% year-on-year on the back of unfavourable demand supply dynamics.

The path ahead is not smooth. India has seen heat waves and unseasonal rains in 2023 so far across the key wheat growing regions of north and central India. “This has raised the risk of crop damage and actual wheat production falling short of initial estimate," said Jefferies. The broking firm notes that there were similar unseasonal rains in 2015, when the actual crop production was 10% lower than initial estimates. Also, in 2022, heat waves resulted in actual production being 3% below initial estimate, they said.

Further, palm oil price is inching up and is higher by nearly 5% this month sequentially. If the situation worsens, margins of FMCG companies would again come under pressure. Also, there is little room for further price increases, given that the companies have taken significant hikes to battle commodity inflation. Further, demand conditions are not encouraging enough. Rural economy is yet to gather adequate momentum. Companies spoke of green shoots in rural demand recovery while announcing their December quarter results. “A full-fledged recovery will depend on a normal monsoon in 2023," said analysts from Motilal Oswal Financial Services Ltd in a 23 March report. There is a risk of 2023 being an El Niño year. “Taking cognizance of this, along with a moderation in commodity prices, companies may look to roll back price hikes and launch schemes to revive demand," the analysts said. Some companies have cut prices of select stock keeping units of soaps in keeping with the lower palm oil prices. Meanwhile, with increasing competitive intensity, investors would do well to follow trajectory of advertising and promotional spends. “While ad-spends should go up, margins should still expand and deliver a 16% earnings per share growth for our coverage," said Jefferies’ analysts. “We see earning growth acceleration in FY24 led by margin expansion, even if demand recovery takes longer than current expectation," they added.

To be sure, volume growth is a key trigger for FMCG stocks. Shares of Hindustan Unilever Ltd (HUL), Britannia and Nestle have retreated 9-10% from their respective 52-week highs. GCPL shares hit a new 52-week high of 965.55 apiece on Monday. Valuations of FMCG stocks aren’t exactly cheap. Bloomberg data shows HUL, Britannia and GCPL shares trade at 44-50 times their FY24 earnings. Better than expected demand could bring cheer.

ABOUT THE AUTHOR
Vineetha Sampath
Vineetha Sampath is a chartered accountant and is experienced in the field of research analysis. She joined Mint's Mark to Market team recently and this is her first stint in journalism.
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Updated: 28 Mar 2023, 12:51 AM IST
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