Why is everyone puzzled over rural FMCG sales?

There are concerns that the once-buoyant rural demand is fading. Against the backdrop of the fact that FMCG companies are still battling with severe input cost inflation, muted rural demand adds to investors’ discomfort. Further, management commentaries of large FMCG companies do not provide much clarity on what lies ahead on this front.

For instance, Hindustan Unilever Ltd’s (HUL’s) management turned a bit cautious on rural demand post September quarter earnings. This was in sharp contrast to its own views at an annual investor meet in August wherein the management said rural demand is resilient and that it is expecting a satisfactory year.

In its Q2FY22 earnings conference call with analysts, the HUL management said it is unclear whether some softening of demand is intermittent due to unseasonal rainfall or other factors. The management indicated that it prefers to closely watch how 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 July and August, but September and October saw a slowdown due to liquidity pressures from the wholesale channel.

However, Godrej Consumer Products Ltd (GCPL) does not seem too perturbed by this. According to its management, 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 GCPL’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.

An analysis by Motilal Oswal Financial Services Ltd showed that after a double-digit average growth in H1CY21, rural consumption finally lost steam last quarter, declining 2.4% year-on-year in Q2FY22.

“As many as seven of the 11 indicators used to determine the trends in rural consumption contracted in Q2FY22, with double-digit growth in only one indicator – farm credit," the domestic brokerage house said in a report on 23 November.

“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," an analyst with a domestic brokerage house said, 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 said.

According to media reports, 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," the report said.

It is not surprising then that the Nifty FMCG index is lagging the benchmark Nifty50. So far this calendar year, the former has risen just 9%, while the latter has jumped 22%.

Meanwhile, on the valuation front, top FMCG firms such as HUL, Nestle and Britannia 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.