Markets
Margins of FMCG firms remain on the edge
Summary
- Indonesia’s ban on palm oil might exclude crude palm oil, which is a positive for FMCG stocks
- Nevertheless, margin pressures for FMCG companies continue to persist amid rising inflation
For Indian fast-moving consumer goods (FMCG) companies already struggling with pressures of input cost inflation, the news of the Indonesian government planning to ban exports of palm oil effective 28 April was another sentiment dampener.
On Monday, the Nifty FMCG index fell around 2%. Shares of Godrej Consumer Products Ltd (GCPL), Britannia Industries Ltd, and Hindustan Unilever Ltd (HUL), for which palm oil and its derivates are critical inputs, fell by 4.5%, 2% and 1.2% respectively.
“Palm oil production is dominated by Indonesia and Malaysia, which contribute about 60% and 25% respectively to the global production," said analysts at Jefferies India in a report on 24 April. The price of this commodity in Malaysia, has already risen by 31% so far in this calendar year (till 22 April). A potential ban by Indonesia, would mean more price escalation, compressing margins of FMCG companies further.
However, later in the day, a Bloomberg report stated that crude palm oil (CPO) and RBD (refined, bleached and deodorized) palm oil would be excluded from this ban. The Indonesian government had not released an official clarification at the time of writing this article.
If this is the case, then FMCG stocks are most likely to see a recovery on Tuesday as supply of CPO, used by FMCG companies, would remain unaffected.
That said, the outlook on the sector’s near-term margins is not too bright. The uncertainties related to the ongoing geopolitical tensions between Russia and Ukraine would keep prices of imported raw materials unpredictable, analysts cautioned.
“FMCG companies in FY22 faced inflation and have already saved on fixed costs and cut back on maintenance advertising spends. As such, they do not have enough levers to manage operating margins in the medium term as most of the selling and general expenses are also inflationary in FY23," said Manoj Menon, head of research, ICICI Securities. Incremental inflation poses challenges, Menon said. “There would be adverse effects of price elasticity and the companies would be cautious in passing on all of the rise in input costs as it would weigh on demand," he said.
On the demand front, analysts are worried that unlike earlier, this time around, as income growth is said to be lagging rising costs of several commodities, the pinch would not only be felt in rural areas, but also in urban regions. What’s more, in some categories customers are down trading and buying cheaper unbranded products or smaller packs, showed dealers channel checks by brokers. Clearly, this does not bode well for the margins and demand outlook of FMCG companies.
HUL is set to announce its Q4FY22 result on Wednesday and expectations are not too high. Analysts at BNP Paribas expect domestic organic volume growth to be flat year-on-year (y-o-y) as significant price hikes by the company to battle cost inflation would have impacted volumes. This means HUL’s Q4 revenue is estimated to increase by 7% y-o-y. As commodity costs remained at elevated levels during the quarter, gross margin is expected to decline by 106 basis points y-o-y. One basis point is 0.01%.
So far in this calendar year, the above-mentioned stocks have corrected by 8-21% mainly because of input cost inflation. As a result, their valuations have moderated.
According to Bloomberg data, Britannia Industries, HUL and GCPL trade at 43 times, 49 times and 38 times, respectively, their FY23 estimated earnings. Given these headwinds, the scope for meaningful rerating of FMCG stocks is limited, analysts said.
