The FMCG sector has been reeling under immense margin pressures over the past year due to commodity inflation. The prices of key commodities like crude, palm oil, and agri inputs soared in FY22,  forcing price hikes across the sector. High inflation and price increases led to a weak demand environment and slowing volume growth. According to the management of Dabur India, the sector saw a 0.7% contraction in volume in Q1FY23. 

However, the worst seems over as  most commodities’ prices peaked in June and have started cooling off. The drop in raw material prices has led to an improved margin outlook for FMCG companies in the upcoming quarters.  

FMCG companies outperform the Nifty 50 index on improved margin outlook

The large players in the FMCG sector have managed to outperform the Nifty 50 over the past quarter. The Nifty50 has grown by a modest 6.4% in the same period. Hindustan Unilever  (HUL) leads the pack as it beat the Nift 50 index by 10.2%.

FMCG stocks have been rising on the expectation of a revival as raw material prices soften. For the past few quarters, the business environment was unfavourable with demand sluggish due to high inflation.

The FMCG sector has gained 14.8% over the quarter, outperforming the Nifty 50 index by 8.4% in the same time period. Only HUL has been able to outperform the sector’s returns among the stocks in focus.

The growth in the sector has mostly been led by small-cap companies rising sharply over 3 months. The only large-cap and mid-cap companies to outperform the sector other than HUL are Emami, Patanjali Foods, Adani Wilmar, Hindustan Foods, KRBL, and Jyothy Labs.

The FMCG sector was the top bet in July for FPIs

In July, foreign investors turned into net buyers of Indian equities after nine months of selling since October 2021. They bought Rs 5,000 crore worth of shares on a net basis, of which the FMCG sector received the lion’s share.

FMCG stocks got an inflow of Rs 4,178 crore, making it the pack leader for inflows in July. The inflows in August reduced but the sector still remained one of the top picks for foreign investors. 

Revenues rose on the back of price hikes and improving distribution reach

Despite a business environment where demand remained subdued due to high price inflation, most companies in focus saw their revenues rise in Q1FY23. This growth was driven by strategic price hikes during the quarter. Segment-wise growth was led by the home care, food & beverages, and personal care segments. FMCG companies saw their beverages segment perform well on the back of robust demand growth due to the extreme summer heat. 

Expansion into India’s rural market contributed to revenue growth for Nestle India, Britannia Industries, and Tata Consumer Products. These companies said their market share increased in the rural and semi-urban markets, which aided revenue growth.

Overall, the domestic segment outperformed exports for most companies, with Marico being the only exception. Only Procter & Gamble Hygiene & Healthcare’s revenue declined, due to a high base last year.

Among these companies, Hindustan Unilever’s revenue grew by the highest margin in Q1FY23, led by the home care and beauty & personal care segments. The home care segment continued its upward trend by rising 30% YoY on the back of liquid detergents and fabric conditioners.

The beauty & personal care segment’s robust recovery was led by growth in the premium product portfolio. Demand growth in the premium products category outperformed the mass products category in the segment. This is an emerging pattern post Covid across consumer sectors, where affluent customers built up their savings, and are now spending significantly more compared to middle-class and lower income customers, whose discretionary spends have been impacted by inflation and higher household expenses. In fact, many companies within the sector witnessed relatively strong revenue growth in their premium segments or product portfolios.

Profits not yet robust: companies see a decline in net profit due to high input costs 

Although price hikes pushed up the revenues for FMCG firms, net profit was impacted by still elevated raw material costs. High commodity costs and fuel costs impacted production costs as well as logistics costs, in the previous quarter, putting pressure on profitability. Only Hindustan Unilever, Tata Consumer Products, and Marico saw a rise in profits along with Dabur India whose profit marginally rose by 0.7% YoY.

Tata Consumer Products’ profit growth was the highest among the larger FMCG companies, gaining 38% YoY in Q1FY23. Profit grew mostly due to a fall in tea prices and a robust pick-up in demand for coffee and salt. Also, the management points out that its joint ventures and associates’ improved performance on the profitability front aided in profit growth.

HUL’s profit posted a growth of 13.5% YoY in Q1, and the management noted that profits increased on the back of improved product quality, branding, pricing mix, and reduced employee and other expenses. Marico’s profit rose as approximately 50% of its raw material basket witnessed deflation, resulting in a lower hit on the  company’s profitability compared to its peers. The strong growth in the international business also aided in improving Marico’s net profit.

Gross margin reduces despite calibrated price hikes

Most of the companies in focus witnessed their gross margins decline due to high raw material prices. Key commodities like crude, wheat, palm oil, milk etc were trading at very high levels during the quarter. As fuel prices skyrocketed logistics costs shot up amid high production costs. Another important factor impacting margins is that the companies did not fully pass on rising costs to customers, given the weak demand environment. These companies do expect margins to improve in the coming quarters as they see raw material costs normalising from H2FY23.

Marico and Tata Consumer Products were able to buck the trend as they were less affected by the inflationary pressures given the dip in tea and copra prices. Around 50% of Marico’s raw material basket witnessed deflation in Q1. The management believes this will enable them to maintain steady margins without needing to cut their A&P expenses. Tata Consumer greatly benefitted from the fall in tea prices along with a rise in demand for coffee and salt.

Volume growth is sluggish as demand remains soft

The FMCG sector’s volumes declined by 0.7% YoY in the quarter due to the inflation-driven demand contraction. Demand has been tepid for a few quarters as inflation affected customers’ purchasing power. This has led to customers switching to economy brands in segments most severely affected by inflation such as detergent, soaps & edible oil categories. However, a few companies did manage to grow their volume on a YoY basis this quarter.

Companies like HUL, Nestle, and Dabur witnessed their volumes rise this quarter despite a high base last year. Nestle’s volume grew the most among the companies in focus. The growth can be attributed to robust growth in its confectionery and beverages segment. It was also one of the few FMCG companies to perform well in the rural market, mostly due to its focus on expanding into the rural and semi-urban market segments in India.

HUL and Dabur’s volumes rose on the back of market share gains across segments along with price hikes.

On the other hand, Marico’s volume decline was worse than what the management had expected. The fall was mainly due to Saffola oil’s volumes declining more than 20% YoY in Q1. However, excluding Saffola the firm’s volume was marginally up by 1.4% YoY. Britannia Industries and Godrej Consumer Products’ volumes also fell as price hikes and inflation took a toll on demand.

Trendlyne’s Forecaster estimates robust revenue growth for FMCG companies in FY23

The revenue growth outlook for FMCG is bright as the demand scenario is expected to improve. Retail inflation is expected to fall from Q3 as key commodity prices soften. The companies are confident about a gross margin expansion and a rise in demand. According to Trendlyne’s Forecaster revenue estimates Hindustan Unilever is expected to see the highest revenue growth among the companies in focus.

Brokerages like HDFC Securities and Edelweiss also expect raw material prices to fall from the second half of the financial year and see companies in the FMCG sector witnessing gross margin expansion and profit growth. However, ICICI Securities does not share the same view regarding margin expansion. It believes that the benefits of declining raw material costs will be limited as it expects companies to increase their A&P (advertising & promotional) expenses for upcoming launches. It also expects FMCG firms to pass on the benefit of declining input costs to the end customer given sluggish demand.   

Given global uncertainties, there remains a risk of commodity prices being volatile and cost inflation persisting for longer than expected. But FMCG companies are upbeat, and focusing on new product launches, market expansion and increasing reach in the coming quarters, as they expect market conditions to improve. 

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.