FMCG companies continue to face cost pressures despite a slight fall in commodity prices. Except for palm oil, most other key raw materials like soda ash, milk, barley and wheat remain volatile and elevated. The depreciating rupee amid high inflation has also worsened the input margin pressures for the sector.

India’s FMCG companies often provide early evidence of how consumers are doing, thanks to their deep urban and rural distribution, and the variety of price points at which they sell their products. And one thing is clear in the Q2 results: rising costs have hit consumers hard.

High commodity prices have impacted FMCG players over the past few quarters. These rising prices led to food inflation and forced customers to cut down on discretionary spending. The impact of inflation has been stronger in rural markets.

However, many companies believe that the cost of raw materials will start to fall in Q3FY23 and demand will improve.

Mohit Malhotra, CEO and Managing Director of Dabur India, said, “Going forward, we expect the quantum of inflation to moderate on account of high inflation in the base. While current demand remains weak, the festive season, near-normal monsoon,good harvest and minimum support price increases should enable rural markets to recover soon.” 

Most large FMCG companies underperformed Nifty 50 over the past six months

Over the past six months, only Britannia Industries and Nestle India outperformed the Nifty 50 index. Britannia’s stellar Q2 results helped it beat the Nifty 50 by the biggest margin among its peers.

Britannia and Nestle outperformed their sector over the past six months. The Nifty 50 index outperformed the FMCG sector by 200 bps in the same time period.

Expensive valuations, only Nestle and Britannia Industries have high momentum  

Trendlyne’s Durability (D), Valuation (V), and Momentum (M) scores a company based on its long-term performance and financial health, price of the stock and buyer demand on a scale of 0 (worst) to 100 (best).

Durability scores indicate a company’s long term financial health, and a score above 55 is considered good. Barring Britannia and Dabur, all other companies in focus have a good durability score.

The valuation score indicates how competitively the stock is priced. It takes into account its P/E ratio, P/BV ratio, and share price. All FMCG players were expensive on the valuation front. A score above 50 is considered good.

Momentum scores indicate the stock’s buyer demand and bullishness across technical indicators. A momentum score above 60 is considered good. Only Britannia and Nestle have good momentum scores. 

Price hikes drive revenue growth in Q2FY23

All companies in focus saw their revenue rise in Q2FY23, mostly led by price hikes. Growth driven by price hikes continued industry-wide as demand remained lukewarm due to high inflation. It has also restricted meaningful volume growth for a few quarters.

Demand growth for premium products continued to outperform the mass products category as inflation hit the middle-class and lower-income customers’ discretionary spending harder. Urban demand growth still outpaces rural demand growth as the effects of inflationary pressures are more pronounced in the rural market. Besides price hikes, the premium products segment and the urban market also aided revenue growth for most companies.

This quarter, Britannia leads the pack in revenue growth, followed by Nestle. This can be attributed to the companies’ focus on expanding their rural distribution network. This insulated the two companies from the weak demand environment. Britannia added 1,000 new distributors to the rural market in Q2FY23, taking its total to 28,000. The company aims to improve its rural footprint and gain market share in the coming quarters. 

Nestle’s revenue growth was broad-based with all its business segments’ growth in the double-digits on a YoY basis.

Dabur India’s revenue growth was tepid as the company was adversely impacted by a sharp fall in rural demand in Q2. For the first time in five quarters, growth in rural demand was behind urban . Rural demand grew only 1% YoY, whereas urban demand grew 6% YoY. 

According to the management, a demand drop in Uttar Pradesh and Bihar’s rural markets caused the firm’s overall rural downswing. These markets were already affected by liquidity crunch and high inflation amid a weak monsoon in the region, which exacerbated the slowdown.

Profits remain sluggish; Britannia and Nestle outperform peers

As key commodity prices remain elevated, the profitability of FMCG companies remains under pressure. Along with high input costs, the weakening rupee made matters worse for these companies. To mitigate cost pressures, the sector took several cost management measures. Capital spent on advertisements and other expenses saw significant cuts across companies. 

Britannia’s net profit grew by the biggest margin in Q2 (28.4% YoY to Rs 493.3 crore) on the back of strategic price hikes, cost efficiencies and robust expansion of its rural distribution network.

Tata Consumer Products’ net profit growth came in second to Britannia’s, mostly due to a one-time gain on a land sale. Its bottom line also benefited from market share gains made in the tea and salt business. The firm’s salt business gained market share despite it raising salt prices by 27% over the past 15 months.

Hindustan Unilever’s profit grew on the back of market share gains made mostly by its home care and beauty & personal products segments. The management attributed the company’s net profit rise of over 20% YoY to a one-off prior-period tax credit in Q2.

Dabur and Marico saw a decline in net profit as they were adversely impacted by the fall in rural demand amid the steep increase in input costs.

High input costs and a falling rupee eat into gross margins

The gross margins of most FMCG companies fell during Q2, continuing the trend for a few quarters now. This is due to the growth in input costs outpacing price hikes. FMCG firms have not been able to pass high input costs to their customers completely, thus hurting their margins. They are strategically hiking prices and not fully passing on high costs to maintain or gain market share.

However, Britannia Industries and Marico were exceptions, as they both saw a rise in gross margins. Britannia was able to protect its margins by undertaking intensive price hikes and cost-efficiency measures. The company witnessed a 3% QoQ rise in raw material costs. To offset this, the company raised its prices by 7% QoQ before its peers. The management expects key raw material prices of wheat, sugar and palm oil to stabilise in H2FY23 and a slight improvement in margins sequentially.

Marico’s gross margins improved on the back of a fall in key raw material prices and cost control measures. Copra and rice bran, two key raw materials for the company, saw their prices decline by 20% and 11% YoY respectively. However, high-cost inventory restricted gross margin expansion.

Volume growth remains weak on muted demand growth

Volume growth remains weak across the industry with only a few segments like food & beverages and home care growing. Most companies in focus saw their volumes grow in single digits on a YoY basis. Britannia and Hindustan Unilever saw their volumes grow by 5% and 4%, respectively. The growth was mostly driven by the urban market and premium products category in Q2FY23.

Reports suggest that many FMCG companies had to resort to decreasing the grammage for many products to keep their prices intact. Consumption of grocery products surpassed pre-pandemic levels in India but consumption in grammage dipped.

Healthy volume growth for FMCG companies is contingent on recovery of demand in the rural market, as it contributes around 35% of the sector’s sales. Downtrading was more prevalent in the rural market, where customers preferred smaller packs of products, which hurt the overall volume growth. 

However, FMCG companies expect rural demand to improve in the coming quarters on the back of a normal monsoon, higher wages, and better minimum support price. They believe this will improve the overall consumption cycle.

Advertisement & promotional expenses largely subdued to protect margins

Given the high-cost pressures and poor demand, FMCG players reduced expenses to protect their margins. Advertisement & promotional (A&P) expenses were lowered to manage costs. Also, companies did not expect robust demand over the past few quarters, and advertising in these circumstances would not have been effective.

Among the companies in focus, only Marico increased its A&P spending. The management does not want to curtail its A&P spending as it expects advertising to aid market share gains and volume growth in the medium-to-long term.

Companies plan to increase their A&P spends gradually as they expect commodity prices to cool off and demand to recover in the coming quarters. Hindustan Unilever plans to increase its A&P expenditure as a percentage of its sales from Q3FY23 onwards. 

Trendlyne’s Forecaster estimates revenue growth for all FMCG companies in focus

The street anticipates double-digit revenue growth for the largest FMCG companies like HUL, Britannia, Nestle and Tata Consumer. Among the companies in focus, Britannia’s revenue is expected to grow by the largest margin (13.4% YoY). Dabur and Marico’s revenues are estimated to grow slower than their peers, rising by only 8.3% YoY and 4.6% YoY respectively.

Companies anticipate only a slight improvement in margins as they expect input costs to marginally fall from Q3 onwards. However, cost pressures persist as the prices of many key raw materials are expected to stay high.

Sanjiv Mehta, Chairman and Managing Director of Hindustan Unilever, expects inflation to fall in  Q3 but still sees challenges. “Looking ahead, we are cautiously optimistic. In the near term, the demand environment remains challenging and growth will be price-led,” he said.

Although market conditions have not recovered completely, FMCG giants are expecting inflationary pressures to fall. They are also positive about rural demand improving in the medium-to-long term, but short-term headwinds remain.

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.