The FMCG sector is considered to be consumer-defensive, and expected to be resilient in an economic downturn. However, the industry is facing headwinds from slowing rural consumption. The rural economy contributes nearly 40-50% of the revenues for the sector. That 50% is under pressure – erratic rains, lower harvest, high inflation, and premiumization of products have hurt rural consumption in FY24. 

The changing, increasingly premium tastes of the urban Indian consumer were a lifeline for FMCG companies. Growth in the first half of FY24 was driven by premium product sales. 

The second half of the year however, has been hit by lower volume offtake. Weak rural demand has pushed volumes down. According to Rohit Jawa, the MD and CEO of Hindustan Unilever (HUL), “Rural growth continues to be subdued. But we expect a gradual recovery with increased government spending, higher crop sowing, and better crop yields this season.”

FMCG CEOs are counting on cooling inflation and lower commodity prices to drive price cuts and volume growth. This, alongside a normal monsoon and election spending are expected to help the FMCG sector in FY25, but the near-term outlook until Q1FY25 remains bleak. 

Higher crude prices are also expected to impact players like HUL, Godrej Consumer Products, and Tata Consumer Products which use high-density polyethylene (HDPE, plastic) for their products. This has resulted in some of the biggest FMCG companies underperforming the Nifty 50 index in the past quarter.

Major FMCG firms underperform the Nifty 50

Only Godrej Consumer Products managed to outperform the Nifty 50 and Nifty FMCG index. Nifty FMCG has given negative returns in the past quarter.

Premiumization driving growth as volumes stay muted

The divide in disposable income between urban and rural populations has become more obvious, with premiumization trends catching up in urban areas, while rural areas are still price sensitive. Consumers are less price-sensitive in urban areas and are ready to spend higher on better-quality products. For instance, premium products of Tata like Tata Sampann, Tata Soulfull, Tata SmartFoodz, etc have seen 40% growth in Q4FY24, while non-branded foods have seen growth of 4%. 

Nestle India’s CEO and Managing Director stated “There is a polarity of booming premiumization and tepidness in the mainstream. However, premium products have lower impact of macro factors, while mainstream products come under stress with changing economic conditions.”

Lately, the demand environment in rural areas has been a concern. Erratic rains, rising inflation (higher in rural areas compared to urban areas) and lower harvest in FY24 have impacted consumption. Mainstream products which typically see higher consumption in rural areas are under pressure. 

In Q4FY24, Nestle India is expected to drive revenue growth on the back of rising coffee prices. Tata Consumer Products has reported a 9% growth in its revenue for FY24 led by its premium product portfolio.  

Forecaster estimates see around 4% revenue growth for the top six FMCG firms

While volumes have been tepid, firms like Tata Consumer Products are achieving growth via the inorganic route by acquisition route. For instance, Tata Consumer Products acquired Organic India for Rs 1,900 crore and Capital Foods for Rs 5,100 crore. The firm has also added one new product every week in FY24. 

Cooling inflation and lower commodity prices have driven price cuts

Food prices have driven inflation in India. Vegetables, pulses, and cereals are the major reasons behind the sticky inflation of the past 6 months. The erratic rains have led to late harvesting and lower yields. For instance, wheat yields and procurement have been at the lowest in the past five years. Wheat forms an important ingredient for FMCG players like Marico, Britannia, Nestle, etc.

However, the wholesale price index inflation is still lower at 0.5% in March 2024. Commodity prices for Barley (-25.5%), Mentha Oil (-18.4%), Palm Oil (-7.1%) and Skim Milk Powder (-1.6%) have fallen significantly YoY. The prices of wheat (2.5%) and palm fatty acids (3.8%) have seen a marginal increase.

CPI inflation in March-24 is lowest in the past nine months

FMCG firms are passing on the benefits of lower input costs in mainstream products to end consumers, by cutting down on prices. This is expected to drive the volume offtake in highly price-sensitive rural markets and limit competition from unorganized players. Categories like biscuits, personal care, laundry and food products have seen increased competition from unorganized players. According to Axis Securities, price cuts are expected to impact revenue growth by 2% for Hindustan Unilever.

While the price cuts are expected to hit revenues from mainstream products,  premium products are expected to reap the benefits of lower input costs. 

Gross margins are expected to rise as inflationary pressures ease

As the inflationary pressure is set to ease further in the first half of FY25, FMCG firms expect to see significant margin expansion.

Advertising and brand spending increase to push falling volumes 

FMCG firms are expected to see their EBITDA margins moderate as they spend more on advertisement and branding. The spending on promotions has increased significantly in FY24. Larger firms with deeper pockets are pushing their premium brand product portfolio, while smaller firms tend to spend on their mass-market product portfolio.

Many firms have been vocal about launching new products to compensate for the volume of offtake losses in rural regions. Tata Consumer’s new products are increasingly on the premium side to drive margins. According to Vikas Gupta, Global Head for R&D at Tata Consumer Products, “ To achieve the balance between margins and volumes we are trying to increase the premium products by incorporating a 50:50 split between premium and mass products.”

FMCG firms have increased ad-spends significantly in 9MFY24

While the spending might have helped in an upbeat market, at the current juncture promotional spending is constricting margins.  

Nestle and Dabur India are expected to drive profitability in the FMCG pack. Tata Consumer Products reported a 19.4% drop in net profits for Q4FY24. A one-off expense of Rs 216 crore related to the acquisition has led to lower profits.

Nestle India expected to lead YoY net profit growth

Normal monsoons and post-election spending to drive the growth in FY25

Heightened competition in the FMCG space due to low entry barriers and price-sensitive nature limits players from taking price hikes. But the trends look locked in: FY25 is expected to see an uptick in volume growth in rural areas, while urban areas will see higher consumption of premium products. Godrej Consumer Products CFO, Aasif Malbari stated, “ Normal monsoons should help increase agricultural output and bolster the rural economy. Rural sector volume offtake will be the key pivotal growth factor in FY25”.

According to NielsenIQ, the FMCG industry is expected to grow around 5.5% in 2024, which is nearly 40% lower than in 2023. Rural sector volume offtake will be the key pivotal growth factor in FY25”. Election-led spending coupled with lower inflation is expected to further push consumption patterns across the board.

Although FY24 looked challenging for the industry with changing market dynamics, the sector is seeing green shoots with cooling inflation and the rising popularity of premium products, indicating a changing urban Indian consumer. The resumption of government spending post a full budget in June is also expected to enhance consumption patterns. However, the industry needs to make further investments in the sector in terms of newer products, higher penetration, e-commerce, etc. The industry needs to evolve according to changing times.

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.