Analysts see more pain ahead for FMCG stocks amid rising input costs

Instead of a recovery in gross margins in fiscal 2022-23 (FY23), Jefferies now builds-in 50-200 basis point (bps) YoY decline, assuming crude stays closer to $100 a barrel and palm oil at $1,500/MT

Rising input costs triggered by soaring crude oil prices have dented sentiment of fast moving consumer goods (FMCG) stocks over the past few weeks. Considered a classic defensive bet in a turbulent market, investors dumped these counters even as the overall market sentiment remained choppy, as surging crude oil prices triggered an upward march in prices of most raw materials used by FMCG companies that could chip away their margins.

“Over the last quarter, prices of commodities like palm oil, crude oil and SMP (skimmed milk powder) are up 23 – 42 per cent. Crude-linked derivatives currently witnessing single digits inflation are likely to catch up with a lag of two-three months," wrote analysts at Antique Stock Broking in a recent note.

TABLE: COMPANY-WISE IMPACT OF RISING PRICES

In the last three months, the S&P BSE FMCG index has lost nearly 1.7 per cent as compared to over 2 per cent rise in the S&P BSE Sensex. And if analysts are to be believed, there could be more pain ahead for these stocks as crude prices continue to rise amid the geopolitical tensions between Russia and Ukraine.

After a four-and-half month freeze, the government bit the bullet and has started to hike prices of petrol and diesel gradually, which analysts say could fuel inflation and also force consumers to cut back on their purchases.

On their part, FMCG companies plan to hike product prices yet again to cope with the rising raw materials cost. Rise in crude oil and upward revision of fuel prices would also translate into higher freight costs. The timing of input price inflation, said analysts at Antique Stock Broking, could not have been worse in the context of a slowing consumption trend, reported by almost all the staple firms, especially in rural India. 

"Rise in key input costs is a concern, especially for staple, paint & quick service restaurant (QSR) firms, and we expect product price hikes despite which, margins are at risk. High level of inflation could pose a threat to consumption, partially visible in sluggish rural trends. Product price hikes have partially impacted consumption and inflation remains a concern in the near-term," wrote analysts at Jefferies in a recent note.

Instead of a recovery in gross margins in fiscal 2022-23 (FY23), Jefferies now builds-in 50-200 basis point (bps) YoY decline, assuming crude prices stay closer to $100 a barrel and palm oil at $1,500 per metric ton (MT) in FY23. 

"This drives 1-10 per cent EPS (earnings per share) cut for staples in FY23 (and lower cuts in FY24E assuming some normalisation). As a result, FY23 would be the third year of single-digit EPS growth in a row. Within staples, our top picks are GCPL, HUL, ITC & Colgate; retail names still trade at steep valuation; in QSR, we prefer Devyani; Zomato remains a BUY, but we are increasingly worried on the capital allocation," they said.

Over FY23-24, Antique has cut earnings projections by 1 – 7 per cent across their consumer universe on an assumption of 40-200bps gross margin contraction with high impact on paints companies, HUL, GCPL, Jyothy Lab and Bajaj Consumer. 

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"In view of short term headwinds (rural slowdown, input cost inflation), we cut our valuation multiple across consumer universe by 5-10 per cent. We are positive on HUL, Dabur and ITC. We maintain Asian Paints to HOLD, purely due to short term concerns on sharp volatility in raw material prices," they said.