Rural recovery, price cuts to drive volume gains for consumer companies

It's 'rule Britannia' for brokerages; analysts divided on extent of margin gains

Fast-moving consumer goods (FMCG) makers saw marginal downgrades after the October-December quarter performance, given poor volume performance and pressures on margins. Volume growth for most companies saw a decline or was in the low single digits.

Aggregate revenue growth of 9-11 per was largely on account price hikes.

Aggregate gross margins, according to IIFL Research, too, contracted for the thirteenth straight quarter due to higher raw material inflation.

One of the key factors holding back volumes has been weak rural demand. The rural segment, which accounts for 40 per cent of the FMCG sector volumes, has underperformed the urban market on quarterly volume growth parameters for seven quarters in a row. This could, however, change if the current trends hold.

Retail intelligence platform Bizom highlighted that FMCG sales growth in value terms was up 28.6 per cent in February, compared to January. Within this, rural sales were up 35 per cent, while urban sales grew 14.9 per cent. Compared to the year-ago period, rural sales in February grew at 12.4 per cent, while urban sales growth came in at 5.5 per cent, says the platform that tracks consumer product sales at 7.5 million outlets.

Vikrant Kashyap of BOB Capital Markets believes there are visible signs of rural revival after a prolonged slowdown. Policy measures, such as wage hikes under the Mahatma Gandhi National Rural Employment Guarantee Act scheme, free foodgrain, hikes in minimum support crop prices, direct benefit transfer, and higher budget allocation for infrastructure development in the hinterland, bode well for rural recovery. Further, a respite from inflation and strong winter crop sowing should boost consumption in these markets, he adds.

The brokerage prefers Britannia Industries (Britannia) and Nestlé India for their strong network build-up in rural India, which offers scope for market-share gains and lends a degree of resilience in a difficult macroeconomic climate.

Sharp falls in crude oil prices and other commodities, such as palm oil, also offer flexibility to consumer majors to pass on the same and boost volume or retain some of the gains to stabilise margins.

The biggest beneficiaries of crude oil prices falling to their 15-month lows recently and palm oil prices falling 49 per cent from the peak are paint companies (Asian Paints, Berger Paints, among others), adhesive makers (Pidilite), and soap majors (Hindustan Unilever, or HUL, Godrej Consumer Products).

Lower crude oil prices also bring down the cost of packaging material, which accounts for about 15 per cent of the raw material cost of consumer majors.

Led by Percy Panthaki, analysts of IIFL Research expect improvement in the margin trajectory to continue and volume growth to revive with recovery in demand as inflation moderates further. The companies are also expected to pass on the benefits of moderation in input costs to the end consumer to revive volume growth in the quarters ahead, says the brokerage.

Some brokerages, however, have a cautious stance on the sector.

Systematix Research believes that increased competition from unorganised players, in addition to continued downtrading, could be a near-term risk for staples companies, especially small and mid-sized ones. While analysts, led by Himanshu Nayyar, of the brokerage, expect gradual margin recovery, they believe that higher marketing and new launch spending could partially offset gross margin improvement.

BNP Paribas remains underweight due to the sector’s rich valuation and elevated consensus earnings forecasts. Says Kunal Vora, head of India equity research at BNP Paribas, “While we think the industry is well positioned for a healthy 2023-24 with moderation in raw material costs and signs of rural recovery, risks remain on the extent of margin expansion due to an increase in advertising spends and cost benefits being passed on to consumers to drive volume recovery.”

While Britannia is the top consensus pick among brokerages, investors can also look at HUL, Emami, Dabur, and ITC as they have a higher exposure to the rural sector and could benefit from a revival of the segment. The key risk remains the progress of monsoons and the impact of El Niño on food inflation.