Elevated inflation trends may dig a deeper hole for FMCG stocks: Analysts

Investors have shunned consumer stocks with shares of HUL, ITC, Britannia, Godrej Consumer, Tata Consumer, and Nestle India dropping in the range of 1-11 per cent in a month

Renewed inflationary pressures, led by a spike in prices of vegetables and cereals, have cast a spell on the equity markets in the past month. 

The BSE Sensex and Nifty50 have declined up to 2 per cent each during the period, clipping the 13 per cent rally from the March lows, shows data from ACE Equity. 

Investors typically consider shares of fast-moving consumer goods (FMCG) companies as defensive bets, putting their weight behind them in a falling market. 

This time, however, the FMCG pack has been among the top sectoral losers, with the Nifty FMCG index declining 1.5 per cent over the past one month. Banks and oil & gas indices were the other laggards. 

Going ahead, analysts see no relief for the sector in the near term as the prolonged inflation would dent demand recovery. 

Prabhudas Lilladher remains ‘underweight’ on the consumer sector as it sees staples like cereals and pulses offering no relief in the near term. 

“Hardening of international crop prices and subdued sowing domestically will keep cost pressures elevated for related companies. Moreover, rich valuations and the probability of a delay in demand recovery make us cautious on the sector,” the brokerage firm said in a recent note. 

In July, India’s headline consumer price index (CPI)-based inflation rate surged to a 15-month high of 7.4 per cent after staying below the 6 per cent upper tolerance band for three months. 

Inflation in the food category more than doubled to 10.6 per cent. 

It was driven by a 37 per cent surge in vegetable prices on an annual basis, 13.3 per cent rise in pulses, and 13.04 per cent increase in cereals. 

Prices of crude oil and palm oil, too, saw up to 20 per cent jump from their June lows. 

The Reserve Bank of India (RBI), on its part, has raised its target for CPI-based inflation rate to 5.4 per cent for 2023-24 (FY24) from 5.1 per cent projected earlier. 

On the bourses, investors have shunned related stocks, with shares of Hindustan Unilever (HUL), ITC, Britannia Industries, Dabur India, Godrej Consumer, Tata Consumer, and Nestle India dropping in the range of 0.2-7.4 per cent in a month. 

“We expect cereal-driven food inflation to have a bearing on food companies dealing with biscuits and noodles in the near term. So, we may see margins of players like Britannia and Nestle India being affected in the near term,” said Ajay Thakur, research analyst at Anand Rathi Institutional Equities. 

El Nino casts cloud 

Cumulative rainfall in August has been 6 per cent below the long-period average (LPA). 

Analysts say that the prevalence of El Nino could affect demand in the coming months. 

“Though volume growth has seen a recovery for two consecutive quarters, it continues to remain subdued. Since most of the days in August were dry, we expect the pace of rural demand recovery to be limited,” said Preeyam Tolia, senior research analyst at Axis Securities. 

Investment rationale 

Analysts expect a recovery in rural demand and sustained urban demand owing to a benign inflation environment. These could push volume growth in the quarters ahead. They say that the upcoming festival season in Q3 will see improved demand, which would bode well for consumer players in the medium term. 

Tolia remains positive on ITC, Varun Beverages and CCL Products for the long haul. 

Thakur is betting on HUL, Godrej Consumer, Emami, and Zydus Wellness due to their earnings growth visibility.