At a time when consumption slowdown in the country is marring growth of the entire consumer universe, including fast-moving consumer goods (FMCG) companies, the recent inflation print could worsen the situation for food-based players such as Britannia and Nestle, among others.
Companies like Hindustan Unilever, ITC, Dabur, etc. too have food-based products but their share is much lower in overall revenues. Even after GlaxoSmithKline Consumer Healthcare gets merged with Hindustan Unilever, the share of foods business in latter’s revenue would be around 27 per cent.
The inflation data for December 2019 shows further rise in the price of food items including wheat, milk and equivalent products and sugar, which are key raw materials of the food-based FMCG companies accounting for around 55 per cent of their total raw material costs. Although companies such as Britannia have long-term supply contracts and hedge for key inputs to protect margins, rising prices of these commodities could make it difficult for the companies to maintain profitability without hurting volume growth given the feeble environment.
Moreover, with consumer price inflation at a six year high, it also means lower purchasing power of households and hence, further impact on overall consumption.
According the Naveen Kulkarni, head of research at Reliance Securities, “The sagging consumption could make pricing power weak. Thus, managing volume growth and protecting margin is likely to be a tough task for food companies.”
While Britannia is planning to take price hikes to pass on the input cost pressure, Nestle has already raised prices in some categories such as baby foods and milk segment, albeit marginally. However, history is evidence that price hikes have a bearing on volume growth. In 2013-14, for instance, price hikes in the biscuit or similar segments had led to a deceleration in volume growth for companies, say analysts. The overall topline growth was supported by realisation improvement.
But, in the current trajectory, companies such as Britannia which have a relatively high rural-revenue share (32-35 per cent of total revenue) are expected to feel more heat as compared to the ones with more urban exposure. Nestle, for instance, is estimated to earn 75 per cent of its revenues from urban areas.
“In the slowdown, price hikes would hurt volume growth of Britannia given its rural market exposure and segment which it operates into (mainly biscuits). However, we believe Nestle is better placed in terms of pricing power,” opines Nitin Gupta, analyst at SBICAP Securities.
Dhaval Dama, analyst at Equirus Securities, too, echoes a similar view, saying that Nestle has better pricing power given a bigger portfolio of products and companies like Britannia could see some volume growth pressure in case of indirect price hikes in the near term.
The biscuits category, mainly in the economy segment, has got severely impacted with the slowdown. Though Britannia is benefiting from its higher share in premium segment, it too felt the heat of the muted consumer demand. During April-September 2019, average volume growth of the company, on estimated basis, fell sharply to around 3 per cent from 12 per cent a year back. While Britannia is also expanding into other segments, to what extent these efforts will help offset the pressures is yet to be seen. Nestle, on the other hand, had managed to report double-digit revenue growth during the above said period. Though Nestle does not disclose volumes, its performance for December quarter will be closely watched.
While some analysts expect rural and also the overall demand to revive owing to good Rabi crop and the government’s welfare schemes, the jury is out on this.
In the above backdrop, even though Britannia and Nestle are considered by analysts as strong long-term consumption plays, investors are recommended to await clarity on margin and volume fronts. The stocks of Britannia at 45 times its FY21 estimated earnings and Nestle at 62 times CY20 earnings (Nestle follows January-December accounting period), aren’t cheap either.