Demand concerns, monsoon forecast weigh on FY20 outlook for FMCG companies

Rising crude oil prices, promotional spends and limited pricing power to impact earnings

The downgrade cycle for fast-moving consumer goods (FMCG) seems to have started with CLSA assigning ‘sell’ rating to Asian Paints from ‘outperform’ earlier, due to initial signs of demand distress. The firm highlighted its concerns over the demand situation for discretionary space which are non-essential commodities such as watches, perfumes, house painting as well as for staples. Analysts at the firm believe that muted automobile sales, HUL and Dabur indicating growth moderation in staples and lower airline traffic growth raise concerns over broader consumption. Though some analysts expect demand to revive post the general election, Skymet’s prediction of deficit monsoon announced last week has only added to the woes.

“Probability of deficit monsoon is a key risk for earnings downgrade for the FMCG space, says Kaustubh Pawaskar, analyst at Sharekhan. Thus, June 2019 quarter is crucial to understand demand direction, he added.

The S&P BSE FMCG index too shed about 3 per cent from its recent highs on January 16 this year. This underperformed the BSE Sensex that rose 7 per cent during the same period.

There has been a demand slowdown for consumer staples in Q4. This is on the back of a slowdown in agricultural income with slower wage growth, prolonged winter impacting offtake of summer-centric products, and liquidity stress at the distributors’ end, among others have hurt the consumer sentiments. Volume gain benefits from lower goods and services tax (GST) are also now behind and rural growth pace has also come down. Analysts estimate consumer staple players to have clocked up to 7 per cent volume growth in Q4. On an average, the estimated volume growth would be around 100 basis points lower than December 2018 quarter.

The slack in demand warrants higher promotional spends either in the form of offering extra volumes or price discounts or direct advertising spends. This would hurt profitability and overall earnings. In Q4 too some analysts believe around 20-30 per cent of the reported volume growth would be on the back of free offers by companies. “Our channel checks suggest there would have been promotional efforts in Q4 either in terms of extra grammage or price discounts. This could have helped overall top line growth of consumer staples in Q4,” says Nitin Gupta, analyst at SBICAP Securities. Nevertheless, benign input cost trajectory in Q4 would have helped to ease some margin pressure.

However, the rising crude oil prices may skew the picture as far as raw material costs are concerned. Also tepid demand situation gives very little freedom to companies for price hikes. In case of Asian Paints, for instance, CLSA believes rising input cost prices and concern on price hikes amid weak macros (indicating demand situation) would weigh on margins.

In this scenario, it would be tough to justify the rich valuations for FMCG companies. This is especially the case if demand fails to recover after the elections. Price-to-earnings ratio of BSE FMCG index currently stands at 28 times FY21 estimated earnings, around 75 per cent higher than that of BSE 500 universe. Some brokerages have indicated earnings cut for FY20. For instance, IIFL has cut its earnings estimates by 1-3 per cent in case some staple companies for FY20 and FY21 and said further cuts are possible if growth remains weak.