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Consumer sector: Rising input costs risk to margins

Raw material costs likely to inch up in FY16, capping further expansion of gross margins

Malini Bhupta  |  Mumbai 

Consumer companies have exited FY15 on a good note, as the sector’s gross margins expanded between 100 and 500 basis points on lower input costs. Operating margins of some large companies hit a multi-year high, as raw material prices saw a sharp fall, led by crude oil, for eight straight months.

This trend has, however, started reversing from April. The input cost index for consumer companies has risen 3.3 per cent month-on-month, driven by a spike in non-food inputs. This trend is being monitored very closely by the Street, as higher prices of crude oil derivatives will have a commensurate impact on gross margins of the sector.

Along with rising input costs, volume growth is expected to remain muted (growth in single digits) in FY16. The Street is currently building in revenue growth of 11-12 per cent for FY16 for home and personal care players. Food companies may see marginally higher growth rate. These estimates face downside risks, if monsoons are deficient and rural incomes are hit.

Explains IL&FS Institutional Equities, “In a weak volume growth environment, we believe companies are likely to pass on benefits to consumers in the form of price cuts and promotions to revive growth. This, along with the inflationary trend observed in April could have a bearing on the margin prospects for HPC and paint companies.”

One of the key levers of margin expansion would be lower spends on advertising and promotions. Operating margins of consumer companies (ex-United Spirits) have risen 10.9 per cent year-on-year (y-o-y) in the March quarter and 10.6 per cent y-o-y in the December quarter. However, this expansion will be capped to an extent in FY16, as demand remains weak and input prices pick up.

Analysts believe companies will step up promotional activity to boost sales and promote new launches. Since the 1990s, advertising and promotional spends as a percentage of sales have increased from five per cent to about 11 per cent. Emami, Colgate and GSK Consumer have reported elevated advertising and promotional spends, while Asian Paints and Nestle have spent relatively less. Citi believes, “A 10 per cent cut in A&P spends over FY16-17 could boost earnings by six-eight per cent across the group (notable exceptions are Nestle/Asian Paints where the impact is much more muted).”

First Published: Thu, June 11 2015. 21:36 IST