Shares of ITC have outperformed those of Hindustan Unilever so far this year amid margin pressure for the fast-moving consumer goods company due to hardening crude oil prices.
ITC has surged over 20 percent year to date, while Hindustan Unilever shares have dropped 8 percent. The benchmark Sensex and Nifty 50 have gained 1.5 percent each, while the BSE FMCG index rose 1 percent.
The subdued performance of Hindustan Unilever shares can be largely attributed to a slowdown in the rural market, resulting in a moderation of sales volumes since the third quarter of FY22 and higher input costs affecting profitability over the past two quarters, analysts said.
According to brokerage Sharekhan, domestic consumers are switching to low-price units and cutting discretionary spending due to a sustained slowdown in the rural markets and a high inflationary environment. It expects Hindustan Unilever’s sales volumes to decline in the fourth quarter from a year ago. However, India’s largest consumer goods company increased prices across its product portfolio and that may result in low-to-mid-single digit revenue growth during the quarter.
Hindustan Unilever executives had indicated earlier that higher costs of inputs such as crude oil and palm oil would increase pressure on gross margins in the fourth quarter. Price increases of 2-13 percent across the product portfolio, along with an 8 percent increase in Q3, would help in mitigating a rise in input costs in Q4.
War impact
However, a sharp increase in commodity prices following the Russia-Ukraine war and supply disruption would lead to operating profit margins declining in the first quarter of FY23, Sharekhan said. It expects a sharp decline in margins in the first half of FY23, which might improve only in the second half if commodity prices ease.
Nielsen data suggests a high-single digit volume decline and flattish value for Hindustan Unilever in both urban and rural India, with the rural market more impacted. Among all product categories, beauty (skin and hair care) would be impacted more, while laundry and nutrition sales would also be affected.
Prices of palm oil and its derivatives, which are used in Hindustan Unilever’s skin cleansing and hair care categories, have been climbing. So have prices of crude oil and its derivatives, which are key inputs for its laundry and household care products.
Inflation hedge
ITC is the least affected by the rural slowdown because its portfolio comprises mainly foods, analysts said. The company offers the best inflation hedge as its core business is completely immune to inflation risk. With volume growth back in the cigarette market and tailwinds elsewhere, ITC may offer earnings surprises in FY23, the analysts added.
ITC is one of the largest consumer companies in India, with businesses spanning categories such as cigarettes, hotels, paper and agri-commodities. Its branded foods division, with products such as staples, confectionery, noodles, snacks and biscuits, is performing well and gaining strong market share across many categories.
“We expect the volume in cigarettes to revive at a CAGR of 5% during FY22–24E as against a CAGR of -1% during FY11–21; FMCG’s EBITDA margin to scale up to higher single digits; and the hotel, paperboard and agri-commodities businesses to revive. This will lead to an earnings CAGR of 12% in FY22–24E against a mere 7% in the last five years,” Edelweiss Wealth Research said in a note.
The brokerage has set a target price of Rs 450 for ITC shares, which is up 80 percent from the current market price.
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