BNP Paribas remains 'underweight' on FMCG sector. Here's why

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Broking house BNP Paribas is underweight on the fast-moving consumer goods (FMCG) sector, wary of El Nino weather pattern affecting rural demand and a reversal of price hike benefits causing a decline in value growth.

"While the industry has achieved a high single-digit revenue compound annual growth rate (CAGR) over the last decade, mature categories such as hair oil and oral care have been slow to grow", the brokerage firm said in a June 19 report.

With a drop in raw material cost, BNP expects margin recovery but is cautious about rural demand being affected by El Nino, characterised by warmer ocean temperatures across the Pacific which have a far-reaching impact on weather patterns around the world.

El Nino is known to bring hotter, drier conditions to parts of Asia and has often been associated with deficient monsoon rains, the lifeblood of Indian agriculture. A drop in production can affect rural income, which, in turn, can hit demand, already a worry for FMCG companies.

The market players are thriving on high inflation in the current quarter but the brokerage expects a normalisation in H2FY24, which will force firms to reduce costs to beat competition and drive sales volumes.

The pick of the FMCG lot

Despite the upcoming headwinds for the sector, BNP Paribas is constructive on Britannia Industries Ltd, ITC Ltd and Emami Ltd, as it sees the high revenue trend returning with improving margin comfort in the FMCG space.

BNP Paribas increased its revenue estimates for ITC by 0.8 percent and for Emami by 1.5 percent but reduced the estimates for Britannia by 2 percent. In terms of gross margins, ITC saw a 544 basis point (bp) increase, Emami 76 bp and Britannia 688 bp increase year-on-year.

One basis point is one-hundredth of a percentage point.

In the fourth quarter of FY23, BNP Paribas observed an 11 percent year-on-year growth in aggregate sales for the FMCG sector, lower than the previous quarters.

"The beauty and personal care segment was affected by a rural slowdown in the previous quarters, particularly in mass categories like hair oil and oral care, due to increased market penetration," it noted.

Certain categories within the segment showed signs of volume recovery despite muted rural consumption sentiment. Some companies were able to regain lost volumes in the soaps category by implementing price cuts.

The home-care category exhibited strong performance, driven by a focus on premiumisation. The beverage business, particularly juices and fruit drinks, experienced strong growth.

Despite facing currency fluctuations and liquidity challenges in some markets, the international business of companies like Dabur, Marico, Godrej Consumer Products, and Emami showed growth trends.

Price-ing in the gains

The decline in raw material costs improved margin comfort for companies. In the March quarter of FY23, prices of major commodities such as crude, palm oil, copra, coffee and rice bran corrected, resulting in better gross margins for most companies.

Palm oil was down by around 30 percent year-on-year, while palm fatty acid distillate (PFAD), used in soaps, halved from its peak. There was around 16 percent drop in the price of linear alkyl benzene (LAB), which is used in making detergent power and liquids. Certain agricultural commodities like wheat, mentha, and sugar did not see a price correction.

As inflation moderates, companies have started passing on the benefits to customers, leading to an increase in volumes and short-term demand, the brokerage said. High inflation in agricultural commodities can contribute to a rural demand recovery by boosting farmer income, the report said.

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