Margin pressures take the shine off consumer staples' steady revenues in Q2

With raw material prices rising sharply, the September quarter (Q2FY22) was a tough one for consumer staples companies as many of them saw their gross profit margins shrink.

Among the large companies, Godrej Consumer Products Ltd (GCPL) was the worst off, with gross margin registering 616 basis points (bps) year-on-year drop. One basis point is one-hundredth of a percentage point.

Margin pain

“GCPL’s September quarter report was a shock on the margin front, with gross margin decline of a magnitude last seen way back in FY09 when the company was a heavily soaps-dependent business,” said analysts from JM Financial Institutional Securities Ltd in a report on November 11.

Gross margins of GCPL’s rivals Marico Ltd, Britannia Industries Ltd, Nestle India Ltd, Dabur India Ltd and Hindustan Unilever Ltd (HUL) contracted by 556bps, 502bps, 240bps, 204bps and 142bps, respectively, on a year-on-year basis.

For consumer staples companies under its coverage, Kotak Institutional Equities’ analysts said, “Margin performance – gross margin moderated 260bps year-on-year, given significant inflation in key raw materials (crude-linked and palm-oil/PFAD).”

Palm fatty acid distillate (PFAD) is a by-product of palm oil refining and is used in soaps, candles and animal feed among others.

Earnings before interest, tax, depreciation and amortization, a key measure of profitability, however, offers hope to these companies, as the contraction in EBITDA margins was relatively smaller.

“Price hikes and lower A&P (advertisement & promotions) spend helped limit EBITDA margin moderation to 150 bps year-on-year for staples pack,” said Kotak’s analysts in a report on November 16.

Resilient revenue show

Companies posted decent revenue growth, helped by price hikes. “Staples pack revenues grew 10.4 percent year-on-year (organic) and +9.7 percent (two-year CAGR) led by Dabur, Marico, Tata Consumer Products (TCPL) and Jyothy Labs registering +12.9 percent/15 percent/13.7 percent/11 percent two-year CAGR, respectively,” Kotak said. CAGR is the compounded annual growth rate.

Broadly, the improvement in mobility had a positive influence in out-of-home (OOH) categories and discretionary demand.

On a two-year CAGR basis, revenue growth for Marico, TCPL, Dabur, GCPL, Britannia, HUL and Colgate Palmolive (India) was at around 15 percent, 14 percent, 13 percent, 10 percent, 9 percent, 8 percent and 5 percent, respectively.

Colgate’s performance disappointed analysts as the revenue growth was in double-digits in the previous two quarters. Better sales growth and market share improvement are key factors which can help improve the sentiment for the stock.

Rival HUL, too, disappointed with underlying volume growth at 4 percent, lower than Street expectations. Announcing its second quarter results, HUL said it had lately witnessed a slowdown in rural demand.

Rocky path ahead

With the rural markets looking a bit uncertain, investors will do well to keep a close eye on how demand shapes up in the coming days, say analysts. But, in general, expectations are not rosy.

“In H2FY22 (half year ending March 2022), volume is expected to decelerate, which can be offset by price hikes,” said analysts from HDFC Securities Institutional Equities.

“With mobility further increasing, we expect the industry to maintain its momentum in categories like OOH and discretionary,” it said.

The margin outlook remains subdued but may not be as bad as in the September quarter. “Margin will remain weak year-on-year, but the impact is expected to be less severe than in Q2FY22,” HDFC Securities’ analysts said in a report on November 18.

Shares of HUL, GCPL, Britannia and Marico have declined 10-19 percent from their 52-week highs seen over September-October.

It appears that investors are factoring in the concerns to some extent, at least. The Nifty FMCG index has increased by 13.7 percent, so far, this calendar year, underperforming the Nifty 50 that has rallied 27 percent during the period.