FMCG sector: Margin pressure to persist on high agri-input costs

“The Oct-Dec’21 quarter saw a 9.6 percent growth for the FMCG sector in India over the last year, primarily based on the double-digit increase in prices for three successive quarters. However, there is a consumption de-growth of 2.6 percent during the quarter due to inflationary pressures, and other macro- economic factors in the country,” it said.

Consumption slowdown continues to be more accentuated in rural markets (-4.8 percent), while urban markets are comparatively better (-0.8 percent), added the NielsenIQ report.

According to Deepak Jasani, Head of Retail Research, HDFC Securities, “this slowdown has been triggered by higher increase in the cost of agri-inputs than that of outputs, poor spatial distribution of monsoon, and lower remittances from urban workers to their families as labour is yet to fully migrate to cities and high inflation in essential commodities, like fuel, edible oil, tea and other daily essentials, due to global disruption in supply chains”.

Inflationary headwinds to persist

The sector was looking for a revival as agri-commodity prices were seen stabilising to a certain extent. However, the geo-political developments of the past few weeks have made matters worse as both Russia and Ukraine combined are the largest producers and exporters of wheat and corn. With Russian exports drying up due to Western sanctions, the prices for these crops have gone through the roof.

The average corn prices in Q4FY22 are 12.5 percent higher than those in Q3FY22. Prices of crude palm oil have increased 12.1 percent month on month and by 12.3 percent quarter on quarter, while prices of soya bean are up 13 percent on quarter.

“Even more concerning is the surge in palm oil price in the last few days, with prices touching record highs of over MYR (Malaysian Ringitt) 8,100/MT, a 60 percent increase from the average prices in December 2021. The situation was exacerbated further by the recent restrictions on palm oil exports by the Indonesian government and Ukraine being a major exporter of edible oils,” a report from Motilal Oswal said.

Barley is another key ingredient which is getting impacted by the Ukraine crisis as that region is the major exporter of this crop.

“Oil-based products and derivatives will face inflationary pressure, and brands will be forced to increase prices in a low-demand environment. This could further impact growth,” said Sonam Srivastava, Founder, Wright Research.

Rising prices of crude oil have further aggravated the inflation scenario and will add to the prices of inputs.

However, “prices of crude derivatives used in packing materials have not risen materially so far, but going by the rise in crude prices, they could start to rise shortly,” said Jasani.

Impact on margins

The higher cost of agri-commodities will continue to put pressure on margins and with successive price hikes already in place in previous quarters, companies will find it difficult to pass on the increase in input costs to consumers. The inability to hike prices will erode margins.

“Gross margins have declined for most companies in the range of 200-350 bps due to the upward trajectory in raw material prices”, said Arun Malhotra, Founding Partner and Portfolio Manager, CapGrow Capital Advisors.

“Most FMCG companies are staying away from hiking prices as consumption patterns are already bleak”, said Srivastava of Wright Research. Companies like Hindustan Unilever, Godrej Consumer Products, Emami and Marico registered low-to-flat volume growth.

However, we could see some companies resorting to price hikes soon to maintain profitability at the cost of volume growth, added Srivastava.

HUL, India's largest FMCG company, has raised prices of all product categories twice in the last two months, ranging from 3 percent to 20 percent.

Ashis Sarangi, Investment Advisor at Pickright Technologies, predicts, “a 10-12 percent impact on margins across products in the current environment, when demand is seemingly low and FMCG businesses’ profitability are strongly dependent on volumes”.

Outlook

A lot would depend on the strategies of companies -- whether they want to protect their market share or margins.

The higher inflationary trends will keep volume growth low as disposable incomes of consumers come under pressure, thereby impacting rural demand. “Rural volume growth should be negative 2-3 percent while urban demand will remain flattish”, said Malhotra. There might be an uptick in advertising and promotion by big players to boost volumes.

Government spending has also slowed down, leading to poor rural demand. It is important for demand in rural areas to recover but February's auto sales figures did not reveal any resurgence in rural demand or income.

“As not much was done in the budget to boost rural demand directly, we could see the numbers continuing to struggle and consumer growth getting further impacted,” said Srivastava of Knight Research.

Sarangi predicted that FMCG firms will continue to increase their volumes in urban regions, thanks to the online delivery apps, but rural India, which accounts for about 45-55 percent of total volume, will continue to lag.

Impact on stocks

Companies that are likely to get impacted by the rise in input costs are Godrej Consumer Products, due to its high dependency on palm oil for its soap business, which accounts close to 20 percent of its consolidated sales.

Hindustan Unilever also relies heavily on palm oil imports as close to 70 percent of its sales are generated by personal and home care segments. The health drinks business of the company is vulnerable to the prices of barley, which is a key ingredient in its malt-based drinks.

Britannia depends heavily on food grains and higher prices will impact margins as 80 percent of its sales are generated by biscuits. “It initiated meaningful price hikes and grammage reductions in Q3FY22 as well as Q4FY22 but its lower gross margin v/s peers mean RM inflation could have a more pronounced effect on its earnings,” a report from Motilal Oswal said.

Raw material inflation will put pressure on the margins of Nestle as well in the current quarter while Marico is likely to be the least impacted by the recent spike in raw material inflation as the prices of copra (its main raw material) have softened 7.3 percent, sequentially, aided by a good harvest.

Dabur might feel the pinch in its packaging costs due to the rise in crude derivatives but “its leadership in categories allows it to pass on commodity inflation sooner than its peers,” added Motilal Oswal in its report.