Industry
Unpacking Q4: With green shoots visible, will FMCG stocks finally pick up pace?
Summary
- The Nifty FMCG index is down over 3% this year till date, compared to a 5% jump in the benchmark Nifty. And many investors are venting their frustrations on social media. HUL, particularly, has been disappointing the Street. Well, there’s a lesson to learn from Spider-Man.
New Delhi: My kids don’t like to eat plain glucose biscuits anymore. So I buy Hide & Seek and Good Day biscuits for them on the condition that they finish their glass of milk every day," says Lata, a 26-year-old mother of two.
Lata, who lives in Rustampur village off the Yamuna Expressway, works as a housemaid in a nearby apartment complex. Her husband abandoned her a couple of years ago and she has been raising her two daughters alone since then.
Despite her precarious financial position, it is not as if she saves these ‘indulgences’ only for the tiny tots.
“I came to know about this thing called ‘tomato puree’ while working at one of the houses here. It is very convenient while cooking and also saves the hassle of going to buy tomatoes. I have been using tomato puree as well as ginger garlic paste at my house too, but these items are not so readily available at the shops in my neighbourhood," she said.
Lata might not realize it, but she—and millions of consumers like her—were one of the key drivers of India’s fast-moving consumer goods (FMCG) companies during the March quarter.
India & Bharat
‘Rural India’ is an excessively elastic term which encompasses everything from the prosperous villages in Tamil Nadu’s industrial belt to water-starved hamlets of Vidarbha and Marathwada. But the vast heterogeneity notwithstanding, rural India has been reeling under some setback or the other for the past few years, from the demonetization of 2016 to the NBFC (non-banking financial company) liquidity crisis in 2018 and finally the hammer blow of covid-19 in 2020.
A recovery in the farm sector, therefore, has been keenly awaited by both policymakers and corporate India.
The March quarter delivered just that, with rural demand outpacing that of urban markets for the first time in 15 months.
According to market research firm NielsenIQ (NIQ), urban markets saw a 5.7% year-on-year (y-o-y) rise in demand in the three months to March. In contrast, rural demand vaulted by 7.6%.
“In the last two years there has been significant inflation which has impacted rural and lower-income households to a greater degree. However, higher-income households have been resilient through that period. As inflation is moderating, gradually the demand environment is returning to normalcy," Siddhant Chhabria, research analyst and fund manager at Mirae Asset Investment Managers, told Mint.
“Volumes are coming back in rural on a low base... Additionally, few indicators are showing signs of improvement in demand outlook, like the RBI consumer confidence survey (multi-year high currently), lower MNREGA demand in recent periods (implying better wage opportunities elsewhere) and positive monsoon outlook," he added. MNREGA or the Mahatma Gandhi National Rural Employment Guarantee Act gives legal guarantee of wage employment for 100 days in a financial year to adult members of a rural household.
Most FMCG firms reported a rebound in demand from the rural segment in the three months to March.
Oral care firm Colgate-Palmolive (India) saw rural growth surpassing urban growth by 200 basis points (bps), while the corresponding figure for Dabur was even more impressive at 400 bps.
“Our rural coverage during the year expanded by 22,000 villages to 122,000 villages," Dabur India CEO Mohit Malhotra said during the firm’s post-earnings call. Dabur also broadened product offerings in rural markets by introducing new affordable and rural-specific packaging across various categories.
Its peer Nestle India doubled down on its “rurban" strategy of deepening its reach in under-penetrated small towns and large villages. It expanded its reach to over 200,000 villages by March 2024, up from 165,000 in December 2022. Also, it increased the fleet on the street and distribution touch points in ‘rurban’ markets by 40% and 55% respectively in CY20-23.
Cigarettes-to-FMCG major ITC, which posted a 1.3% drop in its standalone net profit to ₹5,020.20 crore, also saw “green shoots" in the rural segment.
“While consumption demand remained subdued in Q4FY24, improving macro-economic indicators, prospects of a normal monsoon and green shoots witnessed in rural demand recovery after several quarters, augur well for revival in consumption demand in the near term," it said in a post-earnings statement.
Godrej Consumer Products Ltd (GCPL) said it plans to increase its market share in rural areas by doubling outlet coverage and tripling village coverage through Project Vistaara 2.0.
The rural sector accounts for 30-50% of revenue for most FMCG companies, and hence is a key focus area for them. Uptick in farm income, declining food inflation and expanding distribution footprint were some of the major reasons cited by companies for the recovery in rural demand.
The good life
If volume recovery was the theme of rural markets in Q4, premiumization was the conspicuous trend in the urban segment.
For Hindustan Unilever (HUL), even though the overall growth performance remained underwhelming, the premium portfolio continued to outperform the rest of its offerings across categories. “K-shaped recovery was visible across segments with outperformance in premium laundry, dishwash liquids, premium beauty and wellbeing, plus range in nutrition drinks," analysts at ICICI Securities said in a note.
At its post-earnings call, HUL’s chief executive officer and managing director Rohit Jawa outlined the reasons behind the company’s increasing focus on premiumization.
“Given the context of increasing affluence and under-indexed FMCG consumption, we have a huge opportunity to build categories of the future through market making and premiumization. We are doing this through persuasive communications via the right medium, innovating in new demand spaces and formats of the future and educating consumers at scale," he said.
Market making and premiumization accounted for around 25% of its revenue and more than 75% of incremental media investments.
Similar was the case with Nestle, which highlighted that premiumization will remain a key focus area, with enhanced focus on nutraceuticals and pet care in the medium term.
It also announced the launch of its premium Nespresso range of coffee/machines in India, adding it will open its first boutique store in Delhi after which there will be expansion to other markets.
Operational metrics
Benign raw material prices gave a fillip to companies’ margins across the board.
HUL saw a robust 316 bps y-o-y jump in gross margins to 51.9% on the back of easing inflation in its four most critical inputs—crude palm oil, caustic soda, crude oil, and soda ash. Dabur’s consolidated gross margin expanded 278 bps on-year to 48.6%, while that of Nestle jumped 300 bps to 56.8%.
However, the gains were partly offset by a rise in advertising and promotion costs due to rising competitive intensity.
“Many enterprises are presently operating at peak profitability levels due to the benign commodity pricing environment. Their ability to augment margins further is severely curtailed. As a result, their aggregate earnings growth is unlikely to transcend the 10-12% range on an average basis, unless the favourable raw material cost dynamics sustain, coupled with a marked escalation in demand surpassing the current gradual uptrend," Puneet Sharma, CEO and fund manager at Whitespace Alpha, told Mint.
The scope for enhancing profitability seems restricted until a pronounced demand upswing manifests, concurrently with the persistent tailwinds of subdued input costs, he added.
For the Indian arms of multinational giants, increase in royalty payments to their parent firms was an additional headwind.
HUL reported a 120 bps jump in employee benefits and other expenses, which included an impact of 30 bps on account of staggered rate increase in royalty. HUL contributes around 11% of Unilever’s global sales and India is its second biggest market after the US when it comes to revenue.
Interestingly, shareholders of Nestle India earlier this month overwhelmingly voted against the company’s proposal to increase royalty payments to its Swiss parent Nestle.
The motion called for the payment of general licence fees (royalty) by the company to Societe des Produits Nestle S.A. to be increased to 5.25% of net sales, net of taxes, compared to the current level of 4.5%. The increase was proposed at a rate of 0.15% per annum effective from 1 July 2024.
Analysts say this is a short-term positive for the stock, though it remains to be seen if there is any revised proposal from the board of Nestle India.
Autumn of the patriarch?
To paraphrase the iconic line from Spider-Man, with great size comes great responsibility. If there is one company which is experiencing the reality of this truism, it is HUL.
India’s largest FMCG firm has been disappointing the Street since the past few quarters as intense competition, including from regional brands, is nibbling away its market share.
The story continued in Q4 FY24 as well, with the company reporting a 0.2% decline in net sales, led by a lacklustre 2% volume growth, which has remained at the same level for three straight quarters. The beauty & personal care (BPC) segment saw a 2% deceleration, while home care and foods & refreshment (F&R) grew 1% and 4%, respectively. In sharp contrast to other FMCG players, HUL saw little traction in the rural markets. Many analysts see this as a company-specific issue rather than an indicator of macroeconomic weakness.
“Revenue growth of 1% with unchanged UVG (underlying volume growth) trajectory at 2% in Q4FY24 (in line with our estimate) despite price cuts over the last few quarters is disappointing," ICICI Securities noted.
“With expectations of gradual recovery in volume growth trajectory and pricing growth likely to remain low (marginally negative in H1FY25 and low-single digit in H2FY25 if raw material prices remain unchanged), outlook for FY25 revenue growth in underwhelming," it added.
Buy, sell or hold
One noteworthy feature of bull markets is how investors’ expectations outpace the surge in stock prices. Currently, many investors are venting their frustrations on social media about the underperformance of their FMCG stocks. But that might be an unfair characterization.
The Nifty FMCG index is down over 3% this year till date, compared to a 5% jump in the benchmark Nifty. The performance gap persists if we look at the past 1-year returns, though the FMCG index has beaten the benchmark for 2- and 3-year timeframes.
Sectors like consumer staples are considered as ‘defensives’—which deliver steady returns irrespective of market cycles and act as bulwarks of support during periods of turbulence. Defensives are not ‘supposed’ to outperform the broader markets for extended periods, and comparing them to mid- and smallcap stocks is borderline blasphemous.
But when even random stocks are doubling in a couple of months, can investors be satisfied with technicalities?
“The market as a whole might present better growth prospects, particularly in industries like technology, manufacturing, and consumer discretionary that are more closely related to economic expansion and recovery. A balanced approach could be wise given the current conflicting economic signals and the strategic changes within the FMCG industry," Whitespace Alpha’s Sharma said.
A well-rounded investing strategy can include looking for growth possibilities in the wider market in addition to keeping a core allocation to conservative FMCG stocks for stability. This strategy preserves some protection against market volatility while enabling participation in the bull run, he pointed out.
From a macro perspective, however, India’s $167-billion consumer staples sector looks poised for growth.
The “worst is behind for the FMCG sector," Mirae’s Chhabria said.
IMD’s forecast of a normal monsoon this year augurs well for sustaining the growth in rural demand this year.
“Most companies are focusing on volume growth and are gaining back market share from regional players due to normalcy returning. Pricing growth will come back for the sector during H2 FY25 after negative pricing in FY24," he said.
Despite the outlook improving, he is selective on FMCG stocks.
“We prefer playing mass consumption recovery through the discretionary sector. In staples, we prefer companies where there is scope to expand distribution or category growth rates are more attractive, like packaged foods, beauty and personal care etc.," he said.
“We believe growth rates for the discretionary sector is at an inflection point (India’s per capita income is now more than $2,500) and these companies can grow at 1.5-2x GDP compared to 1x for FMCG. Even discretionary companies have seen a sharp slowdown in the last 12-18 months, and it appears that demand is now bottoming out as inflation is moderating," he added.
