FMCG stocks: Steady monsoon, social welfare thrust likely to aid growth, says Anand Rathi; lists top picks

Following the election verdict, most FMCG shares have seen a jump of up to 10%, attributed to their defensive characteristics and the optimism surrounding improved prospects. 

A convergence of favorable factors—such as the monsoon-driven rural resurgence, heightened focus on social welfare post election, and margin buoyancy propelled by crude prices—bode well for the sector, says domestic brokerage firm Anand Rathi in its latest note. 

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The brokerage noted that the results of the 2024 general election, particularly the loss of seats in key states like UP and Maharashtra, could prompt the Union government to intensify its focus on social welfare.

With upcoming state elections in Maharashtra and Bihar in 2024 and the Budget likely scheduled for July, the brokerage anticipates increased allocation for social welfare schemes, which would boost rural income.

Early monsoon arrival promises bumper harvest season

The India Meteorological Department (IMD) forecasts above-average monsoon rains at 106% of the long-term average this year. 

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The monsoon arrived early in Kerala on May 30th, compared to the usual June 1st, and has already covered much of South India. A consistent monsoon is expected to result in healthy kharif crops, leading to better farm income and a modest rise in food prices for consumers, said the brokerage. 

Fall in crude prices to aid gross margin

Crude oil prices have decreased by 10% over the past 7–10 days. Crude oil and its derivatives are essential inputs for various FMCG products and their packaging, with packaging costs constituting 5-20% of many companies’ input costs.

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"We expect the steady input price environment to persist due to a lack of major supply-demand mismatch/disruption. Thus, we expect better gross margin trajectories for most of the companies that we cover, aided by better mix and price increases in some cases (alcoholic beverages, Emami.)," said Anand Rathi. 

Revival in sight

The brokerage's analysis of 11 FMCG companies (excluding ITC) shows that Q4 revenue grew by just 3.3%, a significant decline from 6% in H1 and 13% in FY23, but an improvement from 2.1% in Q3. 

It projects a gradual revenue growth recovery to 8.8% for the FMCG companies it covers by FY25, primarily driven by volume growth.

The brokerage also noted that advertising and sales promotion (A&SP) expenditures increased by 24% year-on-year (or 180 basis points) for eight FMCG companies in Q4. This follows a 30% rise in H1 and 27% in Q3, driven by heightened competition and new product launches due to the sharp decline in input costs for smaller companies.

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While A&SP spending (as a percentage of net sales) is expected to remain high, its growth is likely to moderate as gross margin gains are anticipated to ease in FY25, it noted. 

Valuations

Given these multiple tailwinds, the brokerage has maintained its 'buy' rating on three FMCG stocks: Hindustan Unilever (HUL) with a target price of ₹3,000, Emami with a target price of ₹730, and Zydus Wellness with a target price of ₹2,150.

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In the consumer discretionary sector, United Breweries is the brokerage's top pick. It has a target price of ₹2,300 per share with a 'buy' rating.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.