Subdued demand, inflation impact FMCG companies; rural areas show signs of recovery

Subdued demand, inflation impact FMCG companies; rural areas show signs of recovery

By Preeyam Tolia

In FY23, FMCG companies were facing the dual challenge of a subdued demand environment and unprecedented raw material inflation owing to the Russia-Ukraine war, geopolitical issues and disruption in global supplies, which led to a steep surge in inflation across commodities like palm oil, crude oil, wheat, sugar etc. Due to this, the FMCG companies had to undertake price hikes or grammage cuts on their key SKUs, which resulted in subdued volume growth and margin compression for most of the FMCG companies. Moreover, the rural slowdown, which accounts for two-thirds of India’s population and 40% of the FMCG sales, further added stress to the sector. 

In a quarter gone by, most of the companies had mirrored a similar growth trend in rural, where it witnessed some signs of rural recovery, while some pockets, such as UP and Bihar, remained under pressure. Nonetheless, going forward, we believe rural growth is likely on the cards in the coming quarters as there are several factors, such as Government spending on infrastructure will be on the higher side, as this year’s major state election would set a base for the following year’s general election.

Also, a strong April-23 service PMI number of 62 was the highest in nearly 13 years, showcasing the continued growth momentum in the service economy activity, which would drive overall urban remittances in rural. Additionally, rural wages already on an upward trajectory, coupled with RBI intervention in controlling overall inflation, will drive the much-needed volume growth in coming quarters. Further, there could also be a huge pent-up demand for a large part of discretionary categories such as skin care, hair care, personal care etc., which could aid the volume growth for the sector. Thus, rural growth would be faster than urban growth in FY24.  

On the margins front, with volume recovery and stable raw material prices, gross margin expansion is likely on the cards. However, the flow of gross margins on EBITDA will be limited as the company will increase marketing spending. Nonetheless, this would help companies gain market share and drive the premiumization agenda, which will benefit them in the longer run.

We expect FY24 to be a stable year for most FMCG companies in terms of top and bottom-line growth led by volume recovery and margin expansion. However, the one risk for the entire sector will be the effect of El Nino, which we should pay attention to as this could delay the rural recovery.

In this backdrop, we foresee companies such as Hindustan Unilever, Nestle, Britannia and Dabur to gain from the recovery in demand, while company such as Varun Beverages is likely to continue their strong momentum on account of the intense summer season as demand for beverages increases coupled with its strong distribution expansion in newly acquired south and west territories. We also like ITC due to its reasonable valuation and stable business outlook across its verticals.

(Preeyam Tolia, Senior Research Analyst – FMCG and Retail, Axis Securities. Views expressed are author’s own. Please consult your financial advisor before investing.)