Can FMCG Be A Go-To Sector In The Medium Term?

India’s FMCG industry continues to be one of the biggest long-term sustainable business opportunities in the country. However, despite being one of the fastest growing markets globally for FMCG products, India’s per capita FMCG consumption is still amongst the lowest in the world. Armaan Madhani sheds light on the sector’s strong scope for growth in the near future 

Over the last three trading weeks i.e. from June 20 to July 8, 2022, the BSE FMCG index gained traction to significantly outperform the broader markets. The sectoral index recorded more than double the gains of BSE Sensex, captivating the attention of investors. Godrej Consumer Products, Hindustan Unilever, Britannia and Emami posted high-teen returns. The FMCG sector is the fourth-largest sector in the country and is growing at an unprecedented rate. The sector is expected to increase at a CAGR of 14.9 per cent to reach USD 220 billion by 2025 from USD 110 billion in 2020. Growing awareness, easier access and changing lifestyles have been the key growth drivers for the sector. [EasyDNNnews:PaidContentStart]

In FY22, the sector witnessed moderation in growth mainly due to subdued demand conditions, especially in rural markets, high inflation eating into household budgets and the high base effect in certain categories. The year also saw an abnormal increase in prices of key inputs which exerted considerable pressure on profit margins. After a rather toilsome FY22, it seems like India’s FMCG sector could be in the course of getting its mojo back. Let us delve deeper to obtain a better understanding of the sector’s macro growth trends in Q4FY22, outlook for Q1FY23, emerging green shoots and factors that make FMCG an ideal candidate for investors as a go-to sector in the medium term. 

Macro Growth Trends in Q4FY22

As per research firm Nielsen IQ’s quarterly update, the FMCG sector witnessed 6 per cent growth on an annual basis on the back of a 10.1 per cent increase in prices and a 4.1 per cent decline in volume. The negative trend in volume growth was evident across all regions, but more pronounced in the rural markets which saw a 5.3 per cent decline – the highest consumption slowdown in the last three quarters. The key reason was the higher extent of price hikes, particularly in small packs of daily consumption items. Prices surged by 11.9 per cent in rural markets relative to 8.8 per cent in the urban markets. 

Pricing-led growth and reduction in volume in small-sized packs drove revenue growth for companies in the March quarter. According to Kantar’s FMCG Pulse update, consumers paid 10 per cent more per kilogram of FMCG products during the February-April period compared with a year ago while pack size was reduced by 15 per cent on an average. Due to the Russia-Ukraine crisis, prices of key raw materials such as palm and crude oil shot up significantly in Q4FY22, after demonstrating signs of stabilisation in Q3FY22. This compelled companies to hike prices and pass on the increase in commodity inflation. However, gross margin contraction was evident for several players. 

Outlook for Q1FY23

Macro growth trends of Q4FY22 are expected to persist in Q1FY23. As per sales automation firm Bizcom, India’s FMCG market’s value growth fell 16.5 per cent sequentially in May relative to April, signalling reduced consumer spends on daily essentials due to rising prices across products. Price hikes and high retail inflation are expected to result in volume compression in the June quarter. Rural markets are estimated to lag behind the urban markets with respect to growth. In their update for Q1FY23, leading FMCG major Dabur India said, “During the quarter, consumption pressure continued across the sector on account of unprecedented inflation which has impacted the share of the income available for spending on consumer staples. This was witnessed across urban and rural markets.” 

The company expects its domestic business to report high single-digit revenue growth in the June quarter. “Current trends indicate that consumers reduced consumption in some nonessential categories and either down traded among brands or switched to smaller packs in the essential categories. In contrast, premium discretionary categories fared relatively better because of a lower base and lower consumption dip in the upper income consumer segment,” Marico said in its business update for the June quarter. The company expects operating margin to expand, leading to reasonable operating profit growth on a year-on-year basis. 

Emerging Green Shoots

Palm and crude oil are the key raw materials for a diverse variety of FMCG products and account for a big chunk of total input cost for several companies. International crude palm oil prices have corrected by more than 30 per cent in the past few weeks on the back of resumption of exports from Indonesia as well as concerns over global demand. As per a report by Hindu Business Line, palm oil prices are currently trading near their six-month lows owing to high inventory in the Indonesian market and key consumers like India and Pakistan delaying imports. 

Global crude oil prices futures have come also off their peak and corrected amid recession fears, aggressive monetary policy tightening by central banks and the likelihood of a weak demand outlook. Therefore, moderation in prices of key inputs will have a positive impact on margins of packaged consumer goods makers in the upcoming quarters. In addition, recent measures by the government such as wheat export ban, restrictions on sugar exports, waiver of import duties on palm oil and decrease in retail price (MRP) of imported cooking oils along with softening of wheat and soya bean oil prices could help further cool down raging inflation and furnish the much-desired respite to FMCG companies. 

The India Meteorological Department (IMD) has recently upgraded its forecast for 2022 southwest monsoon to 103 per cent of the long-period average (LPA) from 99 per cent of LPA predicted earlier in April. This could augur well for the production of both pulses and oilseeds, thereby aiding to regulate their prices. The demand scenario in rural markets is expected to make a sharp recovery in the second half of the financial year on the back of normal monsoon forecasts, better harvest, higher minimum support prices (MSP) and abating inflationary pressures.

"With the advent of technology-enabled distribution models there has been a hyper fragmentation of channels. Accelerated growth of e-commerce has brought about a huge opportunity for FMCG companies to tap into these channels and drive business growth" 

Conclusion

India’s FMCG industry continues to be one of the biggest long-term sustainable business opportunities in the country. Despite being one of the fastest growing markets globally for FMCG products, India’s per capita FMCG consumption is still amongst the lowest in the world. Rural markets account for more than 60 per cent of our country’s population and contribute to just about 30 per cent of FMCG consumption, thus providing significant headroom for growth. Rising affluence, favourable demographics, increasing urbanisation, growing consumer awareness along with preference for trusted brands and rapid adoption of technology are the long-term growth drivers of the industry. 

With the advent of technology-enabled distribution models there has been a hyper fragmentation of channels. Accelerated growth of e-commerce has brought about a huge opportunity for FMCG companies to tap into these channels and drive business growth. The e-commerce share of total FMCG sales is expected to increase by 11 per cent by 2030. The e-commerce trend is gaining immense popularity even in the Tier II and III cities of the country as they now make up nearly half of all shoppers and contribute three of every five orders for leading e-retail platforms. 

With the share of unorganised market in the FMCG sector declining, the organised sector’s growth is expected to increase with the rising level of brand consciousness due to growth in modern as well as e-commerce retail. Headwinds such as geopolitical tensions, high commodity inflation and rupee depreciation have led to a marked slowdown in growth over the past few quarters and continue to pose significant challenges in the short to medium term for the FMCG sector. 

Notwithstanding these challenges, the structural drivers of the sector’s long-term growth remain firmly intact. Also, the last two years of the pandemic has made the business model of well-established FMCG companies more resilient and responsive. 

The Indian equity market posted one of its worst half-yearly performances in the last two years since the market sentiment was marred as a consequence of several factors. These include the prolonged conflict between Russia and Ukraine, subsequent rise in key commodity prices and aggressive monetary policy tightening by central banks to tame inflation. With expectations of downtrend in economic growth, ailing demand outlook, high volatility, sustained selling by FIIs and recession fears in the near to medium term, the equity markets will further stretch investors’ patience to the limit. Generating above average returns in such markets will be a difficult task. 

Hence, as a defensive strategy, investors can allocate a small portion of their portfolio to FMCG companies that are primarily engaged in the non-discretionary segment which consumers require in their everyday life. Several prominent FMCG stocks are currently trading below their five-year historical average valuations and offer a decent margin of safety. Investors should focus on companies with strong pedigree and supply chain agility that are leveraging technology, automation and cost management coupled with expansion of core portfolio into niche categories where market share can be easily scaled up. This will propel them to deliver sustainable and profitable volume growth.

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