Q3 preview | FMCG margins set to expand but slow recovery in rural demand to play spoilsport

Most of the revenue growth will be driven by price hikes, while food will outperform personal care. Discretionary companies such as paints, jewellery, apparel and QSR face a demand slowdown, say analysts

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Fast-moving consumer goods (FMCG) companies are likely to see an improvement in their margins sequentially in the October-December quarter due to the liquidation of high-cost inventory and a fall in raw material prices. Revenue growth, however, is expected to be slower due to inflation affecting demand, mainly in rural areas, say analysts.

For the 19 consumer companies under its coverage, Motilal Oswal Financial Services expects 9.3 percent year-on-year (YoY) growth in topline, 9.6 percent in Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) and 8.1 percent in net profit.

The majority of the revenue growth will be driven via price hikes, which companies took in the past quarters to combat raw material inflation.

“With no clear signs of recovery in rural demand, we expect sales in staples to be driven by price increases and some premiumisation,” Motilal Oswal said.

Also Read: Budget 2023 | With inflation fears subsiding, the FMCG sector wishes for more money in the hands of consumers

According to analysts at Kotak Institutional Equities (KIE), Nestle and Britannia will lead the staples pack with revenue growth of 19 percent YoY and 16 percent YoY. Hindustan Unilever (HUL) is expected to post 14 percent YoY revenue growth.

“Foods will outperform personal care. Biscuits and noodles are expected to see robust momentum due to downtrading from street food,” stated Nuvama Institutional Equities.

Rural demand still sluggish

Rural demand did not improve at all in Q3, note analysts. Dabur India in its Q3 business update highlighted that the pressure on rural demand was further aggravated by the late onset of winter in north India.

Marico’s Q3 business update was also downbeat. The Parachute oilmaker said its consolidated revenue will grow in the low single-digit on a YoY basis due to a muted recovery in rural demand amid elevated inflation.

“General inflation and rainfall deficit in populous states such as Uttar Pradesh, Bihar, Bengal and Jharkhand remain the key challenges, which have affected rural disposable income,” according to analysts at Nuvama Institutional Equities.

Margins and volume growth

The good news for FMCG companies is set to come on the margin front. Gross and operating margins will see sequential improvement as raw material prices have cooled off significantly from their peak and high-cost inventory has been liquidated. However, analysts believe that increased ad spends can keep margin improvement in check.

“The major benefits of benign raw material prices will be witnessed in Q4FY23 onwards,” as per a note from Philip Capital.

Also Read: After a year of struggle for consumer staples, 2023 looks promising for FMCG

Meanwhile, volume growth is expected to be subdued. Kotak analysts expect 4 percent underlying volume growth from HUL, 4 percent from Britannia and 2 percent from Godrej Consumer. In October, HUL cuts soaps prices across India due to a fall in palm oil prices, and as a result, volume trajectory is likely to improve in soaps, believe experts.

Discretionary demand dwindles

The picture looks grim for discretionary companies as the industry saw a demand slowdown in Q3 across paints, jewellery, apparel and QSR (quick service restaurants).

“Paint volumes remained muted in October due to a high base and rains, which affected festive demand, but November and December marked good recovery,” notes Nuvama Institutional Equities.

KIE estimates Asian Paints and Kansai Nerolac’s revenue to decline YoY by 1 percent and 5 percent respectively. Berger Paints and Indigo Paints may clock 7 percent and 8 percent revenue growth, respectively.

Also Read: Kotak cuts target price for QSR stocks as consumption slows down

“Varun Beverages and Westlife Development should report a good print, whereas Jubilant Foodworks, Devyani International and United Spirits should report a weak quarter,” the report added.

Westlife Development’s average daily sales are expected to be resilient, partly aided by a 2 percent price hike taken in October while Varun Beverages is set to outperform on the back of market share gains in under-penetrated areas with its energy drink Sting.

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