FMCG: Despite better Q2 volume outlook, investors should tone down hopes

Down-trading and Covid impact on rural demand are downside risks

The overall performance of fast-moving consumer goods (FMCG) sector in the June quarter (Q1) was not as bad as expected. But, the trend in volumes was the worst ever. On an aggregate basis, the 7.5-per cent volume decline in the March quarter deteriorated to 12.4 per cent in Q1 (refer chart). The figures represent an average of nine FMCG majors. The fall was ma­inly because of disruptions caused by the nationwide lockdown.

Going ahead, volume growth might improve with the easing of lockdowns and many companies hinted at this in their Q1 earnings. However, there are some factors that could hurt earnings growth.

According to Manoj Menon, head of research at ICICI Securities, “The second quarter  (Q2) will see fewer disruptions than Q1, so we believe volume performance will be better, sequentially. However, factors such as down-trading (consumers shifting to low-priced brands/products) and impact of the pandemic’s spread on rural demand are key influencing factors.” Down-trading is not limited to discretionary spend. Even staples could see a similar switch. Menon says the impact of lower income levels on demand is already visible. Though there is some demand recovery in the non-food discretionary category, consumers are expected to switch to the lower end, even within the premium segment.

Shirish Pardeshi, analyst at Centrum Broking, says: “While discretionary products would continue to see depressed demand, people would prefer value-for-money products.” Thus, reported revenue growth would not be as good as volume growth, he adds. This means margin gains, if any, will be limited.

 

 

In Q1, too, product mix deterioration weighed on margin profile, mainly in the non-food segment. Companies like Hindustan Unilever, Godrej Consumer Prod­u­cts, and Bajaj Consumer reported 233-307-basis point year-on-year compression in gross profit margin. However, most firms undertook stringent cost control measures, focusing mainly on advertising expenses, which protected their Ebitda margin and bottom line somewhat.

Analysts say Q2 will indicate how demand will pan out in the Covid-19 era. Vishal Gutka, vice-president at PhillipCapital believes, “While factors such as pent-up demand or inventory de-stocking played out in Q1, Q2 would be more demand-driven. It would give a clear an indication of how demand is shaping up.”

Food firms like Britannia and Nestlé should be outliers in Q2. In Q1, Britannia was the outlier with around 27 per cent revenue grow­th and 81 per cent pre-tax profit growth, while supply chain disruptions impacted Nestlé’s performance. On the rural front, Pardeshi expects farm income to rise with a good kharif crop this monsoon season. However, the pandemic has started to spread to semi-urban/rural areas, and, he­nce, the jury is out on how much of a boost could come from there.

Nielsen’s Q1 FMCG growth snapshot showed that against a flat growth in urban areas, rural business was up 12.5 per cent in June. How FMCGs manage their earnings in the near term will be crucial, given the pricey valuation they enjoy. At 31x its FY22 estimated earnings, the Nifty FMCG index is trading at 77 per cent premium to the Nifty50 index.