Little hope of volume recovery in second quarter from pricey FMCG firms

Analysts estimate low single-digit volume growth, the lowest since June 2017 quarter; companies will need to clock double-digit volume growth in second half to touch FY19 levels

Stocks of most fast-moving consumer goods (FMCG) companies have found favour with investors despite the recent volatility and uncertainties in the markets, amid signs of slowing economic growth and consumption, weakness in rural demand, and floods in certain states. 

With about six per cent gains since the announcement of corporation tax rate cuts, the Nifty FMCG index outperformed the leading market indices, such as BSE Sensex, which moved up around four per cent during the same period.  

However, despite giving significantly high prices, investors may end up a bit disappointed, especially on the front of volume growth in the September quarter (Q2). Average volume growth of major FMCG players is expected to have slipped further to low single digits after decelerating to 4.5 per cent in June 2019 quarter, marking the third consecutive quarter of declining volume growth. Notably, Q2 volume growth could also be the lowest since the June 2017 quarter when volumes were impacted due to the implementation of the goods and services tax (GST). 

In Q2, most of the companies like Hindustan Unilever (HUL), Britannia, Dabur, Marico, and Colgate would post up to four per cent volume growth, predicted Edelweiss Securities’ analysts, led by Abneesh Roy.

Besides the overall feeble macro-environment, low rural demand amid slow wage growth, liquidity crunch, and floods in some parts of the country are among the factors likely to have marred volume offtake of FMCG players in Q2. Channel checks by analysts at SBICAP Securities revealed that lack of liquidity has been a concern for supply chain and adversely impacted stocking by dealers ahead of the festive season. The dearth of liquidity also resulted in companies’ reluctance to extend credit to their suppliers, thereby adding to volume pressure.

Dismal volume growth in the first two quarters indicates that companies will need to clock at least low double-digit volume growth, on average, in the second half of FY20 to be at par with FY19 volume growth. In FY19, average volumes of FMCG companies had risen by close to 8 per cent. While the government’s and the Reserve Bank of India’s efforts to stimulate the overall economy and improve liquidity into the system, good monsoon in large parts of the country, and festive season should help push overall volumes in the coming period, the jury is out on this.

There is some relief in Q2 performance though. Barring food-related materials, prices of many key raw materials, such as copra, palm oil, mentha, and even crude oil remained at comfort levels. The caveat is — margin benefits from benign input costs are likely to be limited, because of increased promotional activities either in the form of price cuts or companies offering extra grammage in the wake of muted demand. For instance, HUL had slashed prices in the soaps category.

According to analysts at Motilal Oswal, in such a weak demand environment, competitive intensity is increasing in the form of promotions and price-offs, which means that benefits from low material costs will be limited. The only solace will be the gains from the cut in corporation tax rates.

Overall, the pressure to recover the volume losses and moderation in earnings growth (excluding tax cut impact) will be greater on FMCG companies given their rich valuation. Thus, investors are recommended to be selective as even a small miss could hurt stock prices. Britannia and Dabur are analysts top picks for now in the FCMG pack.