Nifty FMCG index up nearly 3% over the past month, but future hazy

Industry net sales have grown in double digits in just three of past 24 quarters

After underperforming the broader market for the better part of the previous year, fast-moving consumer goods (FMCG) companies like Hindustan Unilever, ITC, and Nestlé are outperforming the benchmark now. The Nifty FMCG Index has risen nearly three per cent over the past month, against a mere 0.9 per cent rise in the Nifty50 index.

The Nifty FMCG index ended the week with gains of 0.6 per cent against a 0.9 per cent decline in the benchmark Nifty50 index during the week.

Analysts attribute this outperformance to investors’ expectation of a better show by FMCG companies in the forthcoming quarters. “We are incrementally positive on the FMCG stocks. The sector is expected to outperform in the coming months due to a combination of a poor show by the broader market and earnings recovery in the sector,” says Dhananjay Sinha, managing director and chief strategist, JM Financial Institutional Securities. As a result, his firm has changed its stance on the sector from underweight to equal weight. 

The sector, however, remains a laggard from a longer-term perspective. The Nifty FMCG Index has risen 33 per cent since the end of March last year, against an 83 per cent rally in the benchmark index. Even over a five-year horizon, it has risen 63 per cent, against an 82 per cent rise for the benchmark index.

Many analysts don’t expect this long-term trend to change much, despite the recent outperformance by some FMCG stocks.

“Consumer goods companies face a structural growth problem with little or no volume growth and low-single-digit growth in revenues. In the post-pandemic period, consumers are down trading to cheaper options hitting companies’ profit margins,” says Shailendra Kumar, chief investment officer, Narnolia Securities. 

He doesn’t foresee much Ebitda (earnings before interest, taxes, depreciation, and amortisation) growth in the sector in financial year 2021-22 (FY22) because of a combination of high commodity and energy prices and poor revenue growth. This, he says, will ensure that FMCG stocks remain laggards on the bourses.

According to him, the recent outperformance by FMCG stocks was due to the defensive nature of these companies, rather than their superior financial performance. “FMCG and IT stocks are the places where investors take shelter when they become uncomfortable with record high valuation in the broader market and expect a correction. This is what we are seeing right now.”

Over the longer term, FMCG companies continue to face growth headwinds. In the past 24 quarters, industry net sales have reported double-digit growth on only three occasions— Q3FY19, Q4FY19, and Q1FY20. The top line growth of the top 10 FMCG companies recovered in the second half of FY21, but net sales growth last fiscal was still 5.1 per cent.

Most analysts also expect the companies’ Q1FY22 to be a washout because of lockdowns across most of the country to deal with the second wave of Covid-19.

A big worry for FMCG companies is the decline in operating margins due to rise in commodity prices. The industry’s Ebitda margins fell nearly 170 basis points in the second half of FY21 as higher commodity prices began to bite. The pressure on industry margins could worsen in FY22 if volume growth remains subdued.

The bulls, however, expect the rally in commodities to fizzle out, providing relief to FMCG companies. “The rally in commodities is unsustainable and prices will start falling soon. As such, I expect FMCG companies to maintain their current margins in FY22,” says Sinha.