Earnings upgrade, valuation uptick for consumer companies' stocks

Analysts are turning their attention to the FMCG sector for several reasons. Management commentary during Q4FY24 earnings calls cited rural demand pickup, distribution expansion, new launches among others which led to some expectations of volume recovery.

Most analysts see volume expansion in single digits but the emergence of several positive factors could support double digit growth.

As a result, many FMCG stocks have seen price recovery since Q4 results. Post elections, there’s been more attention on the sector due to belief that the new political coalition will focus policy on rural pain points, leading to moves that boost rural disposable incomes and hence, boost consumption demand. Volume growth expectations have thus grown stronger as rural growth has underperformed in the last two fiscals.

Recent declines in crude prices can also boost gross margins. There could be gains as inflation in other raw materials has moderated although it is still a noticeable factor. A good monsoon could be another positive driver.

Managements of many consumer majors had highlighted that they expect low-single-digit pricing growth in FY25 and moderate inflation in input costs across H2FY25.

Further, most companies have beefed up their ad-spends. There was roughly 20-25 per cent Y-o-Y increase in ad-spends in FY24 vs 1-6 per cent Y-o-Y increase in FY20-23. Distribution expansions are also being undertaken by many companies and this could start to yield results quickly, given favourable macro factors.

Increasing trends of premiumisation and volume growth may also expand operating margins by 50-75 basis points, despite higher marketing expenses and competition.

The food and beverage segment accounts for nearly half the sector revenue, while personal care and home care segments contribute to about a quarter each. Rural consumption is around 40 per cent of total revenue and acceleration of growth rates here would have a marked effect on volumes since rural growth had slowed while urban growth remained low but steady.

If rural disposable incomes rise, alongside premiumisation, there could be double digit growth in personal care and homecare. Over the last two fiscals, home care has outpaced food and beverages and personal care, but growth rates in the latter two could improve, given the macro.

Some key food and beverage raw materials including sugar, wheat, edible oil and milk are witnessing price stability, while prices for crude based products like linear alkylbenzene and polyethylene packaging are rangebound but likely to decline if crude stays down.

Crisil says credit rating of FMCG companies will continue to be ‘stable’, due to healthy cash generating ability, strong balance sheets, and sizeable liquidity surpluses. This could lead to merger and acquisition activity as big players may look to buy small or mid-sized businesses which will help expand product range and offerings, especially in fast-growing premium segments.

Volume growth will be a key monitorable in this thesis. The policy impact of the Budget would also be a big factor. The one loser could be ITC which is expected to suffer tax hikes.

Given cost control measures, distribution expansion and competition, competent managements could eke out better gross and operating margins in this scenario.

There’s consensus on going over-weight on the FMCG sector and blue chips like HUL, Godrej Consumer and Dabur could see earnings upgrades and higher valuation targets.