Further correction could make the FMCG sector valuations attractive

The FMCG sector has underperformed the Nifty over the past year as its 20 per cent return is trumped by 29 per cent of the benchmark index. The FMCG index saw a 2.2 per cent drop in the last session, while the Nifty lost 1 per cent. FMCG is seen as a defensive segment. The demand for staples like personal care products, groceries and snacks tend to be stable. FMCG companies are consistent dividend-payers.

The underperformance (though there were nominal share price gains in the past year) is linked to the slow consumption demand. This ties into the narrative of K-shaped trends where the demand for premium goods is strong even as the demand for staples remains low.

In India, FMCG growth is tied to semi-urban and rural demand. Metro and large city demand is almost saturated. Growth comes from smaller places. The Q3FY24 results were largely flat for listed FMCGs.

Uneven and below-normal monsoon impacted kharif harvest with foodgrain production down 4.6 per cent year-on-year (Y-o-Y). The inflation was high though it showed signs of easing from January. 

The unorganised regional players gained some market share over organised players over the past three quarters. This could continue though the market share loss of organised players remained moderate and listed players have taken price cuts, and launched new products to combat it.

The rural volume growth was at 5.8 per cent Y-o-Y in Q3FY24 (6.4 per cent in Q2FY24) but much of that was captured by unorganised players. Dabur was the only FMCG major to see higher rural growth compared to urban growth in Q3FY24.

The urban volume growth moderated quarter-on-quarter (Q-o-Q) as festival-led consumption was lower than anticipated.

The urban growth was 6.8 per cent Y-o-Y in Q3FY24 (down from 10.2 per cent in Q2FY24), which was driven by mid/premium products but rural growth lagged as economy products saw less demand.  

Home and personal care (HPC) growth of 9.6 per cent Y-o-Y, outstripped foods volume growth of 5.3 per cent Y-o-Y. HPC volumes were recovering from a low base. Food volume growth moderated as consumption of packaged foods (largely urban) did not see strong offtake in the festival season.

Over the past three months, there were price hikes in oral care, hair care, feminine hygiene, coffee, dairy, juices and spreads, and very few price cuts. There was some increase in crude and palm oil prices, and softening of milk prices.

However, on a Y-o-Y basis, palm oil and crude prices remain lower. In other agri-commodities, barring sugar and coffee (up 11 per cent and 10 per cent Y-o-Y), prices of most have remained stable or marginally lower in Q4FY24 till date. Wheat prices have declined 11 per cent from the peak in January.

Rabi harvest has been better and this could lead to rural demand recovery. Most FMCG companies in Q4FY24 should see some gross margin expansion. The detergents/ HPC segments will benefit from lower RM costs tied to low soda ash and crude prices, for example.  

Nielsen, which tracks retail data, is looking at 4.5-6.5 per cent value growth for the sector in CY24. Kantar, which tracks household consumption, echoes a similar muted outlook.

Agri growth is projected at 1.8 per cent in FY24, a seven-year low, and there is low expectation of consumption demand from election campaigns.

According to consensus, the listed companies will see FY25 Y-o-Y revenue growth in high single to low-double digits, assuming H2FY25 demand recovery. The de-rated sector valuations and slower growth in H1FY25 could present an opportunity for patient long-term investors.