India FMCG sector profits may be weighed by ad spend hikes, price cuts: BNP Paribas

• Volume contraction for the FMCG sector was more pronounced in rural areas, says a BNP Paribas report.
  
  
• While the research firm expects margin improvement in FY24, its earnings estimates are below consensus on account of INR depreciation, increase in ad spends and selective price cuts.
  
  
• We think consensus earnings estimates for FY24/25 are too optimistic, the report says.
  
  
• The valuation multiples of Indian FMCG companies have expanded since June 2022, BNP Paribas says.
  

Consumer goods majors have been hit hard by inflation over the last few quarters, with volume growth taking a backseat. Clearly, growth has been driven by multiple price hikes that were taken by the players – and not volume growth. The road ahead looks better as commodity prices are cooling and price cuts could even spur consumption.

In spite of the fact that affluent India’s consumption is holding up well, volumes from mass-market and categories that benefitted from Covid like healthcare and hygiene segments were affected by inflation.

“Revenue growth was driven by price hikes, with volumes remaining subdued across categories. The volume contraction was more pronounced in rural areas. Companies expect rural demand to recover in the second half of FY23, on the back of government interventions, a good monsoon and higher crop realisations,” says BNP Paribas.

Ad spends and price cuts

Going forward, BNP shares the optimism of the companies that the second half of the current financial year will bode well for revenues and margins too as commodity prices are moderating.

“While we expect margin improvement in FY24, our earnings estimates are below consensus as we anticipate INR depreciation, an increase in advertisement spends and selective price cuts to drive volumes that are under pressure,” said the research firm.

Lower ad spends in addition to a cut in corporate tax rates have been aiding the sector’s earnings growth for the last five fiscal years in spite of muted growth in revenues and gross profits.

But now ad spends might resume to bring back consumers who have been downtrading to cheaper unbranded products for the last six months, leaving little scope for a strong margin recovery.

Lower estimates, pricier stocks

BNP Paribas raised its sales estimates for most companies during the earnings season but lowered the aggregate EBITDA margin for the sector by 30 bps to 20.9-22.1% for FY23 and FY24 – thereby reducing EBITDA as well as earning per share by 1-2% for both the years.

“While the outlook for FY24 is positive, driven by moderation in raw material costs and signs of a rural recovery, we think consensus earnings estimates for FY24/25 are too optimistic. With no triggers for a sharp multiple de-rating, we believe some stocks can see time correction over the next year. Our preferred sector picks remain ITC, Britannia, Emami and Jubilant Foodworks,” said the report.

Most FMCG stocks have been on a bull run in the last five months, and that has made them expensive relative to the tough conditions that await for its volume growth. “Since June 2022, the valuation multiples of Indian FMCG companies have expanded as concerns about unabated inflation eased. This has led to several stocks moving above their five-year mean next twelve months, price to earnings ratio,” the report said.

The downside risks that the research firm sees include an increase in competitive intensity, leading to companies cutting prices and sales growing at a lower-than-expected rate; and lower-than-expected margin recovery.

Rural recovery to be affected by muted Kharif season

Many economists and rating agencies are also questioning the pace of economic growth of the country – marred by constant downgrades. Apart from global spillovers, experts believe that a lot is riding on the rural recovery – that will play a big role in the volume and revenue growth of FMCG majors.

While there have been green shoots of recovery seen in spurts like auto sales, rural consumption has remained muted even after lockdowns ended. A major driver for rural recovery is a good Kharif crop, which, however, has been affected by erratic monsoons this year.

“Untimely heavy rainfall in the states across North-west and Central India between end-September 2022 and mid-October 2022 is likely to have added to the moisture levels of the standing crop, which poses some downside risks to the kharif output relative to the first Advance Estimates,” said an ICRA report.

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