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What lower inflation means to FMCG players? - Views on News from Equitymaster
 
 
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  • Nov 19, 2008

    What lower inflation means to FMCG players?

    The latest statistics on inflation showed that the same has cooled off to a 6-month low and come down to single digits, primarily thanks to lower commodity prices. Since FMCG companies play a major role in driving consumption growth, which is necessary for a slowing economy, we analyse what kind of impact the inflation number can have on the FMCG sector.

    As seen from the table below, the major input prices for the FMCG companies have declined from their peak rates, though some are yet higher on the YoY basis. The FMCG companies had been witnessing margin pressure right from the beginning of this year. The companies had implemented various options like price hikes, cost saving techniques like change in product mix, reducing the pack sizes and better sourcing of raw materials to offset the input cost impact.

    Lower input prices
    Input Change from peak rate* Change on YoY basis*
    Groundnut oil -14.5% -7.0%
    Sunflower seed oil -25.7% 5.2%
    Coconut oil -4.8% 33.5%
    Palm oil -40.8% -25.6%
    Sugar -3.1% 26.5%
    Wheat flour -45.5% -41.8%
    Crude oil (Brent) -45.5% -41.8%
    LAB (used for soaps) -16.0% 50.0%
    Sorbitol -11.0% 25.0%

    *latest price as on 31st 0ct 08
    Source: CMIE

    However during the September quarter, on account of fear of lower volumes, the companies had restricted taking further price hikes thereby leading to decline in operating margins. The combined margins of large companies (HUL, Nestle, Dabur, Marico, Britannia and Godrej Consumers) declined by 2% on a YoY basis for the September quarter. During our interaction with them, the management of these companies had cited that the commodity prices are to remain a challenge going forward and expected a slowdown in growth if the trend continued.

    The raw material prices accounted nearly 54% of the sales in the last quarter, which was considerably higher than the previous quarters. Hence, the recent correction in some of the key raw material prices comes as good news to these companies. Players present in soaps, shampoos, detergents and toothpastes have signaled that they will not raise prices in the next 6 to 12 months because of input costs coming down considerably. However, firm agri commodity prices are likely to continue pressuring the food companies.

    Margin expansion
    FMCG players are, however, not likely to reduce prices in the near term, as there is considerable amount of stock in the trade channel at any given point. If prices are reduced immediately, companies have to compensate all the market stocks, making it very complex. Hence easing cost pressures combined with retention of pricing power could lead to marginal upside in operating margins.

    Improved cash flows
    Though the FMCG companies have a strong balance sheet, the improvement in margins would further give a boost to the cash flows. While companies in other sectors are struggling for working capital, FMCG companies are comfortably placed. This would help the companies to look at inorganic growth opportunities. Indian FMCG companies have made global headlines by acquiring international companies and brands in the last few years. With signs of slowing demand worldwide, companies like Godrej Consumer Products, Tata Tea and Dabur are looking at acquiring new brands, tweaking promotion spends and expanding distribution network to mop up more sales. This could now get a further boost as more companies could be up for grabs at better valuations. It would also provide them opportunity to enter new growth areas or pay higher dividends to the share holders.

    To conclude...
    The FMCG companies had witnessed higher sales growth in inflation environment indicating resilience of consumer spends on FMCG. Rural income and sentiments (rural consumers account for 50% of FMCG consumption) are on an uptick due to food price inflation, farm loan waiver, satisfactory monsoon and employment generation schemes. Hence the long term fundamentals of the sector, both in terms of breadth (number of consumers using) and depth (existing consumers) continue to remain strong.

    With the cooling of the commodity prices, FMCG companies have further reason to cheer. Products with high brand loyalty in categories like coconut oil, oral care, skin care products would benefit with the reversal of commodity prices on account of lower competition. However, the hair and soap segment and biscuits may witness only a marginal improvement due to intense competitive environment.

     

     

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