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With rural market yet to rebound & El Nino risks in sight, should investors flock to FMCG stocks?

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With rural market yet to rebound & El Nino risks in sight, should investors flock to FMCG stocks?

Synopsis
The earnings of FMCG companies for the March quarter were lacklustre due to subdued domestic demand, reflecting a weak rural market that makes for 30-40% of sales for consumer staples firms. Volumes have taken a hit over the last few quarters as inflation has damaged consumption, leading to down-trading in certain categories. However, with the easing of commodity prices, companies saw a recovery in their profitability. El Nino weather phenomena could derail the recovery in rural FMCG, though most large and midcap FMCG stocks have outperformed benchmark Nifty 50 over the last year.

The March quarter earnings of companies in the fast moving consumer goods sector threw no major positive surprises for Dalal Street investors, while management commentary underscored subdued domestic demand and consumption.

Most companies reported flat to marginal growth in volumes during the quarter, reflecting the weak rural market.
Rural markets make for about 30-40% of sales for a consumer staples company. Volumes have taken a hit in the past few quarters for the consumer staples companies as high inflation hurt consumption and even resulted in downtrading in some of the categories.

Moreover, higher commodity prices pushed input costs higher for the players, forcing them to pass on some of it to end consumers.
So, in the last 3-4 quarters, much of the growth in the revenue for FMCG players was price-led rather than volume-led.

However, the easing of commodity prices gave some breather to companies in the March quarter who saw a recovery in their profitability.

“The numbers from FMCG players have not been really exciting in the year gone by. Going forward however, we do expect some of that change as we expect rural India to pick up in the current year,” said independent market expert Anand Tandon.

Most companies too, have indicated that rural slowdown has bottomed out and that they are seeing some green shoots.

EL-NINO RISKS

Just at a time when companies are getting some breather from cooling prices and initial signs of rural recovery, risks of El-Nino have emerged.

Any rainfall deficit that an El Nino year may present could derail the recovery in rural FMCG, according to Nuvama Institutional Equities.

“Rural India constitutes 36% of the sales pie for a typical consumer company and is a weighty focus area given the much lower per-capita consumption,” the brokerage said.

Companies started seeing some recovery in rural volumes. The proportion of dip in rural volumes was 5-6% for the FMCG sector versus about 9% earlier.

Therefore, El Nino conditions remain a key monitorable that can hinder rural slowdown turnaround in India.

STOCK TALK

The rural slowdown concerns notwithstanding, most largecap and midcap FMCG stocks have outperformed benchmark Nifty 50 by a wide margin in the last 1 year.

Barring Hindustan Unilever, Marico, Godrej Consumer Products, Nestle India, and Britannia Industries have outperformed Nifty 50 by 10-25%. HUL has outperformed the index only by 6%.

Meanwhile, Dabur India and Patanjali Foods have underperformed the benchmark index.

However, with expectations of a recovery in earnings on the back of rebound in rural demand and further improvement in the profitability, analysts are holding a positive stance on the sector.

We actually believe that FMCG is fairly well poised at this point in time. Valuations on a long-term historical average basis, appear to be attractive, and if rural demand does come back, then this is a sector to clearly watch out for,” said Shibani Sircar Kurian of Kotak Mahindra AMC.

According to Trendlyne, Hindustan Unilever has an average target of Rs 2,851.55, representing an upside of around 7% from current levels.

Britannia Industries’ average target of Rs 4,870.91, too, indicates an upside potential of about 6% from the current levels even after the sharp gains the stock has garnered in the last 1 year.

In the midcap space, analysts seem to be most bullish on Patanjali Foods, as the average target of Rs 1,750.00, represents an upside potential of 83% from the current levels.

 

 

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