Despite recent corrections in input costs across commodity baskets, operating margins are likely to remain skewed in the FMCG sector ahead of the festive season.

Over last 12-18 months have led to gross margin decline for most consumer staples companies, and unprecedented inflation and volatility in input costs across commodity baskets. However, the recent correction in a few commodities and management commentaries have likely led to consensus expecting operating margin expansion in 2HFY23. 

Gross margins

Industry experts seem to believe that there is not enough reason to be excited about it. The reasons, according to them are that the gross margins are unlikely to recover to pre-inflation levels as price increases have been lower than inflation in most cases. Secondly, companies will have to pass on the input correction benefits to end-consumer, given the subdued demand situation for volume growth. Lastly, most large FMCG companies have under-invested (in absolute terms) in advertising and promotion (A&P) spends over FY20-22.

“We believe that consensus’ excitement about operating margin expansion due to commodity correction is unwarranted. All said, it may likely create resources for A&P investment and new launches – which we see as incremental tailwinds for Britannia, Colgate, HUL, Jyothy Labs, Tata Consumer,” analysts at ICICI Securities added.         

Demand recovery

Satish Meena, industry expert, and Co-Founder, Sutradhar, explained that the demand recovery in urban India started in July, but rural India which accounts for around 40 per cent of FMCG sales is still not recovered and monsoon will play a bigger role in the delay in recovery of rural demand. 

According to the latest data, India’s retail inflation based on the consumer price index (CPI) the food category has witnessed inflation of 7.6 per cent which is driven by cereals, milk, fruits and vegetables. 

The concern here, according to Madan Sabnavis, Chief Economist at Bank of Baroda, is that with the kharif production of pulses and rice likely to be lower this time, there can be resurgence in pulses inflation which is relatively low at 2.5 per cent. Cereals inflation is high at almost 10 per cent  and could accelerate further given the weak stocks position for wheat.

“Although the price of commodities is reduced, as of now FMCG companies are not in a mood to pass on the benefit to the customers to make up for the loss in volume sales which will certainly impact the recovery,” Meena added.

Demand conditions

Demand conditions of FMCG products have been subdued with many of the categories are declining or even staying flattish. In this context, we believe that companies are likely to pass on the lower input price benefits to end-consumers, analysts at ICICI securities explained. 

“Marico has been very aggressive in passing on the input correction to end-consumers as it had lost market shares (in the past) to unorganised players while trying to delay passing the benefits or retain some of the benefits in previous commodity inflation cycles. Similar examples were seen with HUL as well in the past,” it added. 

All in all, industry watchers said, given that the consumers are still not willing to loosen their purse strings and there has been unprecedented inflation and volatility in input costs across baskets over last 12-18 months, companies are likely to focus on volumes than margins. Not only that, in order to lure more customers, the companies are likely to reinvest some money in advertising and promotions weeks ahead of the festive season.

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