A challenging macro environment, weak consumer sentiment, and liquidity challenges have led to the softest quarter (in terms of demand and volume growth) for most FMCG companies. There are, however, a few other drivers that could also meaningfully affect the sector:
1. Recent Food Inflation can lead to strong rural FMCG growth: Food inflation has picked up to ~7% in October 2019, continuing to rise over the past couple of months.
For instance, in the past, the period of high food inflation from FY06-12 correlated with strong rural FMCG growth. Farmers gained directly from selling their crops at higher prices, while workers gained by higher rural wage inflation.
There has to be a prolonged period of food inflation for any meaningful pick up in rural demand. It is only then that farmer realizations go up predictably to drive rural consumption acceleration.
A short term spike in food inflation can be a headwind, as the farmers are unlikely to gain immediately while the consumer wallet is immediately impacted adversely. The current increase in food inflation is driven by supply disruptions, and hence looks like a short term spike.
2. Government spending likely to slow down: Tax collections for first half of FY 20 have been way below the targeted collection. The corporate tax cut will further aggravate the fiscal situation in the second half of FY20, which could reduce government spending in the near term. These spending cuts could slow down welfare spending which would lead to a further slowdown in consumption.
3. Raw material price movement to affect companies in different ways: The drop in prices of Light Liquid Paraffin (LLP) and High Density polyethylene (HDPE), key raw materials for hair companies, could continue to increase competition in the hair oil segment. For instance, Marico has taken selective price cuts in value added hair oils during the quarter.
The resurfacing of inflation in palm oil prices could put pressure in certain cases. Godrej Consumer Products (GCPL) has sufficient cover till 4QFY20 against the inflation in palm oil prices, while HUL could raise prices of soaps to offset the inflation in palm oil.
Paint companies are expected to benefit from decline in crude and titanium dioxide prices. However, food companies such as Nestle could face inflationary pressure as the prices of key raw materials such as skimmed milk powder (SMP), milk, wheat, sugar, and palm oil have increased steeply.
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