Teji Mandi: Q3 Preview - FMCGs look at margin erosion
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Marico's business update for the December quarter has an important message for FMCG companies. The company reported a robust volume growth across the categories. But, it is their commentary on raw materials, that is more important for the industry.

Marico has updated that the quarter was characterized by higher prices for key raw materials. It necessitated the price hike and cut in promotional spending. Going into the earnings season, this will be the key factor affecting the margins of the FMCGs.

Commodity prices and their Margin impact:

Increased prices of HDPE (packaging), palm oil and palm oil derivatives are likely to put pressure on margins of Home and Personal care (HPC) companies. For food companies, deflation in wheat and Skim Milk Powder (SMP) prices is beneficial. But, the rise in Palm oil prices will create an adverse impact. Paint companies will continue to benefit from benign crude oil prices.

SMP and Wheat prices have dropped by about 17% and 18% since last year respectively. It is expected to benefit Nestle's gross margins during the December quarter. However, its positive impact is likely to be limited due to the surge in palm oil (up 35% YoY) and coffee prices (up 5% YoY). Nestle is expected to post a gross margin expansion of about 100-150bps YoY.

Palm Fatty Acid Distillate (PFAD) witnessed sharp inflation due to the 35% YoY increase in palm oil prices. PFAD is a key ingredient in Soap and beauty products manufacturers like HUL and GCPL. Along with PFAD, High-Density Polyethylene (HDPE)'s prices also increased by about 15% YoY. It is a key packaging raw material that is likely to put pressure on margins for HUL and GCPL.

The companies have raised soap prices by about 5-6% in December 2020. But, it appears to be too late to mitigate the impact of rising raw material prices. HUL is likely to witness a gross margin contraction of about 150-200bps YoY. For GCPL, margin contraction could be in the range of 50-100bps YoY.

Copra prices have seen a sharp surge of 14% during the quarter. It is a key ingredient for Marico's flagship product Parachute coconut oil. Due to the availability of low-cost inventory, Marico is likely to avoid its adverse impact in the December quarter. However, the inflated Copra price could start playing its impact in the next quarter.

Emami's major raw materials Mentha and Light Liquid Paraffin (LLP) prices are in deflationary mode. During 3QFY21, Mentha and LLP prices declined by 21.2% YoY and 6.3% YoY respectively. It could help Emami to improve its gross margins during the quarter.

As for the paint companies, they continue to benefit from benign crude prices. Despite the pick up from the lows, crude prices remained 25% YoY down. Titanium dioxide has seen a marginal increase in prices of about 2% YoY. It is likely to help Asian Paints with 100-150bps margin expansion in Q3FY21.

Closing comments:

Except for inflationary commodity prices, FMCGs are comfortably placed as far as the demand goes. Marico has given an optimistic outlook for the rest of the year provided the economic situation continues to improve. The trend is likely to be similar for the entire FMCG space.

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Free Press Journal