FMCG: Macro situation yet to recover

26 Apr 2023 , 10:58 AM

Meanwhile, farm inflation (another important indicator) is under pressure. As of now, macro indicators do not suggest a recovery. Still, analysts at IIFL Capital Services are hopeful for the future, though visibility for the same is poor currently. In this environment, analysts at IIFL Capital Services would stick to large defensive names, and would move down the market cap curve as timing and extent of recovery becomes apparent.

Twin indicators for growth necessary

For FMCG to grow well, good income growth in the low-income consumers is required. These consumers have two main sources of income viz farm income and wages. Previously, when farm income and wage growth is robust, FMCG companies tend to post strong sales growth and vice versa. Past 20 years can be divided into 3 periods: FY00-06 when sales growth was weak, FY07-14 when it was strong and FY15-20 when it was weak again. The strong/weak periods of FMCG growth coincided with strong/weak periods of farm inflation and wage inflation.

Wage growth improving

Real rural wage growth was -2.7% for September 2022. It has now improved to -0.5% (for January 2023), but is still not healthy enough to boost growth. Moreover, Non-agri real wage growth is even poorer at -1.4%, denoting slow pickup in economic activity outside of agriculture. The improvement over past few months is led by both nominal wage growth improving and inflation moderating. While currently still lackluster, the trend if continued will be positive for FMCG players. Analysts at IIFL Capital Services need real wage growth at ~2% or higher to sustain good volume growth.

Farm inflation moderating

While real wage growth has shown some small improvement, IIFL Capital Services’ proprietary IIFL farm index has been lackluster since past few months, and is showing a 3% YoY inflation in February 2023. Vegetable prices, down ~20% is the main reason, despite cereals and milk prices witnessing double-digit inflation. Moreover, assuming that prices remain stable at current levels, YoY inflation will trend lower than the current 3% for each of the next 12 months. Analysts at IIFL Capital Services need further sequential inflation to pick up for the YoY growth to continue meaningfully. Over the past 3-5 months, the index has been largely flat. For FMCG growth to be strong, they need farm inflation equal to or higher than CPI.

How to play the sector

Visibility of a good growth is better for food companies in near term. Investors with short-term horizon can invest in food companies, whereas HPC investors may require a slightly longer horizon. Analysts at IIFL Capital Services recommend that investors start off with large companies currently in absence of visibility on the time and extent of recovery, and then shift into smaller companies in inverse proportion to the strength of the expected recovery as and when macro indicators suggest it. This is because large companies are better suited to weather the storm on account of their strong brands, better management talent, systems and processes. Smaller players tend to have a leverage to recovery as consumers as well as wholesalers increase the repertoire of categories and brands when demand conditions are robust.