As Oil Tumbles Below $75, Where Do FMCG Margins Go From Here?

Makers of soap-to-staples may recoup lost margins in the ongoing quarter as oil prices slide below $75 a barrel. However, a complete recovery would take time as the price decline has not been uniform across commodities, and in some cases, prices have actually gone up, according to analysts.

Crude oil prices shot up last year as the Russia-Ukraine war disrupted supply lines, even as worldwide post-Covid reopenings lifted demand. This, along with inflated prices of other commodities including milk, wheat, palm oil, etc., contributed to the persistent inflation, eroding demand as well as squeezing the margins of companies like Hindustan Unilever Ltd. to Dabur India Ltd.

However, oil prices have begun to fall gradually. It is now at the lowest level since the beginning of 2022, declining the most in March, down 31.5% year-on-year. The crude oil price is currently hovering at $72-75 per barrel, down 45% from its all-time high of $134 per barrel, even as it historically remains at elevated levels.

Similarly, palm oil—a key raw material for soap companies and, to some extent, food players—also stabilised sequentially.

Prices of agri commodities like tea, wheat, barley and sugar as well as non-agri commodities like vinyl acetate monomer used in packaging and liquid paraffin also softened month-on-month. Yet, prices of most of the inputs are still higher compared to last year.

Margin improvement from hereon will be contingent on commodity costs stabilising at current levels or actually falling more, Sanjiv Mehta, chief executive officer and managing director at Hindustan Unilever, recently told analysts.

"If more inflation does not come in, margin improvement will come from premiumisation of portfolio and mix change," Mehta said.

"Similarly, if the current prices become the new normal, then we have to drive our saving agenda harder, which we have been doing and will keep doing that. This will translate into margin improvement," he said.

HUL had guided for an Ebitda margin of 25% before the inflationary cycle started. In the December quarter, its margin stood at 23.6%, thanks to higher costs.

However, Mehta is hopeful of reaching the target soon. "If we can go from 14–15% to 23.6%, then 25% is not a long journey," he said.

Marico Ltd.'s Chief Executive Officer Saugata Gupta, too, expects margins to "remain steady". "Ebitda margin should remain in the 18-19% range as we close FY23 and move above the threshold of 19%-plus next year."

But, according to analysts, a complete recovery in margins will take one or two more quarters as material prices have not reduced uniformly and in some cases have gone up.

"FMCG companies should see earning growth acceleration in FY24 led by gross margin expansion, after a cumulative 500 basis points pullback in the last four years," Jefferies said in a March 21 note.

Despite deflationary trends in the past few months, inventory covers have delayed the full benefit. "We expect it will be visible during the first half of next fiscal as declines in raw material prices fully reflect."

Operating margins, too, should recover, even though part of the gross margin accretion will be reinvested behind ad spends, the brokerage said.

Home and personal care companies seem to be better placed than packaged foods, Jefferies said. "This is mainly due to the correction in petrochem and vegetable oil prices, while the prices of wheat, milk and their derivatives are higher — a concern for packaged food firms."

On a year-on-year basis, prices of most key inputs have declined by up to 32% in the ongoing January-March quarter, led by edible oil and crude oil.

Wheat and milk are the only major exceptions which have inched up 12% and 11.2%, respectively. As a result, incremental inflation is now largely restricted to certain food products—including milk products, biscuits, packaged snacks, instant noodles, ice cream, etc.

Other inputs such as linear alkyl benzene, used in making detergents; barley; and inorganic chemicals like soda ash, light liquid paraffin are also higher year-on-year.

While the escalation in prices of few commodities could lead to further price increases or grammage cuts by affected companies, the current demand environment could constraint their ability to take price hikes.

While there are clear indications of some green shoots in rural demand, a full-fledged recovery will depend on a normal monsoon in 2023, according to Motilal Oswal.

"However, initial reports [on demand] are not encouraging amid signs of the likely El Nino effect," the brokerage said. "Taking cognisance of this, along with a moderation in commodity prices, companies may look to roll back the price hikes and launch various schemes to revive demand."

Mayank Shah, senior category head, Parle Products, concurred.

The pace of rural consumption, he said, is picking up well in anticipation of a bumper Rabi season in March and April.

"Hence volume growth is likely to have an uptake in FY24 unless there is any impediment. We are only hopeful that we will have a good monsoon and the impact of unseasonal rains will be minimal," told BQ Prime.

For Parle, rural areas contribute around 55% of its total sales.

FMCG sales grew 28.6% in February over January, according to Bizom. Within this, rural sales were up 35%, while urban sales grew 14.9%. Compared to a year ago, rural sales stood 12.4% higher while urban sales growth came in at 5.5%, according to the retail intelligence platform.

HUL and Godrej Consumer Products Ltd., according to most brokerages, will be significant beneficiaries of margin-led earning growth as input costs ease.

Increasing light liquid paraffin costs may affect Dabur's gross margin in the near term, offset by the recent price hikes.

ITC Ltd. and Britannia Industries Ltd. are likely to benefit from the likelihood of reduction in wheat costs after the Rabi harvest.

Analysts, however, have warned that prolonged unseasonal rains raise risk of food inflation, which could have a negative impact on companies.

"The wheat crop may see lower output due to unseasonal rains, and this is likely to have a negative impact on food companies," according to Abneesh Roy, executive director, Nuvama Institutional Equities. "However, it is too early to predict the full impact...we need to wait for the data to come in."