Review of 9 Top FMCG stocks like HUL, ITC, Nestle, Colgate with Buy/ Sell recommendation by HDFC Securities

Demand recovery lags margins

The HSIE consumer index sales grew by 12% YoY in Q4FY23 (+11% in Q4FY22, +11% in Q3FY23). On a four-year CAGR basis, the universe clocked 9% growth in Q4FY23, a trend similar to that witnessed in the previous few quarters. On a fouryear CAGR basis, Paints/QSR/F&B/Home Care have grown ahead of our index average (14/13/12/11%) in Q4FY23. On the other hand, Personal Care/Cigarette/Liquor/Oral Care/Hair care/Footwear underperformed, growing below the aggregate at 7/6/6/5/4/3% (Link). Although discretionary categories exhibited high YoY growth, they are witnessing deceleration in demand on weak consumer sentiment. A large part of the growth across categories was driven by price hike, while volume growth remained soft throughout FY23 (although improved in Q4). The FMCG sector witnessed positive volume growth after five consecutive quarters of decline, led by urban markets. Rural softness has likely bottomed out, given the reversal of the declining trend. Moderating input costs and retail inflation should help sustain demand recovery.

We expect divergence between volume and value growth to normalise in FY24 with volume growth back to its historical average of mid-single digit. Moreover, the easing commodity inflation will help sustain gross margin expansion. However, companies shall reinvest some of these gains in product innovation, distribution expansion and marketing spends, which shall limit operating margin expansion.

We believe there will be no more pressure on earnings for FMCG companies in FY24 (earnings cut cycle is behind) while both revenues and margins should see an uptrend. We remain cautious and selective on valuation for the medium term (do not see rerating as a story); however, earnings pick-up in FY24 will continue to support FMCG stocks. We rate ITC, Dabur, GCPL, Marico, UNSP, and Colgate as ADD and HUL, Nestle, Britannia, Emami, and Radico as REDUCE.

► Essentials performance led by F&B, Home care; OTC FMCG/healthcare weak: F&B and Home care continued to drive performance for essentials, growing by 12/11% (four-year CAGR). Personal Care/Oral Care/ Hair Care saw revenue CAGR of 7/5/4%. OTC FMCG/healthcare revenues fell 2% YoY on account of a high base. We note that Q4/FY23 growth was pricing led; going ahead, we expect divergence between volume and pricing to return to normal.

► Discretionary categories see sequential deceleration: With sustained high inflationary environment impacting consumer wallet, discretionary categories witnessed sequential deceleration in demand. However, Paints/QSR reported a four-year CAGR of 14/13%. We note that QSR growth was largely led by store addition as most players reported deceleration in SSSG. Cigarettes revenues grew 14% YoY on a low base, with underlying four-year CAGR of 6%. We believe discretionary categories will underperform in the coming year.

► Volumes turn positive; rural has likely bottomed out: In Q4, after five consecutive quarters of decline, FMCG sector volumes grew in low single digits. Urban consumption continues to exhibit faster recovery and has remained steady. Moreover, with rural recording reversal of declining trend, we believe the rural sector has most likely bottomed out. We expect demand to sustain this trajectory, given moderating input costs and retail inflation.

► Margins improvement sustaining: With prices of key inputs (palm oil, crude, crude derivatives, etc.) softening, most companies recorded sequential improvement in margins (both at gross and operating level). Companies will look to reinvest some margin gains in marketing/distribution in order to further stimulate demand.