FMCG sector faces rising raw material prices

May hit firms which reported better margins in the September quarter due to lower prices

The better-than-expected performance of fast-moving consumer goods (FMCG) companies in the September quarter, on the back of higher margins due to lower raw material prices, may not be sustained in the coming quarters. According to industry experts, the prices of almost all raw materials are moving up, and this trend may continue.
"Raw material costs were about 45% of sales in the first quarter of FY10 but increased by 200 basis points (bps) in the second quarter. In the next quarter, they can go up to 50% of sales," said HK Press, vice-chairman, Godrej Consumer Products Ltd (GCPL).
Last year, GCPL’s raw material costs were about 60% of its sales, but they dropped to around 47% in the current fiscal. During the September quarter, prices of palm oil, linear alkyl benzene (LAB) and high density polyethylene (HDPE) were down 18.5%, 49.1% and 8.2%, respectively from the same quarter last year.
“During the quarter to end-September, earnings before interest, taxes, depreciation, and amortization (EBITDA) margins widened 50-250 basis points (bps) due to lower raw material costs. On the other hand, advertising spend as a percentage of sales rose 50-150 bps. Net profit, at 26%, was below EBITDA growth because of lower interest rates and higher tax rates, from expiry of some tax holidays and increase in the MAT rate,” said Anand Rathi Financial Services Ltd, in a research note.    
The decline in palm oil prices boosted the margins of soap manufacturers like Godrej and Emami, which reported overall revenue growth of 121% and 27%, respectively during the September quarter. GCPL's revenue from soap sales grew 28% on volume growth of 16% while revenue from its hair-colour business rose 48%.
Hindustan Unilever's soaps and detergents segment recorded sales growth of 9% in the September quarter, while its raw material cost was down 9% from the corresponding year-ago period.
However, Dabur's raw material cost increased 3% for the September quarter; yet sales rose 15% compared to Q2FY09.
Nestle India’s revenues in July-September were up 18% from a year ago, to Rs1,302 crore, driven by strong domestic and international sales. Its operating profit increased 28% to Rs269 crore due to a better product mix and lower commodity prices (except for milk solids and sugar). "Changing lifestyle, increasing disposable income coupled with strong consumer spending will be the key drivers for companies like Nestle India. The only risk which we see is a likely pressure on margins with increasing prices of agri commodities with below normal monsoon this year," said Kisan Ratilal Choksey Shares and Securities Pvt Ltd, in a report.  
Petroleum prices also fell during the September quarter, which mainly benefited the shampoo and detergent segments and also reduced packaging material costs across the FMCG segment.
But despite a deficient monsoon and increasing raw material prices, the FMCG sector may be able to sustain higher margins with volume growth. Anand Rathi Financial Services said, "A good rabi (winter) crop and negligible impact of the poor monsoons should, in our view, lead to the sector reporting steady growth rates. With ‘modern trade’ reviving and companies’ efforts to launch price-point-based SKUs could also help the sector. If raw material prices rise, most companies would be able to exercise their pricing power to maintain or improve margins." 


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