Palm oil saves the FMCG Company’s margins. Foreign investors’ interest in FMCG stocks.

Once upon a time, Hindustan Unilever Limited coined a catchy phrase - CRAP - to describe the challenges faced by new entrants in the FMCG sector.

“CRAP- Can’t Realize Any Profit”

The quote succinctly summarises the difficulties that new FMCG companies face in making a profit. Why is it so hard, you ask? Well, margins play a pivotal role in the FMCG sector, which is notoriously competitive and characterised by low pricing power. With razor-thin margins, companies are locked in a perpetual struggle for market share. For a new company with no established distribution network, high operational costs, and expensive logistics, the odds of turning a profit seem very difficult.

Today we are going to discuss a big factor that has improved the margins in the FMCG sector this year, i.e. PALM Oil.

How big a role does the PALM oil have in the margin of Indian FMCG companies?

Here we have shown a severe fall in Crude Palm oil of around 52% from its top since April 2022. Crude palm oil prices have dropped due to weak demand, pullbacks in rival vegetable oils, and a strong Malaysian ringgit(the official currency of Malaysia).

India is the largest Palm Oil importer in World. Palm oil is widely used as a raw material in various FMCG products in India due to its versatility, affordability, and availability.

Some common FMCG products that use palm oil as an ingredient include:

Cooking oil, Margarine and shortening, Snack foods, Instant noodles, Biscuits and cookies, Personal care products such as soap, shampoo, and cosmetics, Laundry detergents, and Candles

Typically, palm oil can contribute to around 20-50% of the total cost of soap production in India.

The decline in palm oil prices was a relief for FMCG companies like Hindustan Unilever (HUL), Godrej Consumer Products, Britannia, and Nestle since palm oil is a key ingredient in many consumer products.

Let’s take deep dive into a few things like FMCG company’s  Margin expansion, the defensiveness of the FMCG sector and why Foreign Investors are accumulating FMCG stocks.

In the above image, you can clearly see the investor’s top 4 preferences in sector-wise investing.  FMCG investment ranks as the fourth highest, preceded only by the Auto and Auto Ancillary industry, capital goods, and construction sectors. The sector is slowly gaining momentum, and Foreign investors have invested almost Rs. 11,915 Crs in the last six months.

Why are the FMCG stocks attracting investments from FPIs?

There can be two reasons for this.

Reason -1: Defensiveness of the FMCG sector

Do you remember how the market fared during the Covid-19 pandemic? Which stocks displayed resilience and recovered rapidly, even amid the market downturn? The answer lies in the FMCG sector and companies like HUL, Nestle, Britannia, and Dabur. During Covid year, the FMCG sector had a standard deviation of 0.54% in 2020, compared to 1.08% for the Nifty 50 index, which shows a very low volatile sector.

The FMCG sector is considered a safe haven during an economic turmoil. Investors had noticed that even during tough times, consumers still needed basic items like food, beverages, toiletries, and house cleaning products. As a result, companies that operated in the FMCG sector were considered defensive investments, with relatively stable earnings that could withstand market volatility.

Now, we are seeing a few economic issues and global tensions, such as a crude oil price surge, (which might lead to higher inflation), global economic recession and banking crisis across US and Europe. These can be a few reasons why Foreign Portfolio investors are accumulating defensive stocks like FMCG.

During the Covid-19 pandemic, Foreign Investors had a significant amount of FMCG stocks in their investment portfolio, weighing in at a record 9.4% (as reported by NSDL). However, as time went on and things started to get better, the FMCG stocks didn't seem as important anymore. So, the Foreign Investors decided to sell some of their stocks, and the weight of FMCG stocks in their portfolio decreased to less than 6%.

But, as we all know, times change quickly and recently, the FMCG sector has once again become very popular among Foreign Investors. They like it because it's a safe and reliable way to make money in these uncertain times. So, they've started buying FMCG stocks again, and now, the weight of these stocks in their investment portfolio has gone up to 7.3%. This shows that Foreign Investors are really interested in this sector once again.

Reason 2:- The margin expansion and a better result expectation.

In the last three Quarters, all the FMCG companies have shown a good Margin Expansion. Margin expansion in the FMCG sector means increasing the profitability of the company by improving the difference between the cost of production and the selling price of products. This has happened now because of low raw material prices and moderating retail inflation.

Dabur, Godrej Consumers Products, and Marico-like companies have forecasted stronger margins for their March Quarter.

The Margin improved more in Urban Areas rather than in Rural areas. Rural areas contribute to 40% of business in the FMCG sector, which is a significant number. Because of the limited distribution networks, higher logistic costs, and low purchasing power of customers, the Margins generated are very less for companies. Despite the government's efforts to improve rural infrastructure, the situation has not yet shown significant improvement. As a result, companies that heavily rely on the rural market may struggle to keep up with the competition.

All the commodities/Raw material prices have not fallen down. The wheat price as a commodity increased very high for the last financial year, impacting the businesses that are more into packaged foods like biscuits, bakeries, noodles, cereals etc. Britannia(80%-85% of business comes from Biscuits), ITC, and Nestle can be a few who might have been affected by this. Now the wheat price has again fallen by around 28%, which might be little relaxing news for this March quarter.

The price decline in Crude Palm oil by 51% is benefiting the FMCG companies that are producing its derivatives or using them to prepare the products. Palm oil is used to produce a wide range of FMCG products, including cooking oil, margarine, snack foods, biscuits, soaps, Shampoos and personal care products.  Leading soap makers like HUL and Godrej Consumer Products might benefit more because of their high requirement of Palm oil as a raw material, creating a larger profit margin.

We hope this article has given you a thorough understanding. If you enjoyed this content, be sure to subscribe for more articles like this delivered straight to your inbox..