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FMCG sector valuations (ex-ITC), trending near the last 10Y avg fwd P/E of 49x, are holding up on the hope of demand recovery in 2H and thus aiding doubledigit earnings ahead, as the margin-led earnings story is largely at play. While we see continued recouping of margin ahead, recovery in demand may require players to pass-on raw-material benefits for accelerating volume growth. Q2FY24 results do not give us enough reason to change our stock calls, but we reduce topline for FY24E due to muted demand. We still prefer GCPL, Dabur, Britannia, ITC, Emami; we avoid Colgate and have a HOLD on HUL, Marico

Our FMCG universe noted a lackluster topline, but at the back of better margin delivery earnings stood better than expectations. With shift in trade loading from Sep to Oct for the festive/winter portfolios, Q3FY24 topline performance is likely to improve. FMCG players are banking on the trend sustaining beyond Q3. As per AC Nielsen data, the sector’s Q2FY24 volume growth is 8.6%; and we see players increasing focus on volume delivery. Double-digit earnings delivery sustained in Q2, aided by better margin delivery, which is a factor of limited price-cuts in an easing raw-material scenario.

Topline performance muted for our universe; sector growth decent at 9%

Overall topline show for our coverage universe was subdued, with a low single-digit miss. In Q2, our FMCG universe saw sales growth impact from the festive loading shifting to Q3 and from the price-hike anniversarization. Rural has seen recovery on a low base, but demand rebound is missing. Urban continues to do well on the back of accelerated growth in the modern trade and ecommerce channels. Foods & Beverages continues to outgrow the Home and Personal-care categories. This is in sharp contrast to the sector growing 9% (as reported by Nielsen), wherein small and regional players have seen healthy offtake. Unlike Domestic being afflicted by muted demand, International markets are offering FMCG players robust double-digit, constant-currency growth.

Better margin continues to aid earnings

In a muted demand setting amid easing raw-material prices, FMCG companies have largely maintained product prices. This has helped in a better than expected grossmargin delivery. While some players have utilized gross-margin benefits to further A&P spending, our overall coverage universe has seen healthy EBITDA margin expansion. Improved margin and higher yield have led to better than expected earnings in Q2FY24. Also, higher than estimated non-operating income further aided the earnings delivery.Better margin continues to aid earnings In a muted demand setting amid easing raw-material prices, FMCG companies have largely maintained product prices. This has helped in a better than expected grossmargin delivery. While some players have utilized gross-margin benefits to further A&P spending, our overall coverage universe has seen healthy EBITDA margin expansion. Improved margin and higher yield have led to better than expected earnings in Q2FY24. Also, higher than estimated non-operating income further aided the earnings delivery.

Double-digit EPS growth firms-up valuation; demand recovery key to re-rating

FMCG sector valuations have been range-bound, due to a suppressed topline and marginled earnings. Going into FY25, it would be key for FMCG players to revive topline growth, as margin rebound has largely crowned in FY24. Demand recovery would be a re-rating catalyst, while the slow momentum could trigger a de-rating if margin support diminishes. For our coverage universe, we prefer GCPL, Dabur, Britannia, ITC and Emami. We maintain HOLD on HUL and Marico, while retaining SELL on Colgate.

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