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FMCG sector awaits demand recovery with the hope of a better monsoon aiding rural economy and expectations of a pro-consumption full budget. Rural demand recovery green shoots are in place and expected to see moderate improvement in Q1FY25. Full effect of tailwinds are to be felt in H2FY25, when growth is likely to see recovery. Key highlight for Q1 is a harsh summer, which is likely to benefit summer-centric portfolios, whereas select on-the-go consumption food categories are likely to take a beating. Lack of cooling infrastructure may limit growth for select FMCG names like Dabur and Nestlé. Hot beverages are also likely to have a demand effect. We see mid-single digit earnings growth for our FMCG coverage (driven by large-cap stocks), with limited margin expansion. With this report, we upgrade our rating for Colgate to REDUCE (limited downside), downgrade Bikaji to ADD (from Buy), and downgrade Marico to REDUCE (from Add). We now prefer Hindustan Unilever, Dabur, Honasa Consumer, and Emami in our coverage.

FMCG coverage to see mid-single digit growth with uptick in volume growth

Topline growth in Q1FY25 is likely to be volume-driven, where pricing is likely to be in the low-single digit decline to low-single digit growth. HUL is expected to clock 2.5% volume growth YoY, whereas players like Dabur, Nestlé, and Marico should see mid-single digit growth; Emami and GCPL could see high-single digit growth. Bikaji and Honasa are likely to see double-digit momentum with 15% and 23% YoY volume growth. For ITC, we expect 4% volume and 8% value growth YoY. From the competitive landscape, we see arrest in pressure from regional players as large players react in LUPs.

Margin-led earnings delivery to slowdown

With raw material price growth in the base and pass-through of price benefit in select categories, we see gross margin expansion to be limited (vs previous quarters). This, along with a higher need for A&P spends, is likely to limit EBITDA margin expansion. In our coverage, GCPL is likely to see >200bps YoY margin expansion with strategic actions in place to enhance profitability. Colgate and Honasa are other names that are likely to see >100bps YoY margin expansion. For other coverage companies, we see EBITDA margin expansion to be limited. EBITDA growth is likely to see moderation sequentially on a YoY basis, double-digit YoY growth should sustain for Nestlé (11%), GCPL (13%), Dabur (12%), Colgate (14%), Emami (12%), Honasa (44%), and Bikaji (35%).

Valuation factors are fundamental; re/de-rating hinge on external setting

FMCG sector valuations have seen re-rating post-Q4 results, with positive management commentary in demand outlook (given green shoots of rural demand recovery) and expectations of pro-consumption full budget. FMCG firms have rightfully enhanced execution, wherein distribution and brand communication get a boost. We continue to prefer companies with better execution and attractive valuations like Dabur, Honasa, and Emami. We prefer HUL primarily due to the expected improvement in external setting.

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