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Valuations factor in demand slump, inflationary stress, shrinking moat

FMCG sector’s defensive nature is in question, given dwindling earnings growth, with dual stress of demand slump and inflationary pressure. We see near-term sector outlook staying muted, on weak execution by companies and an unfavorable macro. With no visibility on any major positive catalyst, we see the street factoring in the pressure on numbers ahead which will keep valuations stressed. We revise down our target valuation multiple, now at a discount to its 5Y average, given business headwinds. This causes a high single-to-low double digit cut to our TP. We maintain our underweight stance on the sector, with selective preference for LT fundamentals and revamped execution for HUL, Emami, and Gopal Snacks. For Q3FY25 results, we see demand slump with an inflationary raw-material setting hurting earnings delivery. Emami and Marico are likely to report relatively better earnings with mid-to-high single-digit growth, while remaining players would put up a muted show

Earnings cut cycle to weigh on valuations FMCG sector valuations have seen sharp derating in the last three months (~24% derating from the peak; one-year forward P/E ex-ITC now at 48x), considering the muted demand setting and inflationary raw material backdrop. We expect the earnings downgrade cycle to continue during Q3FY25 results and hence have a bearing on nearterm stock performance. In our view, the upcoming Union Budget is a near-term catalyst, with Central Government actions toward reviving the consumption cycle being key.

We maintain our UW stance, with especial preference for HUL, Emami, Gopal Factoring in the business pressure ahead, we cut valuation multiples across most of our traditional FMCG coverage. This leads to a high single to low double digit cut to our target price. As we await execution ramp-up and improvement in the external setting, we remain underweight on the sector and selective on stock picks. We maintain BUY on HUL, despite weak earnings in the near term, given enhanced fundamentals from ramp up in execution. We have a similar stance on Emami. Though Gopal Snacks’s near-term outlook is sabotaged by the fire incidence, we remain positive on its long-term fundamentals

Q3FY25 preview – Lackluster show expected, amid weak demand, inflation The demand slump has persisted in Q3FY25, despite festive concentration. Inflationary stress asks for price hikes, which further affect demand. Expected respite from wintercare offerings was also missing, given the delayed and weak winter. ITC, Marico, and Bikaji are the only players to report double-digit YoY revenue growth. Margins are likely to be weak due to inflationary stress, lower operating leverage, weak sales mix, and need for sustained A&P. OPM contraction is likely to be accentuated for Honasa, Colgate, Gopal, ITC, and Britannia, where we see 200-450bps YoY contraction. Earnings to see decline YoY, with Emami and Marico the only players likely to post mid-to-high single-digit growth.

Valuations need earnings support

FMCG sector valuations have seen sharp derating in the last three months (~24% derating from the peak; one-year forward P/E, ex-ITC, at 48x is under 10-year historical average forward P/E of 51x) factoring in the muted demand setting and inflationary raw material environment. Except for ITC and Marico (down 6-8% in the last three months), coverage stocks have seen more than 20% correction in their price in the last three months. We expect earnings downgrade cycle to continue with Q3FY25 results, which will have a bearing on stock performance in the near term. The upcoming Union Budget is the near-term catalyst, where central government actions to revive consumption cycle would be key. Q3FY25 earnings is likely to disappoint with weak winter and pressure from raw material inflation. Sector valuation premium to border market index (Sensex) is at 140%, and remains 120% above the historical 10-year average.

Supply chain moat under pressure We also see pressure on the moats like general trade supply chain, from where we see the business shift toward modern retail channels. Our checks with general trade partners suggests liquidity pressure, which is hurting the inventory push in trade. Company efforts to enhance volume with trade promotions are ineffective. In modern trade, large players are struggling with slowdown and revamp in the business model. Quick commerce is aiding with faster growth for traditional incumbents, but is channel focused on democratizing platform for all. As quick commerce scales up, we see the need for FMCG companies to address nascent consumer needs, as new players are addressing incremental demand well.

Underweight stance on sector remains Factoring in business pressure ahead, we cut the valuation multiple across most of our traditional FMCG coverage (Exhibit 3). We have also revised earnings over FY25-27E, to factor in the near-term stress (Exhibit 4). These changes have led to a high single-to-low double-digit cut in our target price. As we await execution ramp-up and improvement in external setting, we remain underweight on the sector and selective on stock picks. We maintain BUY on HUL, despite weak earnings in the near term, given ramp up in execution, which enhances longterm fundamentals. We hold a similar view on Emami, where enhanced focus on urban will aid its long-term fundamentals. Gopal Snacks’s near-term outlook is sabotaged by the fire incident in the main facility, but we remain positive on its long-term fundamentals, where we see incubation of professionals and an effort to leverage fast formalization of the savory category as positives.

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