Demonetisation and GST implementation disrupted trade channels, particularly the wholesale channel, which is the backbone of the rural distribution channel

The FMCG sector witnessed various headwinds in H1FY18, namely, tough macro scenario, absence of price hike (deflation in majority of inputs), an aftershock of demonetisation, and various difficulties pertaining to the implementation of the Goods and Services Tax (GST). Demonetisation and GST implementation disrupted trade channels, particularly the wholesale channel, which is the backbone of the rural distribution channel. Further, anti-profiteering measures restricted any major benefits to companies so far as the full benefits GST rates were to be passed on to consumers. However, this has improved the affordability of a number of daily use products.

Q3FY18 witnessed revival: In Q3FY18, the FMCG space reported better performance, owing to weak base and partial normalcy in the wholesale and CSD trade channels. Further, GST rates were cut in November 2017 across various daily use product categories such as detergents, skincare, shampoo, noodles, etc. Moreover, companies started signalling some green shoots for the recovery of the rural market in the quarter.

Massive opportunity created by ‘Natural’ wave: Another highlight for the year so far is the wave of Ayurvedic and natural products that hit the markets (with increasing popularity of Patanjali). The acceptance of Patanjaliproducts among the masses led to market share loss for other FMCG companies in categories like honey (Dabur), toothpaste (Colgate), etc. In order to curb the erosion of market share and tap upon the massive opportunity in the Ayurvedic space, a majority of FMCG companies have launched a slew of products with natural offerings.

Benign raw material price: Key commodity prices for packaged foods like wheat, milk, and cooking oil have been benign. Packaging input costs were also benign, down 4% yoy for 9MFY18. However, copra prices continued to be firm (up 90% yoy in Q3FY18). Tea prices were flat for 9MFY18. In addition to the chaos related to GST, the benign commodity prices restricted any price hike.

Roller coaster ride for cigarettes: Government reviewed the cess on cigarettes and increased the same at the second GST meeting. Hence, unlike most consumption categories, which witnessed either neutral or lower taxes under the GST regime, cigarettes witnessed a sharp hike. The hike was highest in the “King”-sized cigarettes (>84mm). The move of higher taxation forced FMCG companies to sharply hike prices in order to pass on the incremental burden. This move has hit volumes for all cigarette companies so far in 9MFY18.

Companies with extensive product portfolio and direct rural reach outperformed the peers: Amid the chaos of GST implementation, de-stocking and trade disruption, the companies with higher wholesale and rural exposure were hit the most, namely, DaburEmamiMaricoJyothy Laboratories etc. However, company like HUL still managed to sail through and recover at a much faster pace than others.

Sector to be back on track soon: After witnessing a challenging time so far in the year, we expect demand revival in the overall sector driven by (a) expected rural recovery, (b) improving consumer sentiment, (c) supportive base (demonetisation impact and anniversarisation in case of international currency movement), (d) improved affordability post-GST rate revision, and (e) normalcy in trade channels. Further, the focus of FMCG companies on improving direct reach and gradual increase in ad spend would be a major supporter of their recovery.

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