Manik K. Malakar
With today’s change in spending habits and increased demand for products the trend is bound to continue and the high valuation for the sector could remain for years to come, but…
The Indian consumer is notoriously price sensitive and most companies think twice before hiking the prices of their products as not to alienate their customer. Thus, it comes as a bolt from the blue that at least one segment of FMCG is increasing prices. But while price increases are happening in the segment analysts differ about the reasons for the hike.
“Our channel checks indicate pricing action by P&G in laundry, feminine hygiene and healthcare categories,” notes Gautam Duggad, an analyst with Prabhudas Lilladher. To illustrate in the laundry segment Ariel prices have seen an increase of 5%, with a further price hike on the cards in February. “This clearly signals improvement in pricing environment at the top end of the laundry segment and is also a positive for Hindustan Lever,” states Duggad.
Explaining some of the reasons behind the price increase from the company’s point of view, Uday Narayan Dubey, Vice President- Research & Institution Desk R K Global, says, “In our FMCG coverage, we mentioned there that the FMCG (L&H) will resort to price hikes as it’s the only thing they could do to freeze their margins on the rounds of stability.” In the last couple of months the Indian FMCG industry has faced the hurdles of tackling inflationary situation on raw materials (indicating a ~20% increase in raw material prices), coupling with margin pressure impacting growth.
The key question is, will companies in the FMCG space be able to pull of the price hikes in the light of the segment being very price sensitive? “The disposable income with the middle class group has substantially gone up in the last few years, which have led to the change in spending habits of the people,” says K Jayraman, of Bonanza Portfolio. Employment opportunities have been on the rise particularly in the IT Sector which has necessitated and increased the demand for the laundry and the hygiene segments. “It is true that the Indian Consumer is price sensitive, but however the affordability of the people today along with the preference for branded products to maintain the grace and esteem has helped these segments decisively,” Jayraman opines.
And even the rupee fluctuation is adding to the segment’s woes. “Further the impact of currency depreciation (of approximately 15%) is also acting to the detriment of the companies,” says D.K. Aggarwal, CMD SMC Investments and Advisors. A large chunk of raw materials are imported and so the margins of FMCG companies like Godrej, Marico and Dabur would be under pressure until the currency stabilises and raw material prices start declining, is Aggarwal’s view.
Companies in the FMCG space generally command very high PEs compared to other sectors in lieu of their low debt, high cash flows, frequent dividends and sustainable growth oriented revenue models for their branded products. “With today’s change in spending habits and increased demand for hygiene products the trend is bound to continue and the high valuation for the sector will remain for years to come,” Bonanza’s Jayraman ends.
Scrip valuations for the sector Incidentally, experts have differing opinions on whether companies in the FMCG space are worth a buy from the point of view of the investor. The “FMCG being a defensive sector it is not as vulnerable as others. However, valuations are looking stretched and the risk-reward is unfavourable,” says SMC Investment’s D.K. Aggarwal.
“We feel it depends on the investment horizon. If investors are willing to invest for a quarter or so, we would suggest them to hold as stocks upside will be limited,” says Uday Narayan Dubey of R K Global. “But if the investment horizon is more than six months we would suggest go for it as FMCG is the only sector (interest defensive) that gave a positive return (approximately 10.8%) in the entire one year period of CY11 and we believe that it will continue to do so directly co-relating with India’s growth story,” Dubey continues.
“Regarding investment in FMCG sector, the stock prices today are at PE of more than 22 to 25 times for the leading FMCG companies with good market share for their products. Even though the stock market has been on the decline, most investors have already taken a bet on FMCG companies more on the defence of their capital rather than the returns,” says K Jayraman of Bonanza Portfolio.
“Stock prices of FMCG companies could soften from these levels, more so when activities are likely to increase in banking and infrastructure/ real estate sector in the year 2012. However on correction of 15% from these levels could be a better judgment to invest than at current rates,” Jayraman ends.
FMCG and the rural factor
The rural factor is a demand driver for several segments of the Indian economy like motorbikes, and FMCG too is one that has the rural market as a prime driver.
The rural segment has been under a bit of pressure lately and we spoke to some experts as to how rural demand in the FMCG space would be affected.
“FMCG companies have been posting a better set of numbers on the back of relatively strong demand in the rural areas compared to their urban counterparts over the last few quarters,” says Vishal Jajoo, Senior Research Analyst (PCG), Nirmal Bang Securities.
Consumers from the rural areas are relatively more sensitive to price hikes and tend to lessen demand for a product if the price hike is beyond an extent. “As a result, off-late we are seeing a number of FMCG companies admitting the fact that the momentum in rural areas is slowing down,” Jajoo continues.
Rural sales of FMCG products grew at a CAGR (Compounded Annual Growth rate) of approximately 15% over the last three years, though, during H1 FY’12 the same figure stood at 10%. “This clearly states that rural demand in the FMCG segment is not standing up to the mark,” Jajoo ends.
Opportunities
Opportunities for the sector would arise from low penetration levels and low per capita consumption. According to analysis from PINC Research categories like detergent soap, personal soap and washing powder have low consumption and thus any change in consumption patterns will drive demand in these categories.
Recommendations
Company Recommendation Current Target
Price Price
ITC Buy RS.206 RS.`233
Nestle Sell RS.394 RS.3618
Dabur India Accumulate RS.97 RS.109
Marico Reduce RS.52 RS.144
Jyothy
Laboratories Buy RS.164 RS.212
- PINC Research
FMCG and the rural factor
The rural factor is a demand driver for several segments of the Indian economy like motorbikes, and FMCG too is one that has the rural market as a prime driver.
The rural segment has been under a bit of pressure lately and we spoke to some experts as to how rural demand in the FMCG space would be affected.
“FMCG companies have been posting a better set of numbers on the back of relatively strong demand in the rural areas compared to their urban counterparts over the last few quarters,” says Vishal Jajoo, Senior Research Analyst (PCG), Nirmal Bang Securities.
Consumers from the rural areas are relatively more sensitive to price hikes and tend to lessen demand for a product if the price hike is beyond an extent. “As a result, off-late we are seeing a number of FMCG companies admitting the fact that the momentum in rural areas is slowing down,” Jajoo continues.
Rural sales of FMCG products grew at a CAGR (Compounded Annual Growth rate) of approximately 15% over the last three years, though, during H1 FY’12 the same figure stood at 10%. “This clearly states that rural demand in the FMCG segment is not standing up to the mark,” Jajoo ends.