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Going Good For FMCG?

Monday, December 17, 2012

Yes and no.  While input costs have seen a decline, FMCG companies have also begun to report a slight moderation in volumes, although the moderation is, till yet, more apparent in discretionary categories, reports Manik Kumar Malakar, concluding that, the recent slip in demand is a short term phenomenon and may be made up in the ensuring quarters

The FMCG Universe is passing through interesting times. Like the Chinese curse; while the sector has seen some good growth recently, due to the generally negative economic environment, demand for these products is expected to moderate going forward. There also lies the risk of the unorganized segment snapping at the heels of the big players.

However, one among the few saving graces for the sector is that input costs (raw material prices) have seen a decline. “The momentum on volume growth has come down in September / October as compared to June / July,” says K Jayaraman-Research Associate-Bonanza Portfolio. Jayaraman was commenting about the emerging trends coming out of the FMCG/ Consumer Goods universe in the Q2 FY13 and beyond period. “The upbeat mood is on the wane and in the short run many companies are looking for volume dips of 3 to 5% and even more especially on discretionary items and select packaged food products,” Jayaraman continues.

“Though, we wouldn’t say that there was a complete moderation, but the slow start to the monsoon had raised concerns over demand for consumer goods, especially in rural markets,” says Uday Narayan Dubey VP, Research & Institution Business, R K Global. However, the rains picked up in August and that has eased those concerns to some extent, he notes.

Within the FMCG Universe it is the discretionary segment like paints, foods, liquor and retail formats that have witnessed a slowdown according to inputs from a Consumer Goods report by Edelweiss. Food companies and top-end personal products were also impacted.

“FMCG companies have begun to report a slight moderation in volumes, although the moderation is, till yet, more apparent in discretionary categories,” says Ritwik Rai, FMCG Analyst, Kotak Securities.

Then there is inflation, which has also been gnawing at the country’s economic innards, and this is affecting the FMCG Universe as well. “While wholesale inflation is around 7% to 8%, the consumer price index remains at around 9 to 10% which is again pushing consumers to defer or avoid certain discretionary products,” explains Jayaraman about the effects of inflation on sales. Food inflation is high and challenging and thus, there is a drop in the volume of packaged food products.

“While the high-end, super-premium segment does not get impacted by inflation, demand in the mass premium segment could contract if overall economic sentiment does not improve,” elaborates Dubey of the effects of inflation on the various categories within the sector.

And traditional avenues of growth for FMCG companies may be drying up. Consumer goods makers have maintained growth momentum on the back of high-margin products, strong rural demand and innovations. “But these growth drivers could now be tapering off, executives say,” informs Dubey.
Then, the continued slowdown could impact top-end discretionary spends. While the rural segment continues to grow, other factors that could influence consumption.

Another trend that is coming out of the sector is the pace of new launches. “Q2 FY13 saw new product launches as companies are focusing on keeping the momentum alive,” says Abneesh Roy of Edelweiss.

So will these new launches affect the sector’s margins? Apparently not!  “The FMCG / Consumer universe is expanding very well and therefore leading companies will manage to do well even with new launches in the sector. The sales and margin therefore are not a big worry on this count,” explains Jayaraman.

Dubey opines that the new launches will benefit the consumer. “No, we don’t feel such intense competition will take place and the resultant impact would greatly trigger healthy competition, and if we look closely, we will see that most  new launches are unlike to each other,” he says. Thus, if HUL is launching TRESemmé, then there would be Marico launching a new variant of hair care oil. “So, both as a product are independent to each other,” Dubey continues.
For the moment though there is an interesting ‘hit’ against the sector. Sales to the military (CSD or Canteen Sales Department) have slowed. The slowdown continues and seems to have worsened QoQ, says Roy though he does feel that canteen sales will revive from the Q1 FY14 period (First Quarter of FY14).

But, what about the current (Q3) period? “We expect Q3 FY13 to see improvement in discretionary spending across all categories largely due to full benefit of festive season,” says Edelweiss’ Roy. He does however caution that sustained improvement in discretionary spending hinges on the macro economic situation in India.

“Today, the consumer is also very discretionary towards his choice of products,” says Jayaraman of Bonanza. “Generally it is a positive sector with robust growth. The recent slip in demand is a short term phenomenon and may be made up in the ensuring quarters,” he continues of the long-term outlook for the sector.

As far as margins too go, there may be bright spots on the horizon. Rai of Kotak Securities mentions that most FMCG companies had seen significant price hikes through FY12/1HFY13 period. Also inputs costs have been corrected. Thus, gross margins have, in 2Q FY13, expanded for FMCG companies with some few exceptions. “As of now, competitive activity (in terms of prices) seems contained, so we would expect gross margins to remain strong for the rest of the year,” he says.

Commodities and the FMCG sector
The saving grace is that input prices are on the wane. “We see margin expansion for most of the companies as prices of copra, used in coconut oils, declined (Q2 period) over approximately 30% (a boost for Marico), palm oil, used in soaps, saw prices decline ~10% and price of mentha oil (benefits Emami) and linear alkyl benzene, used in detergents’ have been lower thereby giving a positive impact on margins,” says Uday Narayan Dubey of R K Global.

FMCG and Advertising
Ritwik Rai, of Kotak Securities has an interesting correlation between the FMCG and the advertising industries. “FMCG companies typically tend to raise advertising spends when gross margins rise,” Rai says. While Rai does not think that new product launches are going to be the key determinant of ad-spends or margins, he does feel that competitive activity shall rise going forward. “This will significantly reduce the gains that the companies can potentially make from weaker raw material prices,” Rai says.

Unorganized players
There is an interesting relationship with unorganized players and the established companies. Since past year unorganized players have lost market share in great numbers in several categories; like detergents, as caused due to input costs. “Going forward, raw material prices are expected to fall, so margins should improve, but unorganised players will come back in and margins will again be affected,” says Ritwik Rai, Kotak securities. However the saving grace is that going by current trends unorganised players should not gain that much in terms of market share as of now.

The Equity perspective
“Although FMCG is considered a safe sector, valuations are expensive currently,” says Ritwik Rai of Kotak Securities. “Broadly, we have a neutral to negative stance on the sector. For the purpose of capital preservation/ diversification, we prefer ITC to other stocks in our coverage universe. The rating on ITC is Accumulate,” he says. Marico is another stock that Rai is positive about.

“FMCG companies are very expensive and the dividend yield is very low in this sector,” says K Jayaraman of Bonanza Portfolio. “Therefore investors will have wait for the right price and be patient or be well informed to buy at higher levels. Also investments must be made with longer time horizon of 3 to 5 years in this sector. It is must in a portfolio and therefore investors should use SIP opportunities in MFs in this sector for a long term view,” he continues.

“The FMCG index is already trading at a premium of over 20%+ over its 5 year average PE (Price Earning),” says Uday Narayan Dubey of RK Global. Certain stocks are even trading at a 10 year high PE. At this moment most of the stocks are very much valuation rich and widely-stretched. “So, investors who are already into FMCG holding should exit their positions, if they are holding onto ITC or HUL or United Spirits. However, there are stocks like, Dabur, Marico and Titan, which makes them very subtle Buys at this moment. Even we like Nestle, Colgate and feel they will add value to the portfolio,” he says.

Clifton Desilva, Director, Altina Securities, is positive on the sector. “All of the MNCs stocks in this space are good buys over a longer period”. He thus recommends Gillette India, Nestle India and Hind Lever in the segment as buys.  

India versus the world
All said and done at the end of the day however bad the situation may be vis-à-vis India growth; it still beats world growth in FMCG companies.
*In the September quarter, volume growth in India far outstripped rest of the world, justifying premium multiples.

  • P&G India sales surged 25% YoY, while the global company reported a 2% organic sales growth YoY.
  • Coca-Cola India reported healthy 15% YoY volume growth. The parent company’s volumes declined 1% YoY for 9m CY12 (nine months of Calendar Year 2012).
  • HUL reported 7% YoY volume growth against parent company’s 3.4%.
  • Colgate Palmolive India reported 10% YoY volume growth against parent company’s 2%.
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