Introduction

At the end of 2003, we had remarked that although the FMCG sector under-performed the Sensex, 2004 could be a buoyant demand season for the industry. But 2004 was even more difficult than 2003 for the sector as a whole. While Rs 100 invested in the Sensex towards the end of December 2003 would have yielded the investor Rs 114 by December 27, 2004, an investor in the FMCG index would have lost 4% durig the same period. With the Sensex touching all time highs, the performance is indeed poor!

What was different in 2004 as compared to 2003?

While 2003 was a difficult year owing to sluggish demand, there was expectation that increased agricultural output would lead to favourable demand pick up. But everything changed when detergent and shampoo major, P&G, decided to up its market share in the Indian market. So, they more or less halved prices in these categories and took the battle to market leader, Hindustan Lever. What followed was an unprecedented fall in profitability for detergent and shampoo majors. This of course, had a damaging impact on the sentiment towards the overall FMCG sector.

The laggards…

It is no surpise then that companies like HLL, Henkel and Nirma, that operated in the detergent space were most adversely hit in 2004. While HLL's profits slumped 32% in 9mCY04, Henkel reported a 36% decline during the same period. Food processing major, Nestle, found itself to be part of this pack, owing to its lacklustre domestic performance (up 4% in 9mCY04) and a volatile export performance (down over 9%).

Company	Price on Dec 26, 2003 (Rs)	Price on Dec 26, 2004 (Rs)	% Change	52-week H/L (Rs)
BSE-Sensex	5,699	6,513	14.3%	6,567 / 4,228
S&P CNX Nifty	1,837	2,063	12.3%	2,079 / 1,292
Nirma	500	349	-30.1%	520 / 251
HLL	203	145	-28.6%	218 / 104
Henkel Spic	33	26	-22.7%	35 / 14
Nestle	660	586	-11.2%	720 / 500
Rayban Sun Optics	65	59	-8.9%	68 / 46
Dabur	92	84	-8.7%	98 / 61
Gillette	731	689	-5.7%	769 / 499
Pidilite	396	378	-4.7%	415 / 253

The sector outperformers…

The year belonged to the retailing majors - Pantaloon and Trent. Both outperformed the traditional branded FMCG companies by a significant margin. Pantaloon's successful 'Big Bazaar' retail initiative helped to leapfrog to the top of the investor charts. The company hopes to create 3 m square feet of retail space by FY06 (from 1.1 m square feet in FY04). On the other hand, the Tata Group's retailing arm - Trent - witnessed a significant re-rating towards the second half of the year, owing to its entry in the 'Hyper Mart' form of retailing. The company launched its first hypermarket store (grocery, consumer goods, apparel, other durables) 'Star India Bazaar' in Ahmedabad, Gujarat in October 2004. It is estimated that revenues from this general store model will be far more than what it is deriving from its 'Westside' stores.

Company	Price on Dec 26, 2003 (Rs)	Price on Dec 26, 2004 (Rs)	% Change	52-week H/L (Rs)
BSE-SENSEX	5,699	6,513	14.3%	6,567 / 4,228
S&P CNX NFTY	1,837	2,063	12.3%	2,079 / 1,292
Pantaloon Retail	266	724	172.2%	830 / 218
Trent Limited	293	592	102.1%	631 / 180
Godrej Consumer	174	300	72.2%	303 / 140
Tata Coffee	160	260	62.3%	305 / 115
Marico	119	174	45.5%	189 / 100
Tata Tea	331	480	45.0%	489 / 270
Bata India	68	96	40.7%	98 / 38
Britannia	662	905	36.6%	921 / 538
ITC	976	1,309	34.2%	1,329 / 732
VST Industries	202	245	21.6%	256 / 162
Godfrey Philips	433	505	16.7%	523 / 338
Colgate	158	182	14.7%	186 / 101
P&G	480	545	13.6%	569 / 360
Camlin	86	95	10.0%	108 / 52
GTC	27	29	4.6%	34 / 10
GSK Consumers	325	330	1.5%	349 / 208

Coming to the traditional FMCG companies', smaller-niche companies clearly were the favourites. Companies like Godrej Consumer, that took the lead in setting up capacities in tax-free backward regions, were able to grow profits despite the tough environment. Tata Coffee had a good run owing to the restructuring positives, as well as its decision to sell off the 'Barista' stake. The restructuring benefits and the Tetley global growth helped its parent - Tata Tea, finish among the top performers of the year. Edible oil major, Marico, continued its good run owing to its diversified geographical presence as well as its continued dominance of its key categories.

What to expect?

With two successive years of under performance, there emerges an element of circumspection while building expectations for 2005. Nevertheless, we believe that the pricing environment is gradually improving for detergent companies. While the companies suffered in terms of profitability, the price war did manage to grow volumes in these categories. The companies continue to attack costs by either relocating to tax free zones or looking at various productivity improvement measures.

Another important development that took place in 2004 was that most FMCG majors undertook capacity expansion plans. This has not happened over the past 5 to 7 years. It does point to improved demand expectation by the sector majors. For investors, a key thing to note is that with markets at all time highs and interest rates looking to strengthen, the equity risk profile has increased over the short term. In such a scenario, FMCG is likely to be a good defensive bet. For one, most FMCG companies are operating at zero debt levels. Their cash flows continue to be strong and dividend payouts are encouraging. More importantly, expectations of a demand revival are not factored into most forward projections.

It is a given that the consuming class pie in India is growing. While consumer durables and housing have clearly taken a front seat in the consumption pattern, it is unlikely that the FMCG sector growth will not mirror the GDP growth trend over the long term. The environment will no doubt, continue to be competitive, but volume growth may more than make up for it for stronger companies. 2005 will also bring in the implementation of value added tax (VAT) regime. Though the benefits of this will take a few years to filter in, in the long run, the overall tax structure for these companies will get simplified thereby providing a fillip. Also, the government's decision to allow 100% FDI in single-product retailing (like Lacoste, Tommy Hilfiger) is a sign of better things to come in the long term.