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FMCG: No longer an idler!

Jan 4, 2006

2005 was an exciting year for the FMCG sector, as companies did not disappoint investors one bit, unlike the previous four years. However, the year belonged to smaller players in the industry, who managed to outwit their larger peers as far as return on investments in these stocks is concerned. The year saw the implementation of VAT, a shot in the arm for organised players as brands will become cheaper in times to come, though the benefits will take a few years to filter in. Also, owing to this, smaller and unorganised players might lose the competitive edge, which in turn will benefit organised players. The year also saw improved market shares of smaller players, however again at the cost of their larger peers and in some cases, regional players. The main picture...

As can be seen from the graph above, the FMCG index managed to outperform the Sensex by over 7% in the year and Rs 100 invested on the 1st January 2005, was worth Rs 156 by 31st December 2005, as compared to Rs 146 in case of the Sensex.

The Mid-cap mania
The top gainers were relatively smaller players in the FMCG sector, with Dabur and Pidilite being the star performers. Godrej Consumers, the market leader in the hair colour segment, also managed to outperform the benchmark indices considerably, and unlike in the previous years, 2005 saw no laggards in the sector, as even the bellwether, HLL gained handsomely. Another development is that almost all FMCG companies (especially the smaller players) set up manufacturing units in 'tax-havens', giving them excise and income tax breaks. This lowered the tax outgo and consequently, added to the bottomline growth.

The way ahead
One has to remember that the FMCG sector is a play on 'India's consumption potential', which in turn is a function of competition, emerging of organised retailing. More importantly, the story is based on the depth and breadth of consumption. By breadth, we mean the number of people buying FMCG products (from the organised sector as well as from rural markets). By depth, we mean, higher consumption by the existing consumer base (both in terms of moving up the value chain and increased usage). These are typically long-term drivers and therefore, one needs to be patient to realise the potential.

In our view, smaller companies are likely to benefit more from increased consumption offtake, as they follow a simple strategy - give the retailer higher incentives than those given by larger brand owners, and encourage the retail shop owner to push their products more.

All said and done, the environment will no doubt be competitive going forward, but the FMCG sector will continue to be a game of volumes. Market leaders like HLL realised the pitfalls of focusing only on profitability in the last two years. Recent statements from HLL clearly suggest that the focus will be on increasing the market share, even if it is at the cost of margins. The implementation of VAT is another shot in the arm of the sectors. We understand that brands will become cheaper in times to come, though the benefits will still take a few years to filter in. Also, the smaller and unorganised players will lose the competitive edge, which in turn will benefit organised players.

The bottomline from an investor's perspective is to have a balanced portfolio in the FMCG sector (large and niche players) to reap the benefits of the consumption story going forward. More importantly, the FMCG sector is not a high-return sector and to that extent, expectations have to be realistic.

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