FMCG: To be or not to be? - Views on News from Equitymaster

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FMCG: To be or not to be?

Apr 15, 2004

India has achieved a 10.4% growth in GDP during the third quarter with the agriculture sector growing at a faster rate of 16.9% followed by industrial sector growth of 7.4% during the third quarter of FY04. Will this give some impetus to the FMCG sector?Following the recent price cuts on detergents and shampoos by FMCG majors like HLL and P&G, their stocks have witnessed selling on the bourses. Against this backdrop, we conducted a poll on our website asking the investors the following question 'Your view toward the FMCG sector post the price war'? The three options were positive, negative and neutral.

Among the audience, 31% had a negative view towards the sector. While 20% of the audience was neutral, a substantial 49% of the audience was positive about the FMCG sector. Let us analyse this issue in detail.

The recent cut in the selling prices of some detergent and shampoo brands signals that some of the large FMCG (detergents and shampoos around 25%) categories will be facing some erosion in profit margins in the near-term. However, we should understand that the recent price cut was necessary, as major FMCG categories like toilet soaps, detergents, toothpaste, and packaged tea have seen a negative growth since last two years. The fact that penetration of these products is also high does not help the matter either.

Also, the poor growth in agriculture sector in last two years affected the sales to some extent, as rural areas accounted for close to 60% of the tea sales, 58% of toilet soap and detergent sales and 47% of the toothpaste sales.

There are three eventualities as far as the price cuts are concerned.

  1. One, the existing users of lower end detergents may upgrade.

  2. Two, the price cuts may help kick start the elusive demand and

  3. Three, regional and smaller players which were competing on price may find it difficult to grow and we may see a consolidation in this sector. This would mean expansion of market share of organised players.

All the three scenarios are positive for the FMCG majors in the long run. In current scenario where agriculture sector is witnessing a double-digit growth, price cuts in FMCG products are likely provide a double boost to the market expansion.

We believe that the prospects for the sector over the next two to three years remain promising. Factors like increased infrastructure related activities would result in access to markets for the farmers to sell their output. Connecting remote areas with roads will open up other sources of revenues for the people other than agriculture (like employment). Though the current year GDP growth is higher, there is always a lag effect on FMCG demand. Therefore, we expect higher growth in topline for the FMCG sector in FY05 and beyond. In our recent management interaction with Hindustan Lever, the company expects the FMCG market to triple in the next ten years.

Now, the moot question is who will benefit from such a trend? Nestle, in its recent annual report, has commented about the need for a strong supply-chain and distribution strengths to capitalize the growth opportunity. How many FMCG majors have a strong distribution reach?

How many FMCG companies have brands that individually generate more than US$ 100 m in revenues? Has the management shown its ability to withstand competition and grow revenues profitably in the long run? These are the questions that a retail investor needs to ask and find an answer before taking his investment decision. In may seem simplistic, but take a look at the shelve space occupied by brands at a retail store near you!

"FMCG stocks are expensive", which is what we get to hear often from the stock market. In our view, there has to be a premium paid for stocks that has long-term visibility cum stability in revenues, superior return ratios on a 'consistent' basis, zero debt and a negative working capital.

Click here to read our special article on "Identifying a FMCG stock: Do's and Don'ts"

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