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FMCG: Small is beautiful!

Jun 16, 2005

Yesterday we wrote about how large FMCG companies performed in FY05 in comparison to FY04 and the picture was quite bleak. Today, we compare 5 other FMCG companies, albeit this time from the mid-cap space.The five companies included here are Dabur, Godrej Consumer Products, Colgate, Marico and Pidilite.

(Rs m) FY04 FY05 Change
Net Sales 43,011 48,462 12.7%
Expenditure 37,331 41,561 11.3%
Operating Profit (EBDIT) 5,680 6,901 21.5%
Operating Profit Margin (%) 13.2% 14.2%  
Other Income 540 614 13.7%
Interest 214 198 -7.5%
Depreciation 971 1,044 7.5%
Profit before Tax 5,035 6,273 24.6%
Tax 1,064 1,219 14.6%
Profit after Tax 3,971 5,054 27.3%
Net profit margin (%) 9.2% 10.4%  
Effective tax rate (%) 21.1% 19.4%  

What does the report card say?
The consolidated topline grew by around 13% YoY in FY05 (below 6% YoY growth in the case of large-caps) indicating that smaller FMCG companies have benefited more from the increase in consumer spending, largely at the expense of the bigger players like HLL and Nestle. Also, the rise in expenditure was at a slower pace than the sales growth, which could be attributed to improved supply chain efficiencies, which the smaller companies have been working on for sometime now. This resulted in operating margins expand by 100 basis points (down 130 basis points for large FMCG companies). Had commodity (primarily oil) prices not risen drastically in FY05, the operational performance would have had been stronger. Depreciation increased by 7.5% YoY, mainly because of Dabur's acquisition of Balsara, which resulted in a 19% YoY rise for the company. Interest costs have reduced by around 8% as companies like Godrej Consumer and Dabur are working on negative working capital, indicating their cash flow management skills.

All these factors, clubbed together, resulted in a 27% YoY PAT growth for mid-cap FMCG companies compared to a 1% fall in profits for the larger ones. Of the 5 companies, Dabur and Godrej Consumers reported 46% and 38% YoY bottomline growth respectively. The only company to show a net profit increase of less than 10% was Colgate (5%), which was hit by rising oil prices owing to its inability to pass on the increased costs to consumers. The 15% price cuts, the company resorted to during the year, further dampened the performance. Nonetheless, it managed to keep its head above the water.

What to expect?
Mid-caps are currently the darlings of the market with every investor wanting to own them and in the process giving them valuations at par with the larger companies. We believe that selective mid-cap FMCG companies are a good investment option, though their commanding valuations, as compared to the well-established larger companies, make them somewhat risky. Nonetheless, in our view, the smaller FMCG companies have the potential to explore the untapped markets and are already gaining acceptance.

Also, since these companies follow a different strategy by offering higher margins to wholesalers and retailers, it results in their products being pushed more than others. Further, smaller companies have started exploring rural markets, not through their own network as it is an expensive affair, but through other larger companies networks. For example, Godrej Consumer has tied up with ITC to sell its soaps through the latter's E-Choupal network. However, the only drawback in this strategy is that of marginally lower margins.

The FMCG sector, after having underperformed for some time, is on the path to recovery, with acceleration in rural growth, increasing consumer spending along with the shift in product preference towards those being offered by the newer entrants. Also, with greater possibility of oil prices softening in the medium-term, pressure on operating margins of FMCG companies would stand reduced. Dabur and Pidilite remain our top picks in the sector currently and we have already given a BUY recommendation on both these stocks.

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