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FMCG: What's in store? - Views on News from Equitymaster
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  • Jul 14, 2006

    FMCG: What's in store?

    FMCG companies are slated to announce their results next week and some the week after that. After two years of decline, since FY05, the sector has seen demand growing. Growth has been led primarily by volumes, with margins taking a hit across companies. Even in FY06, despite strong growth across segment, value growth followed growth in volumes. In this article, we analyse some key factors that are at the helm in driving growth for companies in this space, and also see at challenges that can impact the overall growth momentum.

    Major growth drivers
    Favourable demographics: India is currently at a sweet spot in the demographic cycle both in terms of income as well as age. This demographic structure has major positives for India, both on account of rising consumption and rapidly growing incomes. Fundamentals of Indian consumer companies look robust, with strong demand translating into robust underlying volume growth. While urban demand growth remains steady, the broad acceleration in demand has been driven by a sharp pick-up in rural growth. Though the rising interest rates may have marginal effect on the demand side, we continue to believe that growth is on the right track. The upturn in investment cycle, strong trends in consumption and outsourcing, and a trickle-down affect in the rural sector will leaf growth into the future.

    Value chain: Improvement in incomes, 'feel good factor' and an increased pace of innovation are likely to drive consumers to move up the value chain. With 45% of the Indian population estimated to be below 20 years of age, willing to spend more with rising disposable incomes, growth in consumer demand is expected to accelerate. Rise in income levels and improving literacy rates (from 52% to 66%) from 1991 to 2004 are expected to raise demand for 'branded' products. Also the growth recovery in FMCG will not be restricted to a few sectors or companies, but instead be broad-based.

    Organised retailing: Probably, this is one of the most prominent reasons for us to be positive on the prospects of the FMCG sector. Organised retailing is currently 4% of total FMCG offtake in the country, and is growing at 30% per annum, while general retailing is growing at 10% per annum. We believe that, going forward, the trend will be that organised retailing contribution will gradually increase, and it will be an important factor for the FMCG sector's growth.

    Key challenge

    Margins: While sales growth continues, we believe that margins may come under further pressure, mainly due to high commodity prices resulting into higher raw material costs. Additionally, consumer companies are also investing heavily in brands in an environment where growth is picking up, and advertising expenditure has remained high across the board. While some price hikes have been affected in certain segments, to mitigate raw material costs, pricing power in the real sense is still not back. In our view, changes in the pricing environment, an improving product mix and a slew of cost reduction programs by companies should see offset these cost pressure.

    What to expect?
    Despite interest rate hikes, there are more powerful factors at play such as favorable demographics, rising incomes and outsourcing that will help sustain the growth momentum for the sector. Higher penetration levels (breadth) and increased per-capita consumption (depth) will also influence the performance of the sector. Also, product mix is improving, with consumers moving up the value chain, and the growth has been both urban- and rural-driven. The FMCG sector, therefore, is a play on 'India's consumption story', for which things are looking up.



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