Aug 31, 2012|
Will the FMCG rally last?
In our previous article, we had discussed how the FMCG stocks have been delivering strong returns on every penny invested by shareholders (One rupee test). And, above all, this good performance has come when the other large sectors (automobiles, capital goods, power etc.) have fared poorly on the bourses. This has further made the "defensive" FMCG sector an even more attractive investment.
Investment guru, Benjamin Graham said that the value of an investment is always a function of the price you pay for it. Therefore to determine the investment potential of the FMCG sector, we need to weigh it against both the fundamentals, as well as the market perception.
FMCG Demand Characteristics
On the demand side, the FMCG sector has been witnessing robust sales. But is this demand sustainable in the future?
So, barring any near-term blips, the FMCG consumption story remains strongly in-tact.
- Majority of the demand is inelastic - A recent study shows that due to the double squeeze of high inflation and lower salary hikes, India's household savings fell to a two-decade low of 7.8% of the FY12 GDP in FY12. This piece of information is not exactly bad news for the FMCG sector as majority of its demand still constitutes daily consumables and so the sector is largely demand-inelastic. However its tremor can be felt in the form of lower discretionary spending and down-trading by consumers.
- Key stock keeping units not impacted by 'New Standard Packaging' rules - These rules that will become effective from November 2012 will remove another weapon from the arsenal of FMCG companies which had been used to maintain price-points. Hitherto, consumer-goods companies tided over inflationary pressures by holding prices but reducing the grammage sold. This indirect-method of price-hikes will no longer be available for a wide variety of consumer goods such as soaps, detergents, biscuits, baby food, bread, butter, cereals, pulses, tea, coffee, other beverages, salt and edible oils. However, the good news is that stock keeping units below Rs 10 have been spared. This price-point has been the growth driver in rural regions, and led to higher impulse buys in urban regions.
- Weak Monsoons - Another headwind that can adversely impact the sector is a 20% rainfall deficiency in the country. In the short term, this is likely to affect rural income and therefore rural spending. However, in the long-term, the small towns will continue to drive growth. As per Nielsen, Middle India comprising of 400 towns having a population of 1-10 lakh witnessed the fastest consumption growth of 20% in 2010, slightly better than the 19% growth in the metros, and higher than the 17.5% growth in rural areas. The report has projected the FMCG market size in Middle India to expand - from Rs 287 bn in 2010 to Rs 4000 bn by 2026 - registering nearly 19% annual growth.
FMCG margins can come under pressure
Despite commodity inflation, FMCG companies have managed to maintain, and in some cases even expand margins aided by judicious price-hikes. Although inflation has eased, the weak rupee and deficient monsoons sparking fears of drought are expected to push up commodity prices once again. However, due to price-hikes taken earlier, companies no longer have the leeway to further raise prices without hurting demand. Apart from that, rising competition has necessitated increased investments in brands through higher ad-spends and promotional expenses. Moreover, as companies gear up to bring their products in line with the new packaging rules, overall costs will be further inflated. Thus going forward, FMCG companies are likely to witness some margin pressure in the immediate future.
Should you invest in FMCG companies?
Notwithstanding temporary headwinds in demand and earnings, we believe the long-term fundamentals of the FMCG industry remain strong.
But, the "defensive" nature of the stocks in this sector has already ratcheted up the valuations of the majority of FMCG companies.
In the absence of any positive break-through in the current economic uncertainity, the other sectors that depend on capital investments and government policies are expected to remain lackluster.
Thus the FMCG sector should continue to ride on the twin waves of robust fundamentals and defensiveness. But, the tricky part is the difficulty in measuring the rapidly changing market perception, which Benjamin Graham suggests be a part of the investment assessment. In such a scenario, it is best to judge the investment potential based on fundamentals alone.
Valuation of major FMCG companies
TTM: Trailing 12 months
The fundamentals suggest that a majority of the FMCG companies are trading at valuations that do not provide any significant upsides over a 2-3 years time-frame.
Thus, even though the FMCG sector is expected to deliver robust financial performance in future, we believe that valuations are too expensive for entering at current levels.
||Madhu Gupta (Research Analyst), Managing Editor, ResearchPro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages. Madhu contributes towards our small cap service Hidden Treasure.
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