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FMCG: Are the 'd' days over? - Views on News from Equitymaster
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  • Sep 14, 2005

    FMCG: Are the 'd' days over?

    It is well known that the FMCG sector was in doldrums in the last three years, with companies trying every possible strategy under the sun to revive growth, but failed. However, things seem to have changed in the past couple of quarters. In this article, we analyze the macro picture and try and gauge the general sentiment towards FMCG stocks.

    About the sector
    Traditionally in India, companies like ITC, HLL, Colgate, Cadbury (now de-listed) and Nestle dominated the FMCG sector, with each one happy in their own segment, negligible competition and many barriers to entry in the form of high import duty. However, the scenario totally changed in the early 1990's, as the government opened the country's doors to imports at a small duty for almost all FMCG products, resulting in the markets flourishing with foreign goods.

    Suddenly came the loan boom, with banks ready to fund everything and anything to a customer. This again hit the FMCG companies and this time around, they failed to woo consumers. It might sound ridiculous, as there is no direct co-relation between buying a house and spending on soap, but since FMCG, including food, accounted for almost 45% of an average consumer's spending, it was by far the largest chunk of expense and hence was the first one to face the consumers axe. Profitability went for a toss for FMCG companies, as they started registering declining or stagnant profits on a year on year basis.

    However, in the past one year, things have changed and the FMCG sector is back on track and is on the path to recovery. Growth is being witnessed in urban as well as rural areas. However, this time around, smaller companies have walked away with larger gains as they follow a simple strategy i.e. give the retailer higher incentives than those given by larger brand owners thus encouraging the retail shop owner to push their products more. Further, almost all companies have set up units in tax havens like Himachal Pradesh, Uttaranchal and Assam, which offer them a 5-year income tax and 10-year excise benefit.

    Now lets take a look at the sectors performance Vis-a-vis the sensex

    As can be seen from the above graph, Rs 100 invested in the Sensex is worth Rs 258 today after a period of 3 years, while the same stood at a mere Rs 169 for the FMCG index, indicating it has clearly under-performed the benchmark index. However, it must be noted that ITC has almost double the weightage of HLL in the FMCG Index and together, they account for over 60% of the weightage in the FMCG index. ITC that was always regarded as a tobacco company, proved people wrong when it posted consistent results and proved that tobacco is not the end of everything.

    What to expect?
    At the current juncture, almost all FMCG stocks seem to be fairly valued, after the unprecedented run all the stocks have had on the bourses, backed by huge liquidity flows from Foreign Institutional Investors (FIIs)'s and mutual funds (MFs). No doubt, FMCG companies have displayed good results in the last few quarters, but stock prices have run far ahead of their fundamentals and investors have already factored in a major part of their future growth in the current stock prices. Also, judging the company from one or two quarters is not a true reflection of the future growth prospects and not a proper way of investing. Although we feel that testing times for the FMCG sector are over and rural penetration is likely to grow, one must remember that venturing into these markets is an expensive affair owing to infrastructure constraints, thus making distribution a barrier.

    Further, input pressure continues to daunt companies with crude prices near all time highs and inability to pass on the hike to consumers, inturn putting pressure on their margins. As far as competition is concerned, there is no respite from smaller players. Managing growth will not be an issue as almost all companies have spare capacity and the bandwidth to handle it. But, as always, any investor must consider the risks, considering the past experience's from investing in FMCG stocks.



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