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FMCG: No longer disappoints!!! - Views on News from Equitymaster
 
 
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  • Nov 11, 2005

    FMCG: No longer disappoints!!!

    It has indeed been an overwhelming performance by FMCG companies in the September quarter. HLL, the bellwether was the last one to announce its results. Revenue growth has been strong on a year-on-year basis. Profit has also grown at a decent pace and faster if we remove the anomalies and has, in fact, outpaced the growth in the topline.

    The FMCG sector seems to be back on track and 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, giving 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.

    Markets have also rewarded these companies whose results enthused them and stocks have done well. In fact, FMCG stocks were always regarded as defensive stocks, but people's mindset is changing and so is their portfolio, with these stocks now commanding a larger share of their investment pie.

    Performance of top 5 FMCG companies...
    (Rs m) Sept'04 Sept'05 Change
    Net Sales 58,822 67,813 15.3%
    Expenditure 45,316 52,632 16.1%
    Operating Profit (EBDIT) 13,506 15,181 12.4%
    Operating Profit Margin (%) 23.0% 22.4%  
    Other Income 1,940 1,931 -0.5%
    Interest 782 297 -62.0%
    Depreciation 1,370 1,545 12.8%
    Profit before Tax 13,294 15,270 14.9%
    Tax 3,714 4,066 9.5%
    Extraordinary items 427 (62)  
    Profit after Tax 10,007 11,142 11.3%
    Net profit margin (%) 17.0% 16.4%  
    Effective tax rate (%) 27.9% 26.6%  

    A thing or two 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. Thus, these companies were able to squeeze the customers' wallets by charging a high premium on their products. This made their stocks a must for a stable investment portfolio, owing to their fat margins.

    Today, the FMCG sector is the fourth-largest sector in the Indian economy, with an estimated total market size of around Rs 450 bn. Further, the growth potential for all the FMCG companies is huge, as the per capita consumption of almost all products in the country is amongst the lowest in the world. Further, if these companies can change consumer's mindset and offer new generation products, they would be able to generate higher growth. For example, Indian consumers used to wear non-branded clothes for years, but today, clothes of different brands are available and the same consumers are willing to pay almost 5 times more for branded quality clothes. It is the quality and innovation of products, which is really driving many sectors. Thus, FMCG companies should use their imagination and respect the tastes of Indian consumers by offering quality products.

    So what does the report card say this time around?
    The consolidated topline of the 5 companies - HLL, ITC, Britannia, Tata Tea and Nestle - has grown at a good 15.3% YoY, indicating that the FMCG sector is on the path to revival, with both rural and urban markets contributing to its growth. However, if compared to 5 smaller FMCG companies like Godrej Consumer, Dabur, Marico, etc, these 5 large companies have clearly under-performed them, indicating that the smaller companies have been able to gobble up a larger share of the consumers' wallet.

    While input costs have gone up for almost all companies besides Britannia and Nestle, due to firm commodity prices (being related to crude oil prices), overall margins shrank by 60 basis points.

    Further, aiding the bottomline growth was a sharp fall in interest burden (down 62% YoY), which was mainly due to HLL redeeming its debentures to the tune of Rs 300 m, Tata Tea's continuous refinancing activities and the overall softness in interest rates. Depreciation, however, increased by around 13% YoY, mainly because of ITC's hotels expansion and Nestle's Project Globe. Other income was at the same level as in the September 2004 quarter and failed to aid bottomline growth. Taxes were down by 130 basis points as a percentage of PBT, mainly due to almost all companies having a part of their manufacturing units in areas like Uttaranchal, which gives them tax breaks and due to lower corporate tax rates.

    What to expect?
    In our view, the testing times for the FMCG sector are over and rural penetration is the key, which is currently extremely low, as venturing into these markets is an expensive affair owing to infrastructure constraints, thus making distribution a barrier. Although companies like HLL and ITC have started Project Shakti and E-choupal, respectively soliciting new pastures, they have not been able to tap the market totally. Owing to their vast potential for growth, companies like Reliance have also decided to jump onto the bandwagon and open retail chains. All of these developments come as no surprise. With 12.2% of the world population living in the villages of India, the Indian rural market is a market that no one can afford to overlook.

    While this quarter has been good, one should also take into account the fact that markets will start expecting these companies to continue their performances over the next few quarters as well. Thus, when expectations begin to go sky-high, there is always the risk of a hard crash-landing. However, we believe that one must maintain a long-term investment horizon for equities and given robust topline and bottomline growth expected for these companies, longer-term valuations are not entirely out of line. Of course, risks always abound, such as raw material prices and managing growth on a higher base. Investors must always consider these factors before making an investment decision.

     

     

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