The BSE FMCG index closed 9% higher in Q1FY14, thus outperforming the BSE-Sensex, which gained 3% during the same period. The sector as a whole has got re-rated over the last few quarters on the back of the companies' ability to sustain a strong growth momentum in both revenues & profits despite the ongoing global economic slowdown. FMCG companies have always been considered as defensive bets as investors prefer them during uncertain economic conditions.
But the results of the previous quarter showed some cracks appearing in the robust sector which could threaten the performance of the companies in this sector. Domestic revenues of Indian FMCG players grew just 10.6% in Q1FY14 - the slowest in the past 16 quarters. It needs to be underscored that the revenue slowdown was largely due to deceleration in revenue growth of the non-food segment. Furthermore, the nominal GDP growth in June'13 quarter was also the slowest in the past 16 quarters.
The sector faces three key challenges:
Economic slowdown - Weak macro parameters, slowing GDP growth, high inflation and weak consumer confidence due to anemic job market / salary hikes have impacted discretionary consumption. The slowdown is more pronounced in urban markets than in rural. The recent Rupee depreciation has raised the threat to gross margins due to 20-50% import component in the raw material basket for consumer companies.
Promotional offers are on rise - Consumer offers and trade schemes have increased over past few months. FMCG firms are extending their offers beyond earlier intended period (e.g. 4 months vs. 1-2 months planned earlier).While such promotional efforts are done to win back consumers, it will have a bearing on profitability.
Moving away from popular price points (PPP) - Popular price point of Re 1, Rs 5 and Rs 10 are getting increasingly untenable for FMCG players on account of rising cost inflation and non-feasibility of further grammage reduction in these low priced SKUs. In the past, departure from popular price points had impacted demand in various brands.
FMCG companies have traded at 25x one-year forward earnings multiple in the past five years and at 26x one year forward earnings multiple in FY11 and in FY12. If the performance in the upcoming result season (for the quarter ended September) remains muted, it could possibly trigger some correction in the valuations of FMCG companies on the bourses; all this given the high expectations from investors.