• JANUARY 13, 2006

FMCG: Preview 3QFY06

The markets seem to have stopped for a breather, as profit booking has resulted in the indices losing more than 3% of their value in a span of a couple of trading sessions from the recent highs hit by them. However, now it seems more of a demand-supply mismatch, as money is waiting at the gates just to rush in and at every dip, there is some 'firang' pressing the buy button to gain a larger pie of our country's growth story. Also, there are a dime-a-dozen 'India dedicated' funds launched in several parts of the country, both developed and developing. However, one must note that at the current juncture, the NSE-Nifty is trading at a tad below 19 times trailing 12-month earnings, which is by no means cheap.

However, in our view, the December quarter results will determine at least the short-term direction of the indices. FMCG companies are slated to announce their results late next week and some the week after that. We are sure that people's eyes will be glued on this particular sector, often called as the 'Sun' and 'Moon' sector, as one will never stop bathing with a soap or brushing their teeth with a toothpaste and hence, is an everlasting sector. Here are some of the major drivers for the sector, a sector that had lost glory on the bourses but is back in action and has again found a place in an investor's portfolio.

Revenues: Growth momentum is likely to sustain in the quarter, backed by increased consumer demand from both urban as well as rural markets. Also, companies have hiked prices of various products and are seeing a movement of product preference up the value chain, which will aid growth in the sector. Further, due to the winter being severe, it will benefit some companies whose portfolios are dependent on these seasonal products to quite an extent, like Dabur and P&G.

Godrej Consumer Products is expected to maintain strong growth momentum, due to its presence in hair colours, the fastest-growing FMCG product, and also soaps, wherein it has managed to increase its market share from 8% to close to 9%. Also in our view, behemoth HLL will sustain its double-digit growth achieved till 9mCY05. Also, with the price gap between a branded and that from the unorganised market having reduced considerably, it would encourage consumers to avoid un-branded/counterfeit brands in some cases, thus benefiting these companies.

Margins: As far as margins are concerned, in our view, price cuts are a thing of the past. In fact, companies like HLL and P&G increased prices of their detergents by around 5% during the quarter (the second hike of the year), indicating that the pricing power has come back in the hands of the companies and that they are able to pass on input cost hikes to consumers smoothly. Hence, we anticipate a margin expansion for almost all companies, some aided by enrichment of the revenue mix, while some due to increase in fiscal benefits.

Net profit: Margin expansion clubbed with a lower tax outgo will lead to the bottomline growth outperforming the topline growth in most cases.

What to expect?
While we have told you about the major factors that will decide the fate of FMCG companies on the bourses, we remain of the belief that, as an investor, one must take a long-term view of any business, including FMCG. One must also take into account the fact that valuations are not that attractive at current levels.

As far as long-term prospects are concerned, one must remember that the FMCG sector is a play on 'India's consumption potential', which in turn is a function of increasing disposable incomes. Competition, emerging of organised retailing, will enable greater penetration of these products.

More importantly, the story is based on the depth and breadth of consumption. By breadth, we mean the number of people buying FMCG products (from the organised sector as well as from rural markets). By depth, we mean, higher consumption by the existing consumer base (both in terms of moving up the value chain and increased usage). These are typically long-term drivers and therefore, one needs to be patient to realise the potential.

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