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Contrarian bets in FMCG

Arun Rajendran | October 04, 2004

There are lots of companies on the shelves in the FMCG supermarket but a majority of them are gathering dust as they are not very investor-friendly.

Of late the sector has almost become synonymous with bad news. In the June quarter, profits of sector biggies like Hindustan Lever and Nestle India declined 45 per cent and 36 per cent respectively.

However, this is a marked contrast to the robust profit growth recorded by Britannia, Godrej Consumer and Colgate Palmolive India. If one sifts through the gamut of companies, quite a few of them would make for a good investment option.

However, none of the picks could be generalised as belonging to a specific category or segment. Analysts are of the opinion that each company should be evaluated on its own merit.

The divergence in performances of various categories in the FMCG space is telling. Personal products and processed foods have witnessed decent topline growth.

However, in personal products, even though sales surged, the growth, especially in shampoo and toothpaste, was not as much as the price cuts would have warranted. Vanity seems to be in vogue with the skincare and hair colour segments growing by 15 per cent and 12 per cent respectively.

Volume growth in staples like soaps, detergents and tea has been minimal. In biscuits, volume growth has stepped up to 8-10 per cent from 6-8 per cent last year.

Marico has done rather well in the hair oil front, thanks largely to new product launches. Cigarettes are another success story where ITC has been the main beneficiary. Analysts feel ITC stands to gain from the Budget, which has largely spared the tobacco industry.

This means that the company would be free to adopt a pricing strategy that would enable further volume growth. Although the skincare segment is doing well, there is no clear beneficiary as the segment lacks a pure play.

The hair colour market grew 12 per cent and Godrej Consumers is expected to be a major beneficiary of this. Ditto for GSK Consumer in the malted food segment, which grew 9 per cent.

Here are five best picks from the FMCG universe.

Marico

Marico's success in hair oil is believed to have contributed significantly to its 17 per cent growth in consolidated revenues in the June quarter. Marico enjoys a 55 per cent marketshare in the branded Indian coconut hair oil market, pegged at a little over Rs 500 crore (Rs 5 billion).

Its share in the edible oil segment, pegged at Rs 1400 crore (Rs 14 billion), is also considerable at 13 per cent with its main brands Sweekar and Saffola enjoying prime positions.

The company has also taken initiatives in the skincare-related businesses by acquiring stakes in a range of ayurvedic skincare products in the US. It has also rolled out 15 skincare clinics under the brand name Kaya.

These steps reaped rich dividends for the company as they doubled its combined turnover to nearly Rs 4 crore (Rs 40 million). Analysts view the company's record of maintaining a double-digit turnover growth as a positive.

Pegging an EPS target of Rs 11.70 for FY05, they vouch for the investor friendliness of Marico, given the bonuses and dividends that it has been churning out.

Godrej Consumer

Godrej Consumer has been a good performer, reporting a strong 15.8 per cent growth in its June-quarter revenues, thanks to its soaps and hair colour businesses. The bottomline grew over 25 per cent along with a 160 basis-point improvement in operating margins.

The company's soaps business grew 24 per cent y-o-y while its hair colour business grew 19 per cent. Soaps and hair colours form over 85 per cent of the company's revenues and the good show was marked by improving margins in both the businesses.

The company shares the 'shareholder-friendly' tag with Marico, thanks to its buyback programme and continuous dividend payouts. Analysts say though valuations look a bit stretched, the stock is a good long-term bet. They peg an EPS target of Rs 12.5 for FY05.

Dabur

Dabur India is another stock that comes recommended. The company's top five brands - Vatika, Chyawanprash, Hajmola, Amla oil and Lal Dant Manjan - contribute around 55 per cent to its revenues.

Dabur demerged its FMCG and pharma businesses into two separate listed entities in FY04 to bring in more focus to both the businesses and unlock value for shareholders. Analysts say the move has helped it improve its financial ratios.

The company has about Rs 270 crore (Rs 2.7 billion) worth of cash in its books. This is expected to help it develop new products. It will also prove handy if the company plans to go for acquisitions.

"Dabur's 'ayurvedic' tag works out to its advantage when it comes to pricing, helping it charge a premium on its products," says an analyst. Analysts say the company is another long-term bet and peg an EPS target of Rs 5.3 for FY05.

GSK Consumer

Though its recent financial performance has not been as encouraging as its peers, a section of analysts believes that GSK Consumer would be seeing good times ahead. The company's topline growth has been slightly over 6 per cent during the June quarter.

However, pressure on operating margins saw it report a 17 per cent fall in bottomline during the quarter (as advertising and staff costs mounted). The company is a dominant player in the Rs 1,300-crore (Rs 13 billion) Indian malted beverage market with a 65 per cent marketshare. Its major brand, Horlicks contributes nearly 80 per cent to its revenues.

Other prominent brands include Boost, Viva and Maltova. Prices of milk, one of the company's main raw materials, have seen a y-o-y decline after being buoyant for a long time. The company has also made changes to its main brands - Horlics and Boost - to cater to the rural market.

"The company continues to generate significant amount of free cash flow and works on almost negative working capital," says an analyst. Its zero debt status and no significant capex requirement in the near future also augur well. Analysts peg an EPS target of Rs 17.13 for the company.

ITC

The company is the analysts' favourite. For the June quarter, it clocked an impressive 24 per cent topline growth led by its key businesses of cigarettes, foods, hotels, paperboards and exports. ITC is a dominant player in India's Rs 12,000-crore (Rs 120 billion) cigarette market, owning six of the top 10 brands.

Its business interests include paperboards, hospitality, retailing, packaged foods, greeting cards, safety matches and incense sticks. The ITC group has the second-biggest luxury hotel chain in India after Indian Hotels. Analysts point to the growth in its non-tobacco business as a positive factor.

Accounting for a free cash generation of Rs 1,600 crore (Rs 16 billion) during the year, the company has net cash of around Rs 2,280 crore (Rs 22.8 billion) in its books. It is set to be refunded Rs 350 crore (Rs 3.5 billion) it has deposited with Central Excise and Gold Appellate Tribunal. Analysts say the company can invest the amount - whenever it gets it - in growing businesses such as paper and paperboards, agri-business and hotels. They peg an EPS estimate of Rs 74 for FY05.

Fresh capacities

Of late, the FMCG sector has been talked about in a positive light, thanks largely to the slew of capacity expansions that many leading companies are embarking upon. Capacity expansions on their own do not mean much, but the phenomena of FMCG biggies looking to set up manufacturing units in designated areas that grant a multitude of benefits surely merits a closer look.

Though the meteorological department may not vouch for it, the industry does have the cloud of inadequate monsoons hanging over it, with the usual side effect of a dip in rural income - the manna that beleaguered FMCG biggies desperately need in the arid environs of slipping margins, falling sales and mounting expenses.

The reports of capacity expansions have provided some respite, but is capex an oasis that beckons or is it just a mirage? Regarding the question of a rebound in the sector, analysts do concede that the first-quarter of FY05 has been good for companies like Britannia, Colgate and ITC in terms of volume growth while those like Godrej Consumer and Dabur have witnessed improvements in margins.

However, they say the growth has been very category-specific and even in categories, it varies from company to company. Most analysts concur that the rationale for expansion seems to be pointing towards availing themselves of the benefits associated with it rather than an anticipated pick-up in sales.

Club HP

Himachal Pradesh seems to be where the action is. Colgate is known to be planning a capex of Rs 70 crore (Rs 700 million) over two years to augment its toothpaste manufacturing capacity in Baddi in the state, which is set to go on stream in financial year 2006.

The benefits: third-party (outsourcing) contracts, which are around 50 per cent presently, will drop to less than 25 per cent (after the expansion of the capacity).

Other carrots include fiscal benefits like 100 per cent exemption of excise for 10 years and tax for five years. Other companies in the Himachal club includes Dabur and Godrej Consumer which would be investing close to Rs 53 crore (Rs 530 million) and Rs 22 crore (Rs 220 million) respectively in areas of haircare, oralcare and health supplements (including digestives) at Jammu, Baddi and Uttaranchal.

Dabur's third-party contracts will fall to sub 25 per cent in two years from the present levels of 40 per cent. Dabur and Godrej Consumer would also avail themselves of similar fiscal benefits as Colgate from the expansions. The shrinkage in third-party contracts is expected to augur well in terms of operating margins for these companies besides bringing in tax benefits.

However, not all the expansions involved are going to rake in tax benefits for companies. Nestle India has earmarked a Rs 100 crore (Rs 1 billion) investment for capacity expansions and other capital expenditure - its largest capex in the last nine years. However, the objective behind the expansions is mainly to reduce the high utilisation levels prevailing at its production facilities.



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