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Home > Business > Special


FMCG: The consumer is back

Shobhana Subramanian | December 13, 2005

They're not exactly flying off the shop shelves. But in October, FMCG retail sales hit a seven-month high. The growth was nothing spectacular, just about 6 per cent year-on-year.

But, for beleaguered manufacturers of washing powders, tooth paste, shampoos and skin creams, who have seen sales crawling and not dared to pass on even the smallest of cost increases, it's an encouraging number.

In fact, no so long back - in July this year - sales had dropped to a seventeen month low of just 2.7 per cent y-o-y, led by the processed foods segment. But that might just have been a blip.

To get back to the October data, the momentum seems to be holding across the sector. Nearly 80 per cent of the categories tracked by market research agency, AC Nielsen, saw their toplines grow. Of the 42 large categories with annual sales of over Rs 200 crore (Rs billion) (Rs 2 billion), 16 posted a double-digit rise in sales and only nine had to contend with falling revenues.

Not all the news was good though: revenues of segments such as packaged teas and biscuits shrank. But shampoos and washing powders continued their good run.

Strong September quarter

Much of the uptrend has been reflected in the September quarter numbers. A study by a foreign brokerage, which took a sample of 12 companies, showed revenue growth at nearly 13 per cent in the September quarter compared with 12 per cent for June quarter and 7.8 per cent for March.

What's more, most companies grew revenues in double digits with HLL and Colgate turning in good performances. Gross profits were at 15 per cent and surprisingly, gross margins remained flat (they were expected to contract) with eight out of twelve companies actually seeing better margins. The average operating profit growth for the sample was 16 per cent.

Markets sharing the success

Not surprisingly, stock prices of FMCG firms have seen a strong run up in recent months and the BSE FMCG index has actually outperformed the Sensex in the last three months.

Says Arjya Chattoraj who tracks the FMCG sector at SBI Capital Markets, "The sector re-rating appears to have happened and valuations are running ahead of the historical median price/earnings (P/E) of 22 times. As usual HLL is trading at the top end and players such as Nestle are trading at premiums too."

Adds Mohan Swamy, Head of Research at ABN Amro Asia equities, "Historically the sector has always traded at a premium to the market that trend should should continue. The reason for this is their high capital return ratios, given the relatively lower capital expenditure. Besides there is inherent value in the brands apart from the huge long-term growth potential."

Revenues on the rise

For over a year now, revenue growth for the sector has been more or less on a steady uptrend. This has been attributed primarily to higher disposable incomes in a strong economy.

Observes Swamy, "Demand is clearly picking up in the urban market and even in the rural markets, there are signs of an uptick." Says Sunil Duggal, CEO, Dabur "Our domestic revenues grew sluggishly in Q1FY06 at around 5 per cent y-o-y but has picked up in Q2FY06 to around 10 per cent, and we hope to post double digit growth for the rest of the year."

The emergence of modern trade or large organised retail outlets has also spurred sales within metros. Albeit on a smaller base, the growth through these larger stores is today much higher than the growth through traditional grocery shops.

Swamy believes that one of the main reasons for the revival in the FMCG space is that the wallet share of the consumer which was being diverted to aspirational products is now coming back to FMCG products. With the demand for these goods now almost satiated, consumers do not mind spending on personal care and household products.

Besides, as Rakesh Sinha, VP, Godrej Consumer Products (GCPL) says, "Prices of durables have also come down. As a result, thanks to higher disposable incomes, there is money left over for daily products even after spending on durables."

Pricing power coming back

The stronger demand has led to a better pricing environment and manufacturers believe that 'downtrading' is on the way out.

In fact, Milind Sarwate at Marico observes that the consumer has actually started "uptrading" in some segments. "We have seen higher sales of coconut oil at 8 per cent this year compared with the 6 per cent that we saw in the last four years. We believe that consumers are shifting from unbranded to branded products," he says.

Sarwate also feels that the preference for 'premium' products within each sub-segment is going up as consumers are prepared to pay when they see quality.

Thanks to this, companies such as Hindustan Lever and Procter & Gamble have actually been able to take moderate price increases for detergents.

Confirms Sinha, "Pricing power is coming back to the industry and that's evident from the fact that some players are being able to pass on higher input costs."

The revival of the sector is also as much due to innovation by companies and the availability of better quality products at reasonable prices. Firms have slashed prices by as much as 40-50 per cent in products such as detergents. They have also launched variants and introduced options for the consumer at different price points. Many firms have beefed up their distribution network and now have a better reach.

The rural kicker

Given the strong pace at which the economy is growing, there seems to be no disagreement on the fact that the FMCG space too should be able to sustain the growth momentum.

Says Sarwate, "If GDP growth is going to be 7-8 per cent, there has to be some trickle down effect." Adds Hemant Patel at Enam securities, "The sector should typically grow at a 1.3 multiple of the GDP, so a 9-10 per cent secular growth should not be difficult to achieve given the fact that spending on lifestyle products will only go up with disposable incomes rising.

Moreover, there is a belief that rising farm incomes will drive sales. Adds Swamy, "The FMCG sector growth has underperformed the GDP growth in the last few years. While the urban market has seen volumes growing in the last one year at around 10-12 per cent, the growth in the rural market has been in low single digits. That should change now."

Observes Sukumar Rajah, CIO -- equity at Franklin Templeton Mutual Fund, "The larger investments in rural infrastructure and improvement in farm production are expected to drive rural incomes. This will be one of the structural drivers for the growth of the sector and we are positive about its long-term prospects."

Valuations: expensive now, but not in the long-term

The long-term positive outlook notwithstanding, analysts are wary about valuations from a near-term perspective.

Says Patel, "Our analysis shows that earnings in FY08 do not match the current P/E multiples of between 19-24 that stocks are trading at. In other words, current valuations probably capture both the topline and bottomline growth and so we are underweight on the sector. However, we believe in the secular growth story and most of the companies are good investments for the longer-term horizon."

Adds Prashant Kothari, who manages an FMCG fund at prudential ICICI Mutual Fund,"Valuations have moved up about 60-70 per cent from where they were about a year back and they're no longer cheap. However, the growth can sustain since consumption demand has to go up. So, from a three year perspective, they're not so expensive.

Cautions Chattoraj, "Companies are in a better position today having a better range of products and at attractive price points. So topline growth could be around 10 per cent while earnings could grow at around 15-18 per cent. There are concerns that valuations might be somewhat expensive in relation to near term earnings, because P/E multiples could contract if companies do not deliver the numbers."



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