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Is the worst over for FMCG firms?
Shobhana Subramanian in Mumbai |
March 22, 2005
Stagnating growth, fierce price wars and consumer downtrading in the last few years have painted FMCG companies into a corner.
Stung by competition from emerging, nimble-footed regional players who focused on niche markets and segments, the majors have been compelled to go back to the drawing board.
The last three years have seen them rewriting their strategies, whether it is to introduce products at lower price points, take hefty price cuts or offer freebies.
Life has been particularly difficult for market leader Hindustan Lever Ltd as it struggled to defend its market share. Indeed, HLL has dropped in the pecking order of market capitalisation, making way for ITC.
Of late, though, there have been signs of a revival. While some of it could be attributed to a buoyant economy and higher disposable incomes, FMCGs now appear to be getting a bigger share of the consumer's wallet.
After spending more of the monthly budget on durables and home loan EMIs, consumers now seem to be willing to spend more on FMCGs. Is this resurgence for real?
The Smart Investor spoke to Lalit Nambiar of SBI Caps, Amnish Agarwal of Refco Sify, Hemant Patel of Enam, Atul Rastogi of Motilal Oswal and Yasmin Shah of Anand Rathi to figure out whether things are really looking up.
What has the Budget done for the FMCG sector?
Agarwal: The thrust on employment, the schemes to boost rural incomes and the tax breaks for consumer are positives. Most important: with VAT coming in, the advantage that unorganised players enjoyed will be gone.
Rastogi: The Budget has helped indirectly, by increasing disposable incomes. If VAT is implemented properly, the larger FMCG players will gain. The cut in import duties for LAB (linear alkyl benzene, a detergent input) should lower input prices.
Nambiar: VAT will help in the long run because the logistics would be aligned to the most optimal distribution structure and tax -wise it won't matter which route you take. That should knock off a chunk of any FMCG company's working cap requirements. Whether VAT implementation will happen on schedule is to be seen.
Patel: The reduction in peak customs duties for some key inputs from 20 to 15 per cent should help. We believe that customers should accept the 10 per cent hike in excise duties for cigarettes.
Shah: The focus on rural India should help, given that it is a major target market for FMCG companies. Most of the excise rationalisation has happened - the average is now 16 per cent. The reduction in the peak duties would lower input costs for manufactures.
Has anything else changed in the last three to six months to improve the outlook?
Agarwal: Some categories such as shampoos are showing growth in volume terms after the price cuts. Demand seems to showing signs of a pick-up and the growth is clearly better for most segments. If the economy continues to do well, growth should sustain.
Rastogi: Volumes are on the upswing due to price corrections over the last three years and we think this growth should accelerate going forward.
Nambiar: The sector has gone through a lot of pain, given the competition and higher costs. However, it appears to be holding its own now and is going to see the benefits of a resurgent economy, the impact of which has not (yet) been seen.
Also, the last two years saw a sizeable share of the consumer's wallet going to durables. That demand appears to be ebbing. Higher disposable incomes are likely to push consumers to uptrade.
The outlook appears to be positive. In any case, the sector is coming out of a very bad period and things will look good, helped by the effect of a low base.
Patel: Growth will happen over the longer term, though not all segments will grow equally, since some already have high penetration. Categories like toothpaste and paints may grow in high single digits, and categories like detergents could grow if there are further price cuts.
Essentially volumes would pick up at the lower price points, since consumers are not really buying incrementally. We are positive that there should be volume offtake across categories if prices are cut.
Shah: Volumes have picked up, especially in soaps and detergents, on the back of price corrections. In tea, the cycle appears to have turned.
The shift in the share of the wallet from FMCG to white goods has more or less ceased because the demand for white goods has stabilised. This should help sustain volume growth.
Even if the sector grows, will the larger players benefit or will regional players gain market-share?
Agarwal: Larger players appear to be growing market-share in categories like soaps and detergents. Companies have introduced products at lower price points and in smaller packs and that has prompted consumers to buy into these brands.
Rastogi: I think it will be a combination. Larger players will increase share and so will smaller players, but the very small players could lose out.
Patel: Larger players are not gaining significantly compared to smaller players at this point--but they are working on penetration, especially in the rural segments. Initiatives like HLL's project Shakti are empowering rural customers to earn more.
There is also a phenomenal rural thrust from ITC through its 'e-choupal' initiative. Branded products will only stand to gain in rural markets. It's difficult to say what will happen to regional players in the long run because there is not too much data.
Nambiar: The pendulum has swung against larger players but we see it swinging back again in their favour. In the longer run, better brands will endure and survive even though in the shorter term smaller players may nibble at the share of larger players.
The benefits of national scale and flexibility will reside with larger players and when store brands begin to take over, larger players will be able to compete better, especially since trade margins are significant.
Shah: Larger players will grow - smaller players whose only plus point was lower price have been losing share post-price cuts. For example, Colgate has taken away shares from Anchor and Ajanta in the last one year.
Do companies have pricing power?
Rastogi: Pricing power is a concern and will remain so in the near term. However, from now onwards there may not be too many price cuts.
Nambiar: In soaps, for instance, there is pricing power at the top end but not so much at the lower end. In detergents, there's no significant pricing power as of now - maybe over three to four years, it will happen.
In biscuits, we are seeing a situation similar to the one we saw in toothpastes in 1998. Britannia is increasingly vulnerable to the kind of strong competition that Colgate faced in that period. In shampoos, too, there doesn't seem to be room for price rises as of now.
Shah: Companies don't really have too much pricing power because competition continues to be strong. In some cases higher raw material costs have been passed on (for example, soaps), but in cases like biscuits, they haven't been passed on.
Patel: The first indication that consumers are willing to accept a slightly higher price came from the detergents price hike in December.
The ORG figures for January are quite encouraging for categories such as detergents. This is the starting point. There could be hikes going ahead because raw material prices do not seem to be easing. The good thing is that companies are no longer giving freebies.
Does the capex by FMCG companies signify higher demand or is it simply to take advantage of tax breaks?
Agarwal: There will be demand growth in the long term. But, in the interim, tax sops in some states is attracting companies to set up capacities.
In some cases, the sops are huge - for example nil excise duties and no income tax for five years. The wage differential between existing locations and places like Baddi, too, would be significant at 15-20 per cent.
Patel: Some part of the savings on account of a lower tax liability would be passed on to customers. This would typically be in those segments where there is no margin pressure from the higher cost of raw materials.
Shah: Demand is not the driving factor for capex. It is just the tax sops that states like Uttaranchal and Himachal Pradesh are offering.
Rastogi: With these tax benefits, it is becoming more cost effective to set up own capacities.
Nambiar: Primarily it is the tax benefits that are prompting companies to put up new manufacturing facilities as they are initially replacing their outsourced production with in-house capacities since the concessions make it worthwhile.
Are margins likely to stay at current levels or could they expand?
Agarwal: Some of the erosion in margins can be made up through the lower costs of production in backward areas.
Shah: There is not too much downside in EBITDA margins from these levels. In fact, margins appear to have bottomed out and with volume growth sustaining, earnings should grow.
Rastogi: In some cases, margins could actually expand, since production is in-house and that could lower costs.
Nambiar: Input costs have gone up sharply, especially in categories like detergents and in general, there has been inflation in commodities.
In the long run, companies should be able to pass these on in most categories with small adjustments in their pricing or by adding value through innovations. They could use some of the sops to offset higher costs and keep prices at these levels so as to grow market-share.
Patel: If raw material prices keep going up or even stay at these levels, margins will more or less remain the same since the benefit will be passed on. In some categories, they might not pass it on. For instance, in the case of detergents where LAB prices are up.
What could be the triggers looking ahead?
Agarwal: There is no immediate trigger, but if the economy continues to do well, growth should happen. In categories where penetration is relatively high, the growth cannot be 20 per cent. But segments like skin cream and biscuits can grow in double digits.
Nambiar: In the long term demographics and better infrastructure driving down cost of delivery and hence penetration. In the short term, higher interest rates could push consumers away from durables in urban markets. A good kharif season could create uptrading in rural markets.
Rastogi: Growing disposable incomes, larger consuming populations and moderate inflation would be the drivers for the sector.
Shah: If companies are able to take another round of price increases, that should be a trigger. We should also watch out to see how VAT impacts the sector.
Patel: A further round of price increase and beyond that good monsoon should give the sector a fillip. In the near term, we are likely to see a negative impact of VAT. This should, however, be only for a short period.
What are valuations like and what are the stocks to be watched?
Agarwal: ITC, Dabur, Tata Tea - all these companies have strong free cash flows. We have a sell on HLL.
Rastogi: ITC is our top pick; the valuations are attractive
Shah: I don t see any further downside in HLL. The valuation looks reasonable, it is trading at 20 times CY05 earnings. Colgate also looks reasonable at 16X FY06.
In terms of performance, Marico and Dabur have been among the fastest growing companies, though the stocks have run up sharply. However, investors could use any dips to accumulate these stocks.
Patel: HLL has historically traded at a premium, but the current valuation is attractive from a long term perspective. We like Dabur because it continues to show growth in its niche categories and the valuation is reasonable.
Nambiar: ITC continues to look attractive. HLL's valuations look a bit demanding.