FMCG may stay buoyant

The FMCG (fast moving consumer goods) sector continues to sail ahead, while virtually all others sectors are floundering in choppy economic and political waters. There’s no evidence yet of a slowdown in consumption so the FMCG sector commands a defensive premium. Our preference in the interim term is for companies which have maintained market dominance despite escalating competition which are least susceptible to input cost pressures, and which have strong pricing power: Dabur, Colgate, Nestle, Asian Paints and Glaxo Smithkline.

A recent consumer confidence survey indicates urban FMCG off take will stay buoyant despite capital market setbacks and expected higher inflation. Rural consumers who are fairly insulated from food inflation by public distribution system, are seeing incomes rise due to higher minimum support prices for crops.

Most players have managed to sustain and improve gross margins in QFY08, despite inflationary pressures in costs. It would take a sustained domestic economic slowdown for the consumer sector to shrink, and that, too, after a lag. Consumer durables and capital goods react immediately.

Roughly 80% of India’s consumption growth is due to rising household incomes, where there is no evidence of a slowdown yet, and around 16% is due to middle class population growth. Rising agricultural process (which help rural consumers) and the Sixth Pay Commission benefits (which will boost urban wages) will more than offset the squeeze caused by high oil prices.

Over the past few years, the relative valuation of the FMCG sector has varied between 110% to 10% premium to the Sensex. With the recent compression of sensex P/E due to rising risk premium of cyclical and growth sectors, the defensive premium of the FMCG sector has risen relatively, but is still favorable. With worsening fundamentals in India, FMCGs will maintain this premium in the near future.

Growth across FMCG products has been broad-based. Relatively under penetrated categories, such as shampoo, skin cares, hair color and toothpaste are growing in strong double digits. Even categories with high penetration levels, such as detergents soap and hair oil, have shown strong underlying volume growth increases in FY08. This is partly due to growth in organized retail (3-5% of turnover for most FMCG players). Many recently launched products cater to the middle to premium market. Continuing growth in these categories belies fears of down trading.

In fact, the FMCG industry is expecting more than 50 percent of its growth till the year 2012 to come from rural and semi-urban segments. But delivering fast moving consumer goods to 6,27 lakh villages spread over 3.2 million sq km will be a big challenge.FMCG sector is projected to grow at a compound annual growth rate (CAGR) of 10 percent which will carry forward its market size to over $275 billion in the next six years from the present $150 billion.

The urban population on its part, will develop a larger craze for organic FMCG products from the health point of view and, as there will not be a large number of such products to make money from the FMCG industry will definitely have to look at the rural and semi-urban areas for expanding markets. Notably, in the rural and semi-urban areas, FMCG market penetration at present is only about 2 percent. With 130 million households, the rural population is nearly three times larger than urban India.

The domestic rural market, with its vast size and demand base, offers a huge opportunity to FMCG companies. Major players like Dabur, ITC, HLL, Godrej, Britannia, Pepsi and Coca-Cola have already forayed into the hinterland.

Given the revival of FMCG growth, regional competition has escalated. Hence, protecting market share is the lynchpin of decisions related to pricing, products (quality, value, mix, upgrades and launches) and promotion (maintaining share of voice) the ability to maintain and increase market share in core categories will dictate the capability to offset cost pressures without sacrificing volumes.. Companies which have shown such a rise in value market share in core categories are Colgate, Marico, Dabur, and Nestle. Such companies will be better able to expand product portfolios.