Tuesday, April 11, 2006

FMCG stocks at all time high ... Whats there in future?

If i go back 4 years, I see FMCG sector in shackles, but now the sector is back on track and is on the path to recovery. Growth is being witnessed in urban as well as rural areas.

Major Drivers: With the implementation of VAT from 1st May 2005, it was a shot in the arm for organised players, as brands will become cheaper in times to come. Owing to this, smaller and unorganised players might lose the competitive edge, which in turn will benefit larger players. Organised retailing has brought a new lease of life to the FMCG sector. With income growth prospects looking strong, FMCG demand is likely to trace GDP growth in the next three to five years.

Some stats: Index grown from 1636 to 2211 (35% growth) ... investors are bullish on it and still forsee appreciable growth

Suggestions: I think the investors to caution at current valuation levels. Investors should look at long tern i.e. three to five and should have the appetite to withstand any sharp decline in stock prices in the near future.

Competitive strengths: FMCG companies’ success is often attributed to their marketing and branding skills. Ability to continuously create successful brands and advertising which gets the message across often spells success for a company. Once a brand is successful, it easier for a company to piggyback on its initial success introduce more products and associate them with the known brand. As they say, ‘nothing succeeds like success’.

The consolidated topline in the last quarter of the top 5 FMCG major (HLL, ITC, Nestle, Britannia and Colgate) has grown by an enthusing 22% YoY, indicating that the FMCG sector is on the path to revival, with both rural and urban markets contributing to its growth. Infact, rural growth has outpaced urban growth in the past six months.

When compared to 5 smaller FMCG companies (including the likes of Godrej Consumer and Marico), the larger companies have clearly outperformed as far as the sales growth is concerned. Though the net profit growth of the smaller FMCG majors combined has outpaced the likes of HLL and Nestle, in the long-term, i believe that the FMCG sector is a volume game (market share). In a downturn, when consumers tighten their pockets, there is a possibility that consumers can be more 'pricey'. In the long-term, the challenge before FMCG players is on two fronts:
1. Increase the consumer base - Here the semi-urban and rural market is an important leg
2. Increase consumption of products per person (including upgrading existing customers to higher priced products in the same category)

Future of FMCG: HLL expects the FMCG sector to triple in value by FY10. As per NCAER estimates, consuming class will touch nearly 50% by FY08 and much of this growth will come from the rural hinterland. With the modern retail sector expanding at a faster clip, FMCG companies are most likely to benefit. Currently, only 4% of industry sales are through the organised retail chains, which is expected to touch atleast 10% in the next three to five years. However, the profit margins are likely to shrink, albeit by around 100 to 200 basis points. But again, the FMCG sector is a volume-driven game i.e. growth at margin.

So it is recommended that investors should choose those companies that have the ability to maintain market share (despite the ups and down in consumer spending) and have the ability to launch products on a continuous basis. By the way, FMCG sector/stocks are defensive in nature and therefore, returns are likely to be stable over the long-term.


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