FMCG: Cost pressures ease

Lower agri-input prices, normal monsoon should help sustain robust performance.

A normal monsoon could bring cheer to several fast moving consumer goods (FMCG) companies that reported a dip in top-line growth in the fourth quarter. Dabur, Marico, Nestle and Godrej Consumer Products Ltd (GCPL) have seen growth decelerate in the last few months. No major price increase hit Dabur, only a small increase in prices marred Nestlé’s revenue growth while price cuts reduced Marico’s growth rate.

Concerns over down-trading (consumers shifting to cheaper brands) due to higher food inflation and increased competition ensured the industry did not effect any major price increase in the last few quarters.
 

ROBUST DEMAND
In Rs crore	Net sales		Net profit		PE (x)
	FY10E	FY11E	FY10E	FY11E	FY10E	FY11E
Britannia	3365	3790	164	173	21.50	20.30
Colgate	1996	2305	395	426	25.50	23.60
Dabur *	3,957	4,582	593	699	26.20	22.00
GCPL *	1,958	2,440	320	388	28.10	23.70
HUL	17,848	19,607	2,252	2,448	23.20	21.20
ITC	18,205	20,708	4,012	4,598	25.00	21.70
Marico *	3,052	3,521	290	350	22.50	18.60
Nestle * ^	5,979	7,022	799	961	33.50	28.10
* Actual figures for FY10, except for Nestle which is CY2009 E: Estimates Source: Bloomberg

But, even though sales growth fell, product-mix changes and control on overheads helped most big FMCG companies deliver higher margins in the March quarter.

Notably, agri-input costs, a major irritant in recent quarters, have started to come down. For example, lower sugar and wheat prices is good news for companies such as Britannia and Nestle that faced pressure on the raw material front in recent quarters. However, GCPL and Marico may not be as lucky as input costs for them are still higher. While a strong brand equity will allow them to take price increases, a rising rupee could negate the impact of rise in costs, said experts.

Falling input costs and a healthy demand outlook seem to have rubbed on to FMCG stocks. The BSE FMCG index has outperformed the Sensex since the start of the year, even as Hindustan Unilever (the second-largest weight in the FMCG index) has underperformed due to fears of price cuts across products and a loss in market share in key categories.

Another key trigger could be normal monsoons, which would bring big relief (boosting growth) considering last year’s deficient rain.

Says S Raghunathan, CFO of Dabur India: “Despite last year’s poor monsoon, income generation and employment schemes announced by the government ensured rural demand did not slump. It outpaced urban demand in 2009-10. We expect this to continue, unless monsoon plays a spoilsport.”

Rural markets account for 35-40 per cent revenue for many FMCG players and a good monsoon could improve fortunes of players such as Hindustan Unilever that earn 45 per cent of their revenue from rural areas. While Dabur (covered recently) is among the preferred picks in the space, below are the three companies that can deliver good returns in the next one year.

GCPL
Godrej’s strategy to launch smaller soap SKUs (stock-keeping units) for Cinthol Original and Deo seems to have worked. It has also not raised soap prices in the last few quarters. These factors have helped GCPL improve market share to 10.5 per cent compared to 9.4 per cent a year ago.

In hair colours, focus on powder versions and re-launch of Nupur Mehandi and Expert hair colour brands helped recoup market share losses in the March quarter. Besides, the international business seems to be in focus with six acquisitions in the past three years and international sales growing at a faster clip than domestic sales.

ITC
India’s largest cigarette manufacturer, ITC, is relatively insulated from input cost pressures. The company sells three out of every four cigarettes sold in the country and was able to offset a sharp increase in excise duty in 2010-11 Budget by hiking prices of all major brands by 4-20 per cent.

Lower losses in the non-cigarette FMCG business, high profitability in agri and paper businesses, along with improving prospects in the hotel business, are expected to help ITC deliver better performance in the coming quarters.

Nestle
Input costs have risen over the last four quarters for Nestle, the country’s third-largest FMCG company by market value. It had taken a hit of 260 basis points in gross margins in the March quarter as sugar, wheat and milk prices rose. Now, easing input costs should improve profitability.

Further, expectations of a good rabi crop should lower prices of wheat and sugar and aid margins in the medium term. Product innovation and thrust on distribution should ensure healthy growth rates in the domestic segment (around 90 per cent of revenues). Even though Nestle’s portfolio is urban-centric, low-priced SKUs will help the company clock good growth rates in rural markets too.