| Not that FMCG companies have done greatly in the past, but this time around their growth story is well supported by the domestic macroeconomic and demographic environment, which is only robust. A reflection of this is also evident from the financial performance of FMCG companies. |
| For the nine months ended December 2007, most companies have reported double-digit growth of 15-20 per cent year-on-year in net sales. Although raw material prices moved northwards, a majority of the companies have managed to keep their heads above the water and saw an improvement in operating profit margins. This was achieved partly through minor price hikes and also due to savings on costs like advertising and sales promotion. |
| Says Mihir Vora, head of funds management, HSBC Mutual Fund, "We have seen reasonable growth in profits in the last few quarters, and it seems that pricing power of companies is coming back." |
| According to many market participants, the outlook for the sector is positive and demand in most categories is expected to be strong. Says I V Subramaniam, chief investment officer, Quantum Advisors, "The rate of growth in the FMCG sector going ahead should be reasonable." |
| The sops announced in the Union Budget 2008-09, such as loan waiver to farmers, higher agriculture credit growth, hike in the individual income-tax exemption limits and reduction in excise and customs duty on many products should leave more money in the hands of rural and urban consumers, lower prices of finished goods and thus, boost consumption--in short, help companies sustain healthy growth rates. |
| Analysts are expecting that the growth of 15-20 per cent seen in the last three years (FY04-FY07) to continue over the next two years at least (FY08 and FY09). And, that is excluding the inorganic growth route that many companies had taken in the past. |
| While the macro story remains healthy, a key thing to look out for in each of the companies is their performance on the profitability front. This is because, the pricing outlook for raw materials (like palm oil, wheat and milk), which has risen sharply in the past few quarters, is still robust. |
| Notably, the higher raw material prices, in a way, also suggest that the rural family may end up with higher incomes, which in turn, can boost consumption and hence, prove beneficial for FMCG companies. |
| For the time being, though many FMCG companies have announced price hikes in the past, the extent and frequency of undertaking price hikes in the future is uncertain and, the consequent impact on volumes. Thus, it is wise to adopt a selective approach while investing in FMCG stocks"�one needs to consider the company's valuation relative to its pricing power and scope of margin improvement. Market experts too share a similar view of being selective and for various reasons. |
| Says Sandip Sabharwal, chief investment officer, JM Financial Mutual Fund, "Valuations of many companies are not cheap as compared to their growth prospects. I am selectively positive and expect FMCG companies to be market performers." Adds Manish Sonthalia, vice president, Motilal Oswal Financial Services, "Within the space, except for a few companies others deserve a 'hold' strategy." |
| For investors, who are looking to de-risk and balance their portfolio, Amitabh Chakraborty, president of equities, Religare Securities has a solution. He likes the sector due to its defensive nature during such turbulent times. |
| To sum up, investors need to consider companies, which offer good growth prospects due to their inherent business model, products and brands, and are also attractively valued. Read on to know more on individual stocks and the ones capable of delivering good returns. |
| MUST HAVES |
| Marico |
| Over the years, Marico has gone beyond its flagship brand "Parachute" and has attained leadership in other categories as well, backed by strong brands such as "Saffola" (premium edible oil), Mediker (anti-lice treatment) and Revive (instant fabric starch). It is also successfully capturing the changing demographics in the Indian economy by way of its foray into high-end skin-care market viz., opening of Kaya Skin clinics. These currently stand at around 56 and importantly, most of them are also profitable. |
| Further, Marico's venture into other geographies with similar growth metrics such as Bangladesh, Egypt and UAE, through the organic and inorganic route, is contributing to overall growth and de-risking its business model. All these efforts have been fructifying since the past few quarters, and will help the company to report robust sales growth, estimated at 22 per cent annually, between FY07 and FY09"�a tad higher than 20.56 per cent recorded between FY04-07. |
| Strong double-digit growth in volumes in its hair oil segment (especially non-Parachute brands) and "Saffola", followed by higher contributions from its international business (including Egypt and South Africa acquisitions) and Kaya, should help sustain these growth rates. |
| Profitability is most likely to be maintained at the current levels, except for a sharp movement in raw material prices. Further, expansion of the international business and opening of new Kaya clinics may prove to be a dampener in the short-term, considering that such moves may take some time to stabilise and turn profitable. |
| Considering Marico's robust growth prospects, the stock looks attractive. Even on one-year forward basis, its valuation viz., PE of 18 times compared with its historical band of 21-25 times, makes it an attractive buy. |
| ITC |
| ITC, the market leader in the domestic cigarettes space, has over the past few years, prudently deployed surplus cash generated from its stable and matured cigarettes business to swiftly diversify into other areas such as agri-related, packaged foods, confectionery, branded apparel and personal care products. |
| Its strong balance-sheet and massive distribution reach have helped the company emerge as a strong contender to existing FMCG companies in the food, health and wellness-oriented categories. Its brands like Aashirvaad, Sunfeast, Kitchens of India and Bingo! enjoy good brand equity. |
| Lately, the company has also entered the soaps and shampoos segment. On the agri-side, the company plans to expand its e-choupal network from its current presence in 40,000 villages in six states to one lakh villages in fifteen states by 2010. |
| These moves have resulted in the non-cigarette business of ITC, which contributed 22 per cent to the revenues in FY04, to increase its share to almost half of revenues currently. Going forward, the company's new businesses are going to be the revenue growth drivers, thanks to the expansion of capacities in segments including in paper and paperboard (an increase of over 50 per cent to 542,500 MT by H1FY09), hotels (again, by 50 per cent to 4,500 rooms, excluding those under management contracts, in the next three-four years) and faster growth in new product categories such as biscuits, snacks, soaps and shampoos. |
| The company's net sales are expected to grow at 15 per cent between FY07-09E. However, profitability will be supported by its stable and matured cigarette division, as the new businesses and capacities may take time to start contributing in any significant manner. Analysts expect a turnaround in its new businesses such as foods, which has been growing at more than 40 per cent for past several quarters, from FY09E onwards and FY10E to be more precise. |
| The company is one of the beneficiaries of the Budget 2008-09 sops given to agriculture and reduction of excise duties on paper, packaging and processed foods, which is partly offset by the higher excise duty imposed on non-filter cigarettes (forming less than 15 per cent of profits), which could perhaps impact its profits, albeit marginally. |
| Given the company's growth trajectory in the next two-three years, healthy growth in the non-cigarette FMCG business and its reasonable valuation of 19 times in FY09 estimated earnings, the stock is a strong buy at the current market price of Rs 190.75. |
| Nestle India |
| Nestle India, a 62 per cent subsidiary of Nestle SA, is the best play on the food processing theme in India. The company has strong and well-established brands in each product category it operates in. For instance, it has Cerelac, Milkmaid and Nestle Dahi in milk products and nutrition, Nescafe, Sunrise and Milo in beverages and Maggie in noodles, soups and ketch-ups. |
| Post Budget 2008-09, the company is expected to gain from the boost given to the FMCG industry through proposals like customs duty reduction on bactofuges (benefit for the dairy industry) and reduction in excise duty on coffee mixes. Going ahead, given Nestle's thrust on growing existing products and its ability to tap new opportunities, the company should maintain a healthy sales growth of around 16 per cent between FY07-09E. |
| In the past, the company has faced cost escalation in raw materials such as wheat, milk and coffee, which it has partially passed to consumers. Going forward, analysts expect a higher operating growth of 25 per cent, which is not surprising given Nestle's ability to sustain margins in the recent past. Nonetheless, one should keep a tab on the margin expansion front. |
| However, having risen by 70 per cent in the past one year"�highest among the FMCG space, and challenges of maintaining operating profit margins, investors can consider the stock at declines. |
| SOME MORE FAST MOVERS |
| Dabur India |
| For Dabur India, except consumer healthcare division that includes baby care and digestive products, all other divisions such as consumer care and foods business are expected to grow at a healthy rate. The company's international business too is expected to support growth rates. |
| In a bid to push sales further, the company has chalked various plans for the next few years. This includes Dabur's foray into the retail space under the brand "New U" with a target of about 150 stores by 2010 and foray into new categories like read-to-eat, ready-to-cook and low fruit concentrate beverages. |
| The company recently launched "Chyawan Junior", an ayurveda-based milk beverage mix, which is currently dominated by multinationals brands like Horlicks, Bournvita and Milo. Considering a reasonably healthy sales growth of 17 per cent, the slight pressure on margins due to expansion and competition, and a relatively higher one-year forward valuation of 21.8 times as compared with its peers, investments in the stock should reap decent returns over the long-term. |
| Tata Tea |
| Tata Tea is the second largest branded tea player in the country after Hindustan Unilever. However, the company is looked upon more as a global brand, given its worldwide presence in countries like Great Britain, US and Canada, thanks to its past acquisition of Tetley (UK), Eight O' Clock Coffee (US), Jemca (UK) and Good Earth (US). This has lead to the share of Indian operations coming down to just 25 per cent of sales. |
| The company also has a presence in coffee and fast growing mineral water businesses, by way of a majority stake of about 50 per cent in Tata Coffee and its acquisition of about 46 per cent stake in Mount Everest Mineral water in June 2007. |
| In the near term, global tea prices, which have been witnessing an uptrend, are likely to move up further, thanks to a decline in production and exports from Kenya-- the second largest tea producing country in the world. This may impact branded tea majors, though marginally in case of Tata Tea, which has been trying to move away from low-margin plantation business, but has sourcing tie-ups in place. |
| Notably, the company has found new growth drivers. Tata Tea's thrust on branded tea has led to good growth in tea sales. In fact, in the last three quarters, sales growth has been strong ranging from 14-22 per cent. Internationally, consequent to some markets experiencing tough conditions, its consolidated growth (excluding acquisitions) has been modest. |
| Going forward, in India, the company has planned to roll out outlets under the name "Chai Unchai" by targeting the young population. Further, the company also plans to consolidate the acquired Mount Everest Mineral water brand. All that, along with its focus on tea variants including green tea, etc should help it to report healthy growth in consolidated numbers. |
| The sale of its stake in Energy Brands last year should add further by helping in significantly reducing its debt and lower interest costs (already reflecting in December quarter numbers) and provide space to consider inorganic and organic growth opportunities. Put together, while the story looks decent, the stock is suitable for patient investors. |
| WAIT AND WATCH Hindustan Unilever |
| Hindustan Unilever, the largest FMCG company, ended the year 2007 with a satisfactory performance thanks to robust growth in its bread -and-butter businesses namely, home (soaps and detergents) and personal care (oral care and shampoos) (HPC). Net sales grew 13.3 per cent year on year"�higher than 9.4 per cent in CY2006, while operating margins were maintained at about 13.7 per cent. However, net profit before extraordinary items grew at a higher rate of 16 per cent. |
| Going ahead, the company is expected to report a sales growth of 12.6 per cent between FY07-09E--as compared to a single digit rate of 9.5 per cent between CY04-07. This is largely due to the launch of new products like Ponds and Dove in the premium category, nutritional products for kids, double-digit growth expected in ice creams, beverages and processed foods (like Knorr) and to an extent, price hikes. Additionally, the sops given in Budget 2008-09, namely reduction in duties of water purification devices (benefiting the company's product Pureit), tea and coffee mixes, should also help. |
| It can also save on packaging costs due to reduction of duties on the same. However, it remains to be seen how the company manages the competitive pressure in its HPC business, which contributed about 75 per cent of total revenues and almost 90 per cent to profits, given the entry of new players like ITC in soaps and shampoos. |
| In December 2007, though the company has reported double-digit revenue growth in beverages and personal care category, it has marginally lost market share in these segments. Also, one needs to see the impact of the company's recent price hikes in soaps, shampoos and detergent segments, on volumes and movement in prices of raw materials (like palm oil) on margins. The company has identified the foods business as a key focus area. |
| The launch of products--the recent being Kissan Amaze brain-food, a milk beverage mix product-- and its success in such initiatives should provide a positive trigger. However, till that time, the outlook on the company is that of wait-and-watch. Moreover, the valuation of about 20.7 times CY09 estimated earnings seems to capture all the near-term positives. |
| Godrej Consumer |
| Godrej Consumer Products is expected to face challenging times going ahead even as it is likely to sustain its past growth rate of around 15 per cent, experienced in past three financial years. The competition in the company's soaps category, which contributes about 63 per cent of revenues and is growing faster (between 18-20 per cent) than the industry (around 10 per cent), is likely to heat up with the entry of new players like ITC and Dabur. |
| On the other hand, prices of palm oil"�a key raw material for soaps"�is likely to remain firm due to higher demand for use in bio-diesel. Though the company has undertaken price hikes in the past, going forward, its ability to pass on cost increases through further price hikes will have a bearing on its profitability and needs to be watched. |
| The company's market leadership in the hair colour category, whose growth has been subdued, is again challenged by products offered by foreign players like L'Oreal and Garnier. Moreover, the acquisitions in the past"�Keyline and Rapidol"�are unlikely to trigger any significant growth to boost the company's performance. |
| The only positive is its rights issue of Rs 400 crore, a part of which will be used for repayment of debt (Rs 84 crore), besides expansion plans (Rs 145 crore). The balance, if utilised in a value accretive manner for acquisitions or new product launches or new market segments, can have a positive rub-off on the stock. |
| (Click here for table) |
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