FMCG: Voluminous growth

The trend of robust volume growth and challenging margin scenario is expected to continue.

FMCG companies are likely to meet expectations of robust revenue growth at 20 per cent year-on-year (y-o-y) to Rs 19,177 crore for the quarter ended December 2010; thanks to continued strong double-digit volume growth across categories and heavy buying due to festive season. Price hikes undertaken in the last quarter (September 2010) will help.

While Asian Paints will benefit the most from the festive season, ITC Ltd may see a single digit positive volume growth in cigarettes (2-3 per cent) compared to negative trend in the last two consecutive quarters. For companies such as Godrej Consumer Products (GCPL) and Dabur India, the y-o-y growth in sales is not strictly comparable due to mergers and acquisitions.

Operating profit margin (OPM) on an overall basis is likely to be maintained at around 22 per cent due to gradual return of pricing power in select categories witnessed in the last quarter. However, companies heavily dependent either on agri-based inputs (mainly tea, coffee, wheat, rice and milk) or crude-based raw materials are likely to face margin pressure. Diversified companies will be able to withstand rising input costs in a better way.

Analysts expect Marico and Hindustan Unilever to disappoint the most on margin contraction y-o-y. While the former will be affected due to high copra prices (up about 30 per cent quarter on quarter), the latter will be impacted by decelerating volume growth, less pricing power due to market share loss and higher input costs. Others, such as Nestle, Britannia and Godrej can also disappoint. Flat operating profitability will also restrict net profit growth and hence net profit margin is also expected to remain flat at 16 per cent.

The macro scenario is turning worse for FMCG companies though volume growth will continue to remain strong due to high sustainability consumer demand and rural focus adopted by most companies.

On the one hand, competition is rising in the sector with multinational companies foraying into the sector (launch of 'Sensodyne' toothpaste by GlaxoSmithKline Consumer Healthcare’s associate company, GSK Asia being the most recent example) while domestic companies are entering new categories to sustain growth (Emami in hair colour and personal care) resulting in higher advertising expenditure. On the other hand, input costs are ruling high and the trend is up for most raw materials whether agri-based or crude-linked.

Rising competition and limited acquisition opportunities in the domestic market has forced several companies to look overseas and make aggressive acquisitions, which is not always positive (case to case basis) as synergistic benefits will take time to meaningfully contribute to growth.

Amid a deteriorating industry scenario, an average valuation of 25 times in the next financial year is estimated earnings look stretched. Companies such ITC, Asian Paints, Dabur and Emami are still preferred bets due to market leadership for the first two and low competition due niche presence in respective categories for the latter two.