Sector Update
14 July 2012
Despite Deficient Monsoon, FMCG Sector likely to Outperform…
The Indian FMCG sector with a market size of $14.8 billion is the fourth largest sector. Owing to increasing consumer incomes and rapidly changing consumer tastes and preferences, FMCG Industry has experienced a phenomenal pace of growth during last decade. FMCG companies managed to make profits in the 2011-12 despite a slowdown in economic growth and increase in raw material price on the back of measures like increasing prices. As the gross margins of the did companies contract by 200-400 basis points (bps), due to input cost pressures, companies had bought down advertising and sales promotion expenditure, which as a percentage of sales was lower by 200 bps. However, further fall in rupee against major currencies, new norms of standard-size packaging, increase in raw material costs due to upward rising interest rates and inflation together might dent the performance of the FMCG sector stocks, which ruled the bourses in the current calendar year.

To explore the FMCG sector we are following the PEST analysis tool to find out the current scenario and future growth driving factors in near term.


The current political condition of the India is not so pleasing enough to keep the confidence among domestic and international investors as well. Govt is gearing up to build accord on 51% FDI in multi-brand retail, Commerce & Industry Minister, Anand Sharma has written to the Punjab, Uttar Pradesh and Odisha Chief Ministers, seeking their support also to employ this policy move. Though, the Union Cabinet on November 24, 2011 approved 51% FDI in multi-brand retail and 100% FDI in single brand, the government has kept the move in abeyance following strong opposition from the main UPA ally, Trinamool Congress, and the BJP-ruled States.

Multi Retail FDI would be advantageous for FMCG companies…
It is expected to get finalized after the presidential polls in July. The government will now have to notify only the new guidelines on multi-brand retail and need not go back to the Cabinet for approval. FMCG companies likely to get the benefit from the proposed FDI in multi-brand retail. Once the FDI in retail comes into place, it will bring enduring capital because these foreign retailers have an experience of how much time it takes to break even. It will also bring in best practices, technology, and experience of operating in other markets along with the learning of what has not worked in other markets.


Standard Sized packing likely to affect the Margin in near term…
As per the new rules commodities under 17 categories, which have to be packed for sale, distribution or delivery in standard quantities as, prescribed, which will be challenging for the companies. Prior to this in 2004 companies had been forced to sell products only in standard packages. But, government allowed non-standard packaging to drive more penetration led growth at lower price points. However, companies used this as a tool to manage margins. By this initiative, FMCG companies will be affected in short run, as they will not be able to manage their margin, this makes it tough for them to maintain a price point of Rs 5-10. Most of the companies in the industry are offering products at that particular price point. Firms like HUL, Nestle and Britannia are expected to be impacted most in the short term as there are about 17 categories that are mentioned currently in this proposal. This rule is expected to impact between 3-5% of earnings in the short-term.


Budget 2012-13 was a depressing for FMCG sector…
In Union Budget 2012-13 Govt has raise the rate of excise duty and service tax by two per cent each. Most fast moving consumer goods come under this 10% excise bracket. So, an increase of that rate has a direct impact on the end-prices. The same is the case with service tax, too. A two per cent increase means a consequent pass-on to consumers. Cigarette makers also had to bear with additional ad valorem duty of 10% on existing rates. This has been done on cigarettes of over 65 mm length, which accounts a major portion of volume in this segment. This ad valorem duty is chargeable on 50% of the retail sale price declared on the pack.


Earlier this season the India Meteorological Department (IMD) had predicted a normal monsoon at 98% of the long period average with a 5% error. However, El Nino conditions may emerge in August and September, which can parch Australia, Southeast Asia and India while flooding South America. With a cycle of 3-7 years, the chance of El Nino emerging this year has been assessed at 50:50. Right now as per the latest data from the weather office the June-September rains were 49% below average in the week to July 4, widening the 18 percent shortfall in the previous week. Between June 1 and July 4, rains were 30 percent below average. However IMD has also the rains revived over cane, oilseeds and cotton areas of India's western region and there had been increased rainfall over states such as Maharashtra, Gujarat and Madhya Pradesh in the past few days. A source in the weather office also said monsoon rains had moved north, halting in central India. The rains would now move to the northwestern region, bringing showers to parched almost all over the country.


India - Major Rural Population, A favorable market for FMCG…
In India, the major population is mainly accounted by the rural population, rural population accounts for more than 740 Million consumers or 62% of the Indian population and accounts for 50% of the total FMCG market. In which, working rural population is approximately 400 Million and an average citizen in rural India has less than half of the purchasing power as compared to his urban counterpart. So FMCG Companies have the scope to capture this untapped market and most of the FMCG Companies are taking different steps to garner rural market share. The market for FMCG products in rural India is estimated about 52% and is projected to touch about 60% within a year.


Advanced technologies in businesses of varying industries have impacted households, society and economy at large. So far FMCG companies have survived over their basic characteristics like low contribution margins, short shelf life, high stock turnover to remain profitable, but with ever increasing competition and advancing era, the sector is provoked to foray in an era of social media and digital marketing.


Directly Connected with Retailers…
Applying strategy into the technology space P&G has a systems in manufacturing plants, which facilitates customers to use iPads to download production line data. They have also built-in the logistics Control Tower to follow transport operations through different stages right from raw material to finished goods inventory. P&G is digitally connected with retailers through GSDN system and retail-specific mobile apps using which they can place their orders over a Wi-Fi. Finally, with the help of the 'virtual wall' multiple projector tool, they have enhanced the way a shopper visualizes their product line and take the experience outside the store space.


Optimizing Water Utilization…
Hindustan Unilever has also invested an unique feature to reduce the water consumption. The test marketing of HUL is an after-wash laundry brand known as Magic, which will reduces water usage by two-thirds. Magic is used for rinsing clothes and is the first product to have emerged from India as part of an initiative called the global sustainable living plan launched by parent company Unilever.


Using E-Choupal to Connect with Farmers…
ITC, a large multi business conglomerate in India has took initiative called e-Choupal, to link directly with rural farmers via the Internet for procurement of agricultural and aquaculture products like soybeans, wheat, coffee, and prawns. E-Choupal has been envisaged to tackle the challenges posed by the unique features of Indian agriculture, characterized by fragmented farms, weak infrastructure and the involvement of various intermediaries. The programme involves the installation of computers with Internet access in rural areas of India to offer farmers up-to-date marketing and agricultural information.


In the quarter-ended March 2012, FMCG companies' sustained sales momentum even at a time when inflationary pressures were high. A study of the aggregate financial performance of the leading 10 FMCG companies over the past eight quarters shows that the industry has grown at an average 16-21% in the past two years with average operating margins being 22%. The quarter to March performance of FMCG companies like HUL, Dabur, Godrej Consumer Products, Marico, Asian Paints, GSK Consumer Healthcare, Procter & Gamble Hygiene and Healthcare and Jubilant Foodworks is a reflection of consumption-driven growth. Except Nestle and P&G hygiene and healthcare, majority of the players in the industry have registered double-digit top line growth, barring Nest Nestle and P&G hygiene and healthcare both rose 13% AND 39% respectively.


Volume Growth derived the Revenue growth across the sector…
HUL's 20% revenue growth during the March quarter was volume driven. Dabur's domestic sales rose 19.2% with volumes rising 9.5%. Godrej Consumer Products logged 30% sales in soaps in India - 17% of which was volume-driven. Asian Paints registered 29% growth in its revenues from domestic business, of which 15% was volume growth. Jubilant Foodworks, owner of the Dominos Pizza franchise in India, reported 26% same store growth, which was almost entirely volume-driven despite the company raising its menu prices by 10%. Marico has been able to achieve a 17% volume growth for the March quarter from a total revenue growth of 23% for the quarter. GSK Consumer Healthcare registered 14.5% increase in net sales - 7% of which was driven by volume growth and the rest through higher realizations on account of price increases. Nestle was probably the only company to have a largely value-driven revenue growth of 13% during the March quarter.


The chart below shows that FMCG sector registered lower drop in 2008 that is during slowdown in the economy. The performance of FMCG sector suffered in 2009 when economy was recovering and major sectors started performing well contributing to growth in SENSEX. However, performance of BSE FMCG index in 2010 was outstanding on back of fiscal stimulus but got hit again in 2011 due to European debt crisis and domestic reasons. In 2011, SENSEX was volatile and gave negative returns of -25% by end of the year whereas; FMCG was the only sector which gave strong returns of 9% in 2011.


Belated Monsoon may affect the Sector…
FMCG companies are expecting normal rainfall this year despite the prediction of a possible decline in the rainfall because of weather phenomenon in August-September. However, the sector is also losing the confidence as a delayed monsoon and lasting worries in the economy pressurized to restraining revenue growth for the sector at least in the next two quarters. In 2009 India suffered a drought, caused when there is a shift in ocean temperatures and atmospheric conditions in the Pacific Ocean. The last two years were good in terms of rains for India, with the plentiful food grain production along with growth of 10% in kharif crops.

Meteorological department announced that monsoon rains in 2012 would be 96% of the long-term average overall, down from its April forecast of 99%. It has raised the concerns over farm output in the major producer and consumer of food stuffs triggered by sparse rainfall in the last few weeks. A good monsoon helps FMCG companies in many ways, as it facilitates increase farm output, which in turn increases the income of the farmers, impacting sales. About 30-40% of FMCG sales come from rural areas. Most of the FMCG players aim to take this number up, as rural market has wide opportunities. Good rainfall also affects consumers in general, since food price inflation can be under control, as food constitutes over 50% of the monthly household expenditure of a family in urban as well as rural areas. While headline inflation stood at 7.23%, consumer price inflation, which measures product prices to the end-consumer, was over eight per cent last month. Less rainfall has a cascading effect in the consumer's ability to pay, especially in rural areas, as well as supply-side bottlenecks in procurement of commodities by FMCG companies.

FMCGs companies have always been considered a defensive bets as investor's select them in a downturn of the market or the economy. Even as financial year 2011-12 (FY12) started with terrific cost pressures, FMCG companies have delivered growth through volumes and value. Commodity prices for most FMCG companies rose at the start of FY12, forcing them to undertake calibrate price hikes to offset the pressures. The price rises are beginning to impact volumes of some players in the FMCG segment, but it is expected that FMCG stocks will continue to fare well in FY13.

The sector's future growth is expected to be similar with the December quarter that is more prices and less volume dependent. However, commodity prices are cooling down, but it's doubtful whether companies will pass on the benefits to consumers. FMCG companies are expected to increase advertising and promotion (A&P) spends, to avoid erosion in their brands. HUL, for instance, is likely to increase ad spends in the personal care space but may cut back in the soaps segment. Competitive intensity is expected to play a role in the A&P strategy of companies.

Hence, during 2012-13 FMCG sector is expected to maintain the volume and sales growth momentum. Managing cost will be a concern for the sector because of inflation, monsoon delays and global economic scenario, but companies are expected to pass on that pressure to consumer, to maintain their margins.

Varun Gupta
Head - Research
Pashupati Nath Jha
Research Analyst
Vikram Singh
Research Analyst
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