Fast-Forward Your Portfolio Returns With FMCG STOCKS

Indian consumption story is something that global investors are betting on. Yogesh Supekar and Nikita Singh along with the DSIJ Research Team analyse the ground realities for the FMCG sector and identify investing opportunities in the FMCG space. Read on to understand the latest trends that are shaping one of the largest sectors in India.. 

Sawan Gulati is a 35-year-old cloth merchant and lives in Aundh, a posh locality in Pune. He has recently purchased online Desicow A2 ghee, organic jaggery and moringa powder all from the same vendor – ‘Two Brothers Organic Farms”. Digital-savvy, Gulati often uses his latest Samsung S9 to order organic and Ayurvedic products and has even taught his wife how to do it on her latest iPhone.

Welcome to the new India and its emerging hi-tech consumption pattern! Increasingly, the consumption growth in India is driven by growing affluence, changing consumer lifestyles and behaviour. Among the young generation, there is a clear trend emerging and that is their preference for health-related and Ayurvedic products. Within the FMCG sector in India, health-related products and Ayurvedic products are the new growth drivers. 

The economic growth in India has supported the consumption story of India over the last decade. The per capital income (PCI) in India has grown from Rs 29,524 in 2006-2007 to Rs 103,219 in 2016-17, according to Central Statistical Office (CSO). This impressive growth in the PCI has led to a definitive increase in consumption, thus benefitting various companies that cater to one of the largest sectors in IndiaFMCG. What the increase in PCI has done is that it has pushed the people’s propensity to consume. This has led to growth in FMCG and consumer durables segment.

The present government has focused on building infrastructure, improving roads, enhancing rail and air connectivity and providing housing and electricity to people. The attention to rural areas and announcement of several welfare schemes, along with the measures taken to support the agriculture sector, spells growth for the consumer-facing businesses in India.

FMCG sector outlook :- 

Zooming upwards on robust macro factors, India’s FMCG sector's revenue is forecasted to grow at 20.6 per cent CAGR and hit USD 103.7 billion by 2020. Filling up the consumer’s daily basket, the FMCGs are comprised of all the goods essential for a modern day lifestyle. FMCG sector has three main segments, viz., food and beverages, which accounts for 19 per cent of the sector, healthcare, which accounts for 31 per cent, and household & personal care, which accounts for the remaining 50 per cent.

Despite the urban segments' impetus for diversity in product lines, about 60 per cent of the FMCG revenue is sourced from the rural segment. Rural regions, which constitute the largest area of India, recorded a market size of USD 29.4 billion as of 2016, while the segment is expected to grow exponentially in the coming years on the back of government initiatives to double the income of farmers by 2022. Keeping in view the positive developments and the government’s growing emphasis on the rural segment, the market size of India’s rural economy is likely to grow up to USD 220 billion by 2025 and is set to provide a momentum to the FMCG sector.

Drivers of Indian FMCG sector 

India’s favourable demographic trends;
Rising income levels;
Low per capita consumption;
Growing rural economy.

However, the sector is faced with challenges of volatile environment as regards input costs and increased competition in recent times. With volatile crude oil prices and uncertainties on the global trade front, escalating US-China trade war and worries over inflation in India, the sector may encounter difficulties of swimming through rough waters in times to come.

Nevertheless, the expected growth in India’s rural economy, growing urbanisation and broadening of the markets with wider usage of new-age technology, including internet and smart phones, indicate a positive story and are likely to keep the sector booming steadily. India’s 

Online FMCG: The next growth driver 

Quickly maturing as one of the most crucial components of an FMCG’s operation, e-commerce platforms offering FMCG products have created a safe haven for sellers and buyers, with greater visibility and variety, wider distribution and lower cost. Fortified by the wave of digitisation across regions and economic classes, online FMCG segment has become the new-found sales driver for the sector. 

The FMCG sector, which is ordinarily dominated by the heavyweights, is slowly witnessing a change in the competitive environment as e-commerce platforms such as Amazon and Flipkart are taking over as more popular and convenient distribution networks. Slowly defeating the high moat nature of the sector that comes with large advertisement budgets, massive distribution networks and access to stores, e-commerce is steadily enabling smaller manufacturers to grow their market shares. 

A platform such as Amazon India provides consumers with a vast variety of over 3000 soap brands, with brands such as Dove having over 178 products, including variants. Thriving on such huge variety of offerings, FMCG e-commerce is expected to expand as much as USD 5-6 billion in size by 2020 against its current size of USD 1 billion. The digital impact is likely to be so profound even in the Indian markets that it is expected that a majority of people in India may most likely purchase even their daily groceries from online platforms in just over the next three years. With the fast-increasing youth and tech-savvy population in India, the country will also witness a huge surplus in internet users in the coming few years. The user base of internet is likely to hit 650 million by the year 2020 from 390 million internet users in 2016. With over 50 per cent of the growth in internet users happening in rural India in the next four years in accord with the FMCG companies’ sourcing substantial revenue from the rural segment, online FMCG is set to expand by leaps and bounds. However, this expansion is less likely to be uniform. While, skin care and colour cosmetics sales is likely to witness the most significant growth in online sales in the next three years, growing by over 10 per cent, the online sales of dairy products and soft drinks are likely to grow by only 1-3 per cent during the same period. Furthermore, the online platforms led by heavyweights Amazon, BigBasket and Grofers are likely to contribute growth of over 10 per cent in the FMCG sector during the next 3-4 years. According to reports, the digital channels may even increase their sales up to USD 45 billion by 2020 in the FMCG sector. 

While the convenience of online shopping may be one of the major drivers of popularity of the online FMCG segment, that is not all. The stiff competition in the internet space with regard to pricing, discounts, offers and non-price factors such as range, service and interface of the e-retail space and targeted advertising are attracting huge number of consumers for the FMCG companies. With the internet age flourishing and India’s e-retail space still at the cusp of growth, online FMCG is the growth catalyst of the FMCG sector right now.

Patanjali: Transforming the FMCG sector 

Pitched as the second largest consumer goods manufacturer after Hindustan Unilever, homegrown FMCG major Patanjali generated revenue worth Rs 10,561 crore since its launch in January 2006. The company has witnessed a significant rise in its revenue despite its limited distribution network. Selling its products through its mega stores, Patanjali Chikitsalaya and Patanjali Arogya Kendra outlets, over a million retail stores and online retailers, the company’s main growth drivers have been its cow milk ghee, toothpaste and herbal soaps and shampoos. It has flipped the face of FMCG sector, especially in the personal care segment with its wide range of herbal and Ayurvedic products. 

While Patanjali’s market share has witnessed a tremendous rise in recent years, it is also bearing down on the market shares of FMCG heavyweights such as HUL. India’s largest consumer goods company, HUL recorded a decline of about 0.4-0.5 per cent in its market share since 2011, posting the steepest fall in its share by value among the top 20 brands in the personal care segment in India. Similarly, brands such as Fair & Lovely, Lux and Clinic Plus have also recorded a slump in their shares by retail value since Patanjali entered the scene and started to gain prominence. With its marketing strategy revolving around the products being Indian and rural-oriented, the company has inspired a sincere brand loyalty among most of its customers. 

Patanjali’s market share has risen drastically from a meagre 0.2 per cent in 2011 to 2.1 per cent in 2016, recording the highest rise in share of 1.9 per cent to gain a place amongst India’s top eight brand. The penetration of Patanjali into the regular personal care markets with its herbal and Ayurvedic products has further led to the introduction of ‘natural’ variants of the existing products by its competitors including Fair & Lovely, Clinic Plus and HUL as well. The company is also aggressively increasing its spending on advertisements. Ranked as the seventh largest spender on ads in the FMCG sector, the company is the fifteenth largest in overall terms. 

The company is realising retention gains through its ad campaign featuring ‘Baba Ramdev’, its founder and brand ambassador, and has clocked in a turnover of Rs 10,561 crore in FY17. Furthermore, the company is set to encash greater revenue and growth opportunities with its constant efforts to explore newer markets and launch more products, as most of the product segments in India are brimming with opportunities and are yet to be fully penetrated by packaged branded products. 

FMCG Mutual Funds :- 

While in the last one year the FMCG sector funds have notably outperformed the broader markets, over the periods of 3-year and 5-year as well the funds have offered greater returns than the broader market indices. In recent times, as S&P BSE Sensex recorded a return of 3.67 per cent for the last one month and S&P BSE FMCG posted a return of 5.32 per cent, the FMCG sector funds recorded an average return of 4.6 per cent for the period. Individually, SBI FMCG Direct (G) posted a return of 4.9 per cent, SBI FMCG Fund (G) 4.7 per cent, ICICI Pru FMCG Fund Direct (G) posted return of 5.6 per cent and ICICI Pru FMCG Fund (G) 5.5 per cent in the last one month. 

These funds outperformed both the broader S&P BSE Sensex and the S&P BSE FMCG index returns of 16.94 per cent and 16.97 per cent, respectively, in the last one year. While SBI FMCG Direct (G) posted a return of 31.6 per cent and SBI FMCG Fund posted 30.2 per cent return for the last one year;ICICI Pru FMCG Fund Direct (G) recorded a return of 18.5 per cent and ICICI Pru FMCG Fund (G) recorded 17.6 per cent return, making these funds profitable investment options. 

Conclusion:- 

FMCG sector is considered as defensive in nature. FMCG stocks are held in the portfolio to provide stability in volatile markets as they showcase lower beta. FMCG stocks normally pay higher dividends when compared to other sectoral stocks and these stocks normally reflect higher RoEs. Such pertinent qualities of FMCG stocks make them darlings of long term investors. Having said that, investors need to be cautious on the price they should be paying for these highly sought-after stocks. In the long run, to make money in the stock market, it does matter the price at which one buys a quality stock. One needs to study if the quality FMCG stock under consideration is trading at a reasonable valuation and whether the compounding growth story is intact for the underlying stock. 

Looking at the year 2018 and the increased volatility in the markets, quality growth-oriented FMCG stocks should be a part of the portfolio for any investors. FMCG stocks outperformed key benchmark index returns in CY17 and the probability of the FMCG stocks outperforming in 2018 is very high, given the consumption story of India and a healthy GDP growth rate in CY18. The good monsoon this season may add to the rural consumption story. India is a goldmine of demographic dividends and the same advantage is expected to remain with India for the next 50 years. FMCG consumption can grow at a faster pace owing to changing lifestyles and rapid urbanization. 

Investors should look at FMCG sector with an ultra long term view and wait patiently to allow the investment theme to play out. 

Achin Goel 

Head of Financial Planning & Wealth Management, Bonanza Portfolio. 

Accounting for a revenue share of around 60 per cent, rural segment is the largest contributor to the overall revenue generated by the FMCG sector in India. The rural segment recorded a market size of around US$ 29.4 billion in 2016 and is expected to grow to US$ 220 billion in 2025.

growing e-commerce and rising digital connectivity is especially likely to augur well for the sector. The transformation in lifestyles and an increasing emphasis on looking good, eating good and wearing good in this social media age is creating greater opportunities for the FMCG sector, while India’s demographic dividend is likely to further give it a boost. In recent times, the sector is also witnessing a shift towards wholesome organic and Ayurvedic products, which is stimulating more demand and opening newer markets for the sector. Thus, the FMCG sector in India is at the cusp of explosive growth as India is brimming with opportunities to explore newer markets and penetration of larger brands. 

Good monsoon to have positive impact on FMCG sector :- 

India's meteorological department has predicted a normal monsoon this year Usually, a normal monsoon helps improve rural incomes, which in turn boost rural demand. With the rise in rural demand, one of the sectors that could benefit is the FMCG sector. The increased rural demand translates into higher earnings for the FMCG companies. With improved earnings the financial trend can get positive for several of the FMCG companies.

Thus, with the announcement of normal monsoon along with the possibility of increase in farmers' income due to the enhanced minimum support price for crops, there is a good chance that the rural demand will accelerate, leading to impressive growth in rural consumption. This may lead to improvement in the financial performance of the FMCG companies, which may push FMCG stock prices higher in the coming quarters. 

Young India with over a third of its population below the age of 35 is witnessing a boom in consumption. The uptick in consumption has been outstanding in the past 10 years, which also coincides with uptick in the use of social media, technology, smart phones and television advertisements. 

Sachin Relekar,
Fund Manager–Equity, LIC MF 

Do you see FMCG stocks outperforming in 2018? 

The FMCG index has outperformed the Sensex in six out of the last ten financial years, including YTD performance in FY18. This has been on the back of multiple re-rating as well as strong earnings growth (major contribution being the former). Thus, while earnings growth for the top consumer stocks have compounded ~12%, their stock price returns have been much sharper. We expect this outperformance to continue in the coming year as well due to limited volatility in earnings. The FMCG sector, like all other sectors, witnessed headwinds in the 2HFY17 and 1HFY18, driven by a difficult macro scenario, absence of price hikes, aftershock of demonetisation and the implementation of GST (which impacted the trade channels). We expect demand revival in the overall sector, driven by the normalisation of trade channels, rural recovery, improving/ changing consumer sentiment and a supportive base (demonetisation impact).

What are the key risks that investors should keep in mind while investing in FMCG stocks in FY19? 

The growing challenge for most of the companies currently is from online/digital channels, which could possibly dilute the distribution advantage of large incumbents and cause pressures on margins. While most of the FMCG companies have realised the importance of digital and are allocating a dedicated resource to this vertical. Companies with outstanding and difficult-tobeat brands and enjoying strong consumer relevance are likely to do better. Another risk would be the volatility in raw material prices. While commodity prices for wheat, milk, and cooking oil have been benign, copra prices continued to be firm, coupled with increasing crude and crude-linked derivatives. Raw materials and packing inputs constitute close to 45-50% of sales, hence the movement of these prices should be monitored. 

What is your expectation on earnings growth in FMCG sector in FY19? 

Low volume growth in the last few years was offset by operating efficiencies and continuous price hikes taken by most consumer companies. This has resulted in elevated margins (~300 bps expansion in EBITDA margins for the major staples companies in the last two years). FY19 would see growth coming from both volumes as well as value (on the back of price hikes due to the inflationary environment) driven by improved consumer sentiment and premiumisation of product portfolios across categories. We expect earnings to growth to be healthy for the FMCG pack. 

In your view, what will be the main growth drivers for the FMCG sector in CY18? 

We believe that as the penetration levels for various categories rise, volume growth will moderate. Instead, younger, more educated and globally connected Indian consumers will drive premiumisation and make ‘value’ growth the key driver. The shift in the consumption basket to "good to have" categories (conditioners, softeners, make-up, shower gels and deodorants), discretionary (packaged foods, high-end skin care etc.) and premiumisation is a an important trend. Furthermore, the development of new age channels like Modern Trade and e-commerce will aid with convenience and drive impulse purchases. 

The Indian government has introduced a string of initiatives to revive the rural economy. Do you think the FMCG companies are well-placed to reap benefits from the growing rural economy? 

We expect focus on increasing rural income levels to be continuous theme. It will reflect in better growth for FMCG companies. We expect rural growth to come back this year and companies having higher contribution of rural sales would benefit. Given the disruption and de-stocking that demonetisation and GST caused in the wholesale channel, which is the backbone of the rural distribution channel, all the major FMCG companies are focusing on improving their direct reach 

Mustafa Nadeem,
CEO, Epic Research 

Will FMCG stocks outperform in 2018? 

It is very likely that FMCG stocks will perform. There are many reasons for the same technically. The index did bottom out in Q4 2016 and has given a phenomenal rally. We have seen a brief consolidation or, to name it, overdue consolidation in the last three months. The stocks that were underperforming were like ITC, Marico and GSK. They have seen some rebound with the recent upmove in ITC. The analysis also reveals that, with this reversal, we expect the leaders of the sector like HUL, Godrej CP and Industries, Tata Global to continue to perform better in the coming months, while a rebound in laggards will add flavour to the overall growth story of FMCG.

What sort of percentage allocation will you have for FMCG stocks in a diversified portfolio? Mostly, FMCG has been seen as an investment that can add a cherry on the cake in terms of dividends they provide that increase the returns annually and gives certain cushion to the overall portfolio. With the current correction in the broader market and the total outperformance we have seen in last few quarters, it would be reasonable to have an exposure of around 10-15% of the overall portfolio that can be given to the FMCG as a sector.

Harendra Kumar,
Managing Director, Institutional Equities, Elara Capital 

What is your outlook on FMCG stocks? 

Volume growth is looking upwards due to overall pick-up in the economy and also due to low base (4QFY17 was impacted due to demonetisation). Most of the FMCG companies have at least 4-5% of their topline growth coming from new product launches at premium prices as compared to the base portfolio. For example, Pure Derm Shampoo, launched by Hindustan Unilever to replace Clear Shampoo, is at 3x the price of Clear. Tresemme Keratase treatment was launched at a slight premium to Dove’s base portfolio. Nestle has launched RTDs (Nescafe) and Noodles (Hotheads). We are pricing in 6.5% YoY volume growth for Hindustan Unilever for FY19 and we expect the trajectory to move up to 7.5% YoY in FY20E with more traction in GDP growth. 

Real GDP growth has been inching upwards, albeit on a low base. n 5.7% YoY – June’17 n 6.5% YoY – Sept’17 n 7.2% YoY – Dec’17 Although the pricing component is currently little low as most of the pricing actions were taken in 4QFY17 which have annualised now, however, we expect that with rising crude inflation, FMCG companies, and especially market leaders, will take > 5% price increase. 

What are your expectation on Q4FY18 results for FMCG stocks? 

Early double digit growth in topline led by 6-7% volume growth and 100 bps of premiumisation and 3-4% of price increase. We expect EBITDA to grow by >15% YoY led by margin expansion. Overall, FMCG companies have saved at least 2-3% of sales as cost savings coming from GST – which has come in freight forwarding costs and tax levied on ad spends, which is now getting a set–off against the GST charged on finished goods. 

Are you seeing margin expansion for FMCG stocks? 

Yes, we expect margins to expand by 100 bps this quarter due to cost savings led by GST 

Prabhakar Kudva,
Co-Founder and Director, Samvitti Capital

FMCG companies have been one of the biggest beneficiaries of GST and they have been rallying since the implementation of this game-changing reform. Leading FMCG companies have significantly slashed the prices of a number of goods post-GST, which has resulted in a faster consumption shift from unbranded to branded products, thereby spurring volume growth.

Simultaneously, GST has also brought operational efficiency with rationalisation of supply chain by removing bottlenecks, which has led to margin expansion. Channel stabilisation and demand revival are the frontrunners. Revived consumer sentiment with channels stabilising would lead to a strong Q4. Greater urban demand and deeper rural penetration would drive demand. Moreover, GST-led benefits would start flowing even stronger from Q4. While the wholesale and pharma channel has not yet stabilised fully, FMCG companies' efforts to widen direct reach would drive their growth.

To conclude, both volume growth and margin expansion are coming to the fore together, on a relatively low base, which should continue during the year and support the ongoing rally in these companies

Vivek Banka
Founder, Altiore Capital 

In the Indian context, the defensive stocks are often synonymous with IT/exports/pharma/select consumer stocks. Defensive stocks typically have characteristics that make them in a way inversely correlated with other sectors in the market and resilient to the downturns in the market. 

Typically, defensive stocks are recommended when the indices have run up too fast in a short period of time, making them vulnerable to a large fall, to find shelter in such stocks.

GCPL 

CMP : Rs 1131
BSE CODE : 532424
Face Value : Rs 1
BSE Volume : 10,259 

Godrej Consumer Products Ltd (GCPL) is a part of the Godrej Group, which is one of the oldest business groups in India. In line with its 3x3 approach to international expansion, the company is building a presence in three emerging markets (Asia, Africa, Latin America) across three categories (home care, personal wash, hair care). The company has established a strong international presence through a slew of acquisitions over the years. GCPL is among the largest household insecticide and hair care players in emerging markets. The company has de-risked its business model with 50 per cent of revenue coming from India and the rest from the international business. 

On the financial front, the net sales of the company increased by 11.37 per cent to Rs 1,425.04 crore in the third quarter of FY18, as against Rs 1,279.52 crore in the same quarter of previous year. The company PBDT surged 27.52 per cent to Rs 401.39 crore in the third quarter of FY18 on a yearly basis. The company’s net profit has also gone up by 29.24 per cent to Rs 299.07 crore in the third quarter of FY18, as against Rs 231.4 crore in the same quarter of the previous year. 

On an annual basis, the net sales of the company increased by 5.77 per cent to Rs 5,088.99 crore in FY17, as against Rs 4,811.57 crore in FY16 on a year-on-year basis. The company’s PBDT surged by 17.76 per cent to Rs 1,164.16 crore in FY17 as against Rs 988.59 crore in FY16. The net profit also went up by 14.64 per cent to Rs 848.03 crore in the FY17 as against Rs 739.72 crore in FY16. 

On the valuation front, the company maintained a PE ratio of 54.10x as against its peers HUL (62.10X) and Nestle India (72.03x). The company’s return on equity (RoE) and return on capital employed (RoCE) stood at 27.08 per cent and 22.35 per cent, respectively. The company has a debt-to-equity ratio of 0.75x. GCPL has also been maintaining a healthy dividend pay-out of 29.42 per cent. 

The company’s domestic business is expected to maintain strong growth momentum in the coming quarters with expected recovery in rural demand and new product launches getting good response in the near term. The innovative new launches in household insecticides (HI) and hair colours segment in India, major focus on backward locations in soaps; prioritised recovery plan in Indonesia HI segment and a ramp up in wet hair care in Africa would be some of the key growth drivers in the medium term for the company. We recommend our reader-investors to BUY the stock 

ITC 

CMP : Rs 276
BSE CODE : 500875
Face Value : Rs 1
BSE Volume : 386,668 

ITC is one of the largest consumer companies in India with businesses spanning cigarettes, hotels, paper and agri-commodities. The company is among the top players in all the businesses it operates in. In FMCG, ITC is one of the fastest growing players, and in hotels too, ITC is one of the largest and fastest-growing hospitality chains in India. In agriculture segment, it is a pioneer in rural transformation and in paperboards and packaging, ITC is the market leader in revenue and profit. 

On the financial front, the net sales of the company showed a de-growth of 36.35 per cent to Rs 9,952.19 crore in the third quarter of FY18, as against Rs 13,569.97 crore in the same quarter of previous year. The company PBDT surged by 16.57 per cent to Rs 4,920.30 crore in the third quarter of FY18 on a yearly basis, while the company’s net profit has also gone up by 16.76 per cent to Rs 3,0090.20 crore in the third quarter of FY18, as against Rs 2,646.73 crore in the same quarter of the previous year. 

On an annual basis, the net sales of the company increased by 50.52 per cent to Rs 55,448.46 crore in FY17, as against Rs 36,837.39 crore in the FY16 on a year-on-year basis. The company’s PBDT surged 3.43 per cent to Rs 16,541.00 crore in FY17 as against Rs 15,992.84 crore in FY16. The net profit also went up by 3.62 per cent to Rs 10,200.90 crore in FY17 as against Rs 9,844.71 crore in FY16.

On the valuation front, the company maintained a PE ratio of 31.64x as against its peers Dabur (48.78x) and HUL (61.98x). The company’s return on equity (RoE) and return on capital employed (RoCE) stood at 23.15 per cent and 62.80 per cent, respectively. The company has a good RoE track record with 3-year RoE of 26.68 per cent. The company has reduced debt and is virtually debt-free. ITC has also been maintaining a healthy dividend payout of 60.47 per cent. 

The finance minister in the Union Budget has not proposed any change in the tax rate on cigarettes, which comes as a big relief for the company. We expect cigarette volumes should improve and if there is a shift from illegal to legal cigarettes, it can be an added boost to the overall volume growth for cigarettes. While presently the cigarette segment contributes about 85 per cent to ITC’s overall EBIT, going forward rising profitability of other segments is expected to reduce cigarette’s contribution. 

The ITC stock was battered because of fears around the GST, and while those fears have dissipated, the stock has not recovered yet. ITC is available at the lower band of valuation and the investment in non-tobacco businesses are now giving returns. Nascent segments where ITC is likely to scale up fast are salt, juices, dairy and spices. We recommend our readerinvestors to BUY the stock.