With volumes drifting to single digits and sales growth tapering, it is time for shareholders to take some profits off the table.

Fast-moving consumer goods companies have borne up well under inflationary conditions, managing to post healthy growth in sales and profits. The BSE FMCG index has accordingly rocketed 36 per cent in the year to date.

The stock of GlaxoSmithKline Consumer Healthcare, which holds over 70 per cent of the malted food drinks market, has partied right alongside, shooting up 21 per cent since January.

At Rs 3,075, GSK Consumer trades now at 32 times trailing 12-month earnings. Valuations at the start of the year stood at 29 times and are now well below Nestle India, but on par with Britannia.

But the time may be ripe to take some profits off the table on a few counts. One, sales growth has been gradually tapering off for GSK Consumer. Other pure-foods companies such as Nestle and Britannia have also been growing much slower than other FMCG players. Two, the volume-driven growth of previous quarters seems to have given way, with volumes drifting down to mid-single digits.

Three, prices of GSK Consumer’s inputs are agriculture commodities, whose prices are beginning to inch up again. Operating margins may come under pressure again with limited room for compromise in advertising. Intense competition in segments such as biscuits and instant noodles warrant more adspend, as does improving penetration into the north and western malted food drinks market.

Slowing down

Growth in revenues slowed from 18 per cent in the September 2011 quarter to 12 per cent in the June 2012 quarter. With regular price hikes as input costs soared, the wear on consumption is beginning to tell with volume growth dwindling over the past three quarters.

Sales volumes for key brand Horlicks slowed steadily to 7 per cent in the June 2012 quarter. Growth is well below the double-digit volume expansion in earlier years.

The other base brand, Boost, has shown erratic growth in volumes, with the March 2012 quarter clocking a 2.1 per cent growth and the June quarter an 11 per cent growth.

Some of this dip may be attributed to a drying up of bulk buying by the Indian armed forces. A revival in spending could prop up volumes. In its absence, though, volume growth is likely to see the biggest boost from an increase in penetration.

Rural markets have low penetration levels of around 11 per cent compared with the 40 per cent levels of urban markets. Rural markets could also benefit largely from health drinks, GSK’s mainstay. However, a rise in raw material prices could limit efforts to capture rural markets through traditional methods of low-value small packs (these packs have inherently low margins).

GSK Consumer is also pushing activity in the northern and western markets, but since this strategy has been in place for a while now, benefits from increase in market share are largely priced in.

Small gains

Instant noodles brand Foodles was launched in late 2009 and made quick initial headway. The company has since failed to significantly move this brand, facing tough competition from other new entrant ITC’s Yippee. Aggressive marketing by dominant player Nestle (Maggi) has added to the drag.

In biscuits too, the competition is intense with GSK Consumer’s health platform being challenged by the likes of Britannia. The premium category, also GSK’s ambit, is drawing increasing attention. The two segments have failed to move past a contribution of 5-7 per cent of sales. Gains from this front appear to be minimal given the rampant competition.

Prices rise

Costs of key inputs, wheat and barley, are already up 8 and 11 per cent in the year to date, with sugar following close behind.

Prices of milk, which had stabilised earlier, are creeping up again. But GSK Consumer’s dominant presence in food drinks affords it pricing power.

Operating margins were maintained at 21 per cent for the six months ending June 2012 (GSK Consumer’s fiscal coincides with the calendar year), primarily on account of improvement in input costs.

But the company also spent more on advertising — in the June 2012 quarter, adspend went up to 16 per cent as a proportion of sales, higher than most FMCG peers. If the company is to advance penetration and push non-food drinks products, advertising and promotion may have to sustain at higher levels. Thus, margin improvement through price hikes could be offset by adspend.

The June 2012 quarter, while seeing decelerating sales, saw a strong 29 per cent jump in net profits.

This is attributable to a 40 per cent rise in other income (mainly from distribution of products such as Sensodyne and Crocin), and the second, a 24 per cent shrink in depreciation.

Sustaining such boosts to profits may be difficult. Where GSK Consumer does score is in its superior returns on equity and high dividend payout.

(This article was published on September 15, 2012)
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