Every bull market has its superhero stocks. In the dotcom boom of 1998-2000, technology stocks were credited with superhuman abilities to deliver scorching growth rates for eternity. In 2006-08, real estate and infrastructure developers were put on this pedestal. But when sectors that are market heroes face unexpected challenges to their growth, their stocks suffer setbacks.
The sectors that have attained superhero status in this bull market are the entire set of consumer-facing businesses. In the last seven years, with the investment leg of the economy limping and export growth muted, consumer-facing companies are the only ones to have managed predictable earnings growth.
This is perhaps why stock market investors have become die-hard fans of consumption plays — lapping up not just FMCG, durables and automobile manufacturers, but also fruit drink, ceramic tile, paint and inner-wear makers. The Nifty India Consumption index is up 180 per cent since December 2011, topping the Nifty500’s 150 per cent gain.
Earnings growth rates of listed consumer companies provide little justification for their stock price performance. In the last five years, companies in the Nifty Consumption index have grown their sales at an annual rate of 7 per cent, while their operating and net profits have expanded at 12 per cent a year.
A bulk of the gains in consumption stocks have clearly come from the markets taking a rose-tinted view of their prospects. In December 2011, the Nifty India Consumption Index traded at a price-earnings (PE) multiple of 20 times, while the market (Nifty500) PE was 16 times. But today, the PE multiple of the Nifty Consumption index is at a lofty 46, while the market PE is 29.
These multiples indicate that the markets are perhaps assuming that these companies will continue to enjoy a blue-sky scenario of strong pricing power, high margins and an unassailable market position while rapidly adding to their sales.
But it would be a mistake to assume that consumption stocks are immune to disruption. There are at least four big disruptors on the horizon which can pose a challenge to listed companies over longer horizons.
Strong pricing power is a key aspect of Indian consumer companies that has endeared them to investors. Branded consumer goods players have always enjoyed the ability to peg up their prices to compensate for rising input costs, and then some more. Price increases have thus contributed at least as much to the sales growth of these companies as volume increases.
While this pricing power is partly a function of their big brands and ad budgets, it is also a function of overall inflation rates in the economy. On this count, consumer companies in India already face threats to their pricing power.
CPI inflation, after averaging 10.3 per cent in the five-year period from September 2008 to 2013, has collapsed to 4.8 per cent in the last five years. With food prices deflating and the RBI watching like a hawk, inflation rates appear unlikely to shoot up beyond the single digits. Inflation rates also determine income growth which has a direct bearing on consumer spends. Employee costs for India Inc after expanding at 15-20 per cent between FY11 and FY14, have grown by just 9-10 per cent in the last couple of years.
This may require consumer companies to rely more on volume growth than pricing power.
Consumer sectors in India have so far thrived because they haven’t faced the heavy hand of over-active regulators, even as regulatory diktats have proved a big wild card factor for financial services, agri-inputs, pharmaceuticals or telecom.
But that is set to change now, with a new wave of consumer activism leading to a tightening of India’s weak consumer protection laws.
The advent of GST has seen the setting up of an anti-profiteering authority who has been giving FMCG giants a hard time on pricing decisions. Under the new Consumer Protection Bill 2018 which is in the works, a regulator will be appointed to oversee the entire gamut of consumer goods and services, with provisions for product liability claims.
There is also a move to give more teeth to the FSSAI.
At the best, these regulatory changes will raise compliance costs for consumer firms. At worst, like the Nestle Maggi controversy showed, they could disrupt entrenched brands and categories.
The rise of big retail
One of the big sources of high margins for listed consumer firms in India has been their unquestioned clout over the unorganised and fragmented retail industry. Large FMCG and consumer durable players today call the shots on product display, positioning and retail margins, elbowing out new challengers.
India hasn’t made big headway on organised retail. But its retail sector now faces disruption from 800-pound gorillas such as Amazon and Wal Mart-owned Flipkart. Yes, with online retail making up less than 5 per cent of retail trade, these players hardly make a dent in segments such as FMCGs, apparel or appliances.
But as e-tailers make significant headway in select products (mobile phones, beauty and electronics) they can skim off the creamy layer of consumers. Amazon’s global push to woo consumers to its private-label products with nosebleed discounts, has turned the heat on quite a few global brands. As AmazonBasics tests the waters in India, there’s no guarantee that value-conscious Indian consumers will stay loyal to their brands.
Studies have shown that millennials and the Gen Z generation perceive products and services very differently from their parents. They dislike asset ownership. They are wellness fanatics. They are socially and environmentally super-conscious. They value authenticity and don’t revere big-name brands. They prefer customisation over mass production.
Therefore, when these young adults enter the workforce, their product and brand choices can disrupt the large consumer categories. Environmental consciousness may drive a shift from car ownership to public transport. Niche products in beauty or food may sideline multinational brands. The super-premium ends of many product categories may come to be occupied by hand-made or customised products.
While these trends may seem a long way away in India, some conventional product categories are already facing the heat from shifting consumer preferences. Global cola majors have been forced to take a detour into fruit drinks. The packaged food strategies of MNCs have been thwarted by local ready-to-cook products.
All this not to say that the listed consumer firms in India are unaware of all these trends, or that they aren’t reworking their strategies to prepare for them. Over the next five years, they may well pivot to adjust to these shifts. But not all of the current crop of consumer firms will be up to this challenge and new, nimbler players may win in some categories. The problem is that the current valuations of consumption stocks offer no room for such mis-steps.