Portfolio

Consumer companies to enrich your portfolio

Aarati Krishnan | Updated on February 20, 2011 Published on February 19, 2011

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Some consumer companies have proved better at winning the battle against rising input costs, inflation and interest rates. Here's how investors can identify them.

Stocks of consumer goods companies reigned supreme in the bull market of 2009-10. However, they have been knocked off their pedestal in recent months, on spiralling inflation and fears that consumers may turn more frugal with their purchases. Stocks of leading companies featured in the BSE's sector indices have tumbled 7-30 per cent from their November values. Is this a good entry point? Maybe for some of them.

The nervousness about consumer stocks stems from two new risks to the India story that have cropped up in recent months. One, global commodity prices (crude oil, agri-commodities, industrial metals) have soared unexpectedly, exerting pressure on profit margins of most companies.

For consumer goods makers, the question is how much of this increase can be passed on to their customers. Two, powered by fuel and food prices, domestic inflation has soared. If this prompts the RBI to tighten liquidity and raise interest rates, would this impact the demand for big-ticket purchases such as white goods, two-wheelers, cars and homes, which are funded by borrowings?

As a corollary, is the fear that consumers may turn parsimonious with their purchases, cutting back spending on goods ranging from skin creams to plasma television sets.

However, when it comes to handling inflation or higher interest rates, not all consumer companies are made equal. After a study of how consumer goods companies fared through previous high-inflation or rising interest rate phases, we put together a portfolio of consumer stocks that may weather these risks well. As inputs go, FMCG makers are mainly grappling with higher prices of milk, soap and detergent chemicals, vegetable fat and packaging material. Increasing prices of steel and metals pose risks for automobile and durables makers.

Wielding pricing power

While every consumer goods company is facing input price pressure in one form or another, they do differ in their ability to pass it on to their consumers.

Three factors endow some consumer goods players with greater pricing power than others. One, companies with dominant market shares in a category usually display good pricing power. GlaxoSmithKline Consumer, which has a 70 per cent share of the health drinks market, or Nestle India, which dominates baby foods, have traditionally adjusted to swings in raw material prices quite well, thanks to their ability to take annual price increases of 5-7 per cent on their key products.

Two, the nature of the product itself may endow the marketer with pricing power. Gold jewellers in India have always pegged jewellery to the day's gold prices. That endows premium jewellery retailers such as Titan Industries with an automatic ability to pass on input price increases to buyers, almost on a real-time basis.

Within FMCGs, again, consumers tend to digest price increases on food products much more easily than on soaps and detergents, where increases are fought tooth and nail! Cigarette-maker ITC has been repeatedly slapped with higher excise duties and taxes, year after year, but has nevertheless notched up a steady pace of volume and profit growth.

Three, input price increases in some consumer categories may be more benign or short-lived than others, allowing these companies to tide over such blips through savvy procurement or product mix changes.

Handling higher interest rates

Rising interest rates usually have implications for two different sets of consumer goods makers. Consumers buying big-ticket items such as cars, two-wheelers and white goods usually resort to borrowed funds to finance these purchases.

Higher interest rates mean a bigger monthly outgo for these buyers towards their EMIs (equated monthly instalments), which may prompt some new buyers to postpone or re-evaluate their purchase decisions.

However, there are exceptions here too. Consumers opting for entry level brands may put off purchases at the prospect of a higher EMI, but not so buyers of higher end or premium products. Take the case of motorcycles, illustrated in Bajaj Auto's 2007-08 annual report.

When the RBI went on its previous interest rate hiking spree in 2007-08, the entry level segment (less than 100 cc) for motorcycles shrank, from occupying 69 per cent of the market to 64.

In contrast, executive and high performance bikes actually improved their share of the market from 31 to 36 per cent.

Bajaj Auto took a hit on its sales and net profits in 2007-08, even as it focussed on more premium launches. However, that eventually paid off in the form of a strong profit rebound over the last two years.

Consumer companies that have taken on substantial borrowings to fund buyouts or expansion too could face pressure in a rising rate environment. However, as the consumer space features umpteen cash-rich companies which carry little or no debt on their balance sheets, investors can easily sidestep this risk by including only such candidates in their portfolio.

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Published on February 19, 2011
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