What to do with FMCG stocks

Profit growth for FMCG companies is set to moderate further, even as PE multiples show no indication of a climb-down for now. SO, in such a scenario, which stocks should you be cashing out on and which should you retain in your portfolio? The trends in the FMCG space indicate that the following themes may work well in the sector.

Volumes and categories

While volume growth has slowed down for the sector, some companies managed the slowdown better than others. This was either due to their operating in niche segments, or because they had products at lower price points and hence being more resistant to spending cutbacks.

For example, hair oils, while being discretionary, are relatively cheap, and account for a small share of the wallet.

Competition is also milder than other mass-market personal care products, such as soaps, toothpastes and shampoos. Marico, with its flagship Parachute range, managed an 8-9 per cent volume growth for the past couple of quarters with a 10-11 per cent sales growth.

In contrast, HUL’s volume expansion was 5-6 per cent. Emami too, held on to superior volumes.

Godrej Consumer and Dabur India both operate in niche segments such as insect repellents, hair colour, digestives, health supplements, and fruit juices.

Home care constitutes more than a third of Godrej’s revenues. Insecticides, which form bulk of this segment, clocked growth of 27 per cent in the March 2013 quarter.

Earlier quarters saw volumes at over thrice the category growth.

Dabur, meanwhile, maintained volume expansion at 9-12 per cent over the past year.

Other factors which play a role in maintaining sales growth are market dominance and the pricing power it affords. This benefited Colgate Palmolive, which saw steady volume growth of 9-12 per cent.

It has also fought off competition to retain its holding over 50 per cent of the market.

Global presence

Domestic FMCG companies have moved into emerging markets, and the share of global revenues has been steadily improving. Such a diversification offsets tightening domestic demand. A weak rupee too, is beneficial here.

Spreading operations across several countries also helped. The Indonesian market, growing 30-45 per cent over the past few quarters, and the African markets aided Godrej Consumer, compensating for slightly slow Latin American markets. Dabur received a boost from its Bangladesh presence, overriding slow demand in Egypt and Nepal.

A good rural presence will also help companies tide over shrinking urban demand in discretionary products. Good monsoon and thus good harvest would raise rural incomes. The market has already shown promise in skincare and homecare demand. Additionally, urban markets being very well penetrated leaves limited room for further expansion. Emami derives about 27 per cent of sales from rural markets already while Jyothy Labs has strong brands and a strong 75:25 rural-urban mix.

Valuation mismatch

PE multiples of stocks such as Dabur, Godrej, Colgate and Emami have also not seen sharp re-ratings, with earnings growth keeping up. But some companies trade at multiples which may not be matched by earnings growth.

HUL and Nestle India have seen sluggish growth. GSK Consumer clocks erratic volumes and has a narrow category presence where competition is stiff. Britannia Industries too, is plagued by competition.

The stock price galloped on the strong 4 percentage point margin expansion to 10.3 per cent in the March 2013 quarter in an otherwise low-margin food business. This expansion was due to a combination of raised product prices and low input costs, the effect of which will taper off in the coming quarters.

Also read: > FMCG STOCKS - THE PARTY'S OVER

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