Will FMCG sector's fortunes revive?

While most research houses believe improvement in rural demand augurs well, a few leading names such as Morgan Stanley have recently turned cautious

A majority of companies in the fast moving consumer goods (FMCG) sector have been struggling to take their volume growth higher in recent times, thanks to weakening rural as well as urban consumption demand. Volumes reflect the inherent demand trends in the industry. In a bid to push volumes, these companies have been adding more muscle behind their advertisement and promotional spends, in addition to passing on the benign input cost inflation to the end users via price cuts. While these efforts have enabled FMCG companies to maintain the pace of volume growth in recent quarters, the same has not accelerated. While there are hopes of an improvement in demand given various catalysts falling in place for the sector, a report last week by leading foreign brokerage Morgan Stanley is quite in contrast to the general expectations.

For one, analysts at the foreign brokerage are more cautious. “With a mere four per cent aggregate revenue growth in FY16, lowest since FY03, and markedly low elasticity to increased advertisement spends, it appears that marketers may have plucked the low-hanging fruit and will now have to strive to penetrate the lower-income groups,” write analysts at Morgan Stanley headed by Nillai Shah in the report on the sector. “We envision structural changes in marketing strategies amidst continuing weak volume growth and peak gross margins that may force companies to sacrifice medium-term earnings to build stronger long-term business,” they add.

However, Morgan Stanley believes that unlike staples companies such as Hindustan Unilever (HUL), Nestlé India (Nestlé), Marico and Colgate among others, consumer companies focused on the discretionary segment such as Asian Paints, Titan, United Spirits, etc. could do well in the future. These views seem to be in sharp contrast to most other leading brokerages.

HSBC Global Research is one such example. “We believe the consumer sector offers an attractive long-term growth opportunity driven by income growth, an attractive demographic profile and catalysts such as urbanisation and rising living standards,” believes Amit Sachdeva, consumer analyst at the foreign brokerage. HSBC believes companies having strong and sustainable positioning in the segments they operate in will do well in the longer run. Asian Paints, Nestlé, HUL and Britannia are its top picks in the sector.

The positive stance of a majority of the analysts is based on the multiple boosters to rural consumption aided by good monsoon, higher income in the hands of government employees, extension of direct benefit transfer to more schemes/programmes and implementation of one rank one pension (OROP) recommendations. Thus, most industry experts as well as company managements are hoping of an uptick in volume growth.

Despite rich valuations wherein the sector’s PE is 38 times one-year forward estimated earnings, most investors continue to like consumer companies as they believe a pick-up in rural demand will aid not just the volumes but operating margins as well as earnings of these companies. Premiumisation is another theme which most companies are focused on and should aid their margins and realisations even if volume growth does not pick up meaningfully in the near-term.

Amit Purohit, consumer analyst at Emkay Global, says, “Premiumisation and increasing penetration are the key themes in the sector. Rural revival will accelerate penetration for categories that still have urban flavour like hair colour, dishwasher and home insecticides. We like HUL, Britannia and Colgate to play the premiumisation trend, and Godrej Consumer & Jyothy Labs as key beneficiaries of increased penetration.” Rising growth of companies focused on the naturals/ayurvedic segment such as Patanjali and Sri Sri Ayurveda, among others, could lead to expansion of the naturals segment itself which will rub off favourably on Dabur and Emami, among others, which have a meaningful presence in this segment.

While sustained improvement in rural demand may be a couple of quarters away, volume growth could get some fillip from the upcoming festive season.