FMCG: Flying off the shop shelves

The BSE FMCG index has outperformed the market since the start of 2008, giving up just 7 per cent compared with a loss of about 24 per cent for the Sensex. That’s not surprising because companies in the sector have done well in a challenging cost environment.

The good news is that the top line growth in the June 2008 quarter was fairly robust driven by a mix of better volumes and higher prices. For a sample of companies tracked by brokerage Morgan Stanley, revenues were up just a shade under 20 per cent. The Rs 3,504 crore Nestle did particularly well to turn in a sales growth of around 23 per cent y-o-y while Hindustan Unilever came up with 21 per cent.

However, while realisations were up, the price hikes were not enough to fully mitigate input cost pressures. As a result, both gross and operating margins came off. For instance, copra prices shot up by 30 per cent y-o-y pulling down the operating profit margin for the Rs 1,907 crore Marico, by 150 basis points, to 12.5 per cent. That’s despite the firm having taken a price hike of 5-15 per cent across products which pushed up revenues by a smart 28 per cent.

Godrej Consumer too increased prices but higher spends on advertising—up 210 basis points y-o-y— along with a rise in vegetable cost hurt operating margins which fell sharply by 410 basis points to 13.7 per cent. Even Nestle could not buck the trend: with milk and wheat prices up, operating margins were down some 70 basis points.

Companies will no doubt look to pass on costs through price hikes though they may be wary of losing out on volumes given the general slowdown in the economy. They would probably wait to see whether the momentum in volumes sustains before initiating further price hikes.

Firms like Nestle, which has strong brands in categories such as infant nutrition, dairy products and coffee, for which there are few substitutes, should continue to see good demand. Valuations in the space are, however, no longer cheap— stocks are trading at multiples between 17and 29 times.

At 29 times estimated CY08 earnings, Nestle is the most expensive while HUL, at Rs 242, commands a multiple of 26 times. Dabur, at Rs 90, trades at just over 20 times estimated FY09 earnings, Godrej is cheaper at 17.5 times estimated FY09 earnings, while Marico at Rs 59 trades 18.5 times.