FMCG: Margin erosion still on

Most companies cut ad spends to deal with pressure on profitability.

Ranbaxy is already preparing the Street for some shares of fast moving consumer goods (FMCG) companies are facing an interesting situation. While the valuation of these companies have ran far ahead of profits, the market can’t seem to own enough of these stocks. As institutional investors lose appetite for riskier sectors, FMCG is suffering from the TINA (there is no alternative) syndrome. So, before anything else, investors should know that most FMCG stocks are trading at their peak valuations and, hence, have a limited upside from here.

Having said that, analysts say some stocks are placed better than others. According to Sharekhan, the first quarter of FY12 was another period of strong topline growth for most FMCG companies, except Tata Global Beverages and Zydus Wellness. This was largely driven by a mix of growth in sales volume and the price increases undertaken by companies. However, volume growth continued to stay ahead of the price-led one. Also, higher input costs kept putting pressure on margins.
 

HOW THEY STACK UP
	Gross Marg (%)		Ad spends as % to sales		OPM (%)
	Q1FY11	Q1FY12	Q1Fy11	Q1FY12	Q1FY11	Q1FY12
HUL	49.0	44.1	15.7	11.5	12.5	12.3
Marico	48.8	43.3	11.9	9.8	13.4	11.9
GCPL	51.1	51.2	10.4	11.7	18.7	14.8
Tata Global Bev.	57.3	54.5	15.7	15.3	9.9	8.0
Zydus Wellness	64.2	67.5	34.4	25.3	11.6	14.1
Dabur	52.6	47.8	16.4	12.6	15.7	14.7
GSK Consumer	62.3	59.4	13.9	15.3	19.5	18.2

The big trend this quarter has been lower spends on advertising and promotion. Most companies have chosen to cut such spends to reduce the pressure on profitability. The only companies to buck this trend are Godrej Consumer Products Ltd (GCPL), Glaxo SmithKline Consumers and Colgate.

Analysts say this strategy has backfired on HUL, as its key categories such as soaps and detergents have suffered and sales volume growth has moderated from double digits to higher single digits. On the other hand, GCPL supported its brands with adequate advertisement spends and was able to achieve a strong growth in volumes (ahead of category growth) in the soap, hair colour and household insecticides categories.

Going forward, analysts expect companies to hold on to volumes and improve average realisations. However, in over-penetrated categories such as soaps and detergents, intense competition could have an adverse impact. Also, for the next couple of quarters, FMCG players will continue to face cost pressures, as raw material prices have not come off meaningfully.