FMCG for long-term investors

Being overweight on it is an unexciting prospect but attractive

The fast-moving consumer goods (FMCG) industry is seen as a defensive haven. The logic is simple. People use soap, toothpaste, powder and other personal care products as a matter of habit. Hence, FMCG has stable demand and rarely sees volume contraction.

In India, two macroeconomic factors have led to strong growth over the past decade. One is better infrastructure, which has made rural access easier and, therefore, helped open new markets. The other is the movement of lower income people into the middle class and attendant lifestyle upgrades. Even during periods, such as now, when consumption growth is collapsing, FMCG is among the last sectors to get hit.

FMCG businesses also tend to be fairly low-debt and not working-capital-intensive. By their very nature, the credit cycle isn't too long. Assuming the management has been smart about building brands and managing distribution channels, an FMCG can be a cash cow forever.

One issue, however, is that successful FMCGs tend to become very high-valuation precisely because of the predictable, stable nature of business. Institutions love FMCGs and every major investor has sung the praises of the sector at some stage.

In the Indian context, these stocks have long periods of trading sideways. By long periods, I mean several years. Hindustan Unilever, Colgate, Dabur, etc, have all exhibited this trait. The stock hits a certain price band and then trades sideways. However, while this is a test of patience, FMCGs rarely see massive sell-offs, so it isn't usually a test of nerve. Investors with deep pockets can simply collect dividends and wait.

FMCG is a very heavily covered sector in terms of news and institutional focus. In many ways, it is over-analysed. Analysts write reams about FMCG stocks and there is much debate about the possible implications of the gain or loss of 0.5 per cent market share in some product or another. B-School professors and management theorists also write many theses about FMCG strategy.

Largely, the stock recommendations can be encapsulated into one of the following statements: 'Buy and hold' or 'Buy on declines'. This is looking like a bear market and it could get more bearish. Under the circumstances, even FMCG is likely to see some

selloffs. Indeed, HUL and ITC have both seen major profit-booking. So, it is a 'Buy on declines' situation.

When it comes to analysis, obviously financials do make a difference. The quality of earnings, stability of earnings, consistency of dividend and an ability to build a brand are differentiating factors. I think there's no point stressing over losses or gains of minor market share. It is difficult for a new player to get into this market because the incumbents are well-entrenched and have deep pockets. (That said, one can never quite rule out another Nirma arriving on the scene).

If you buy, say three or four majors in this space, they will continue to hold the same combined market share indefinitely. One or another business will do better at various stages but they will all tend to make profits and pay dividends.

This is not a sector likely to see enormous upheavals. The listed players are established and many are subsidiaries of global giants. They enjoy strong balance sheets, respectable managements and high institutional interest. There could be the periodic open offer shaking up valuations but that is hardly a bad thing. Being overweight in the sector is unlikely to be an exciting prospect for a while. But that is precisely why a long-term investor might find it attractive at the moment.

If FMCG follows the pattern of earlier selloffs, the drops in valuations will come in just after the quarterly results, while the recession lasts. So, the best way to take positions might be to hoard cash until each set of quarterly results and then buy the respective target stocks on declines in the next five sessions.