We initiate coverage on the fast-moving consumer goods sector. We expect most companies to sustain a 15% plus revenue CAGR (compound annual growth rate),deliver margin expansion and maintain high capital efficiencies over FY12-15. As such,we expect their historically rich valuations to sustain.
We prefer companies with portfolios positioned for higher-than-industry growth and with brands dominant enough to minimise a medium-term risk to margins from competition. We initiate coverage on ITC,Godrej Consumer,GSK Consumer,Emami,Marico and HUL with Outperform,Nestle with Neutral and Colgate and Dabur with Underperform.
Focus on the micro over macro
A phase of very strong and consistent growth post-2005: As against a CAGR of 5.7% over CY01-05,the FMCG market has seen a CAGR of 18.7% over CY05-11. A confluence of economic and behavioural factors helped this structural shift in growth rates in the FMCG markets. In our view,the two key drivers for this change have been (i) a significant acceleration in rural income growth and (ii) rising consumption aspirations of mid and lower-income groups due to sustained increase in media penetration,leading to a shift from unbranded to branded products and premiumisation.
While the economic slowdown have some impact on consumer incomes and sentiment,we expect key drivers like rural income growth and rising aspirations in mid and lower-income groups to help largely sustain the growth momentum in the sector.
Rural turnaround has been a key driver: Rural consumption growth has been a key driver for the FMCG market over the past four-five years. Rural monthly per capita expenditure (MPCE) saw a 17.5% CAGR over FY10-12 as compared to a 10.6% CAGR over FY05-10 and an abysmal CAGR of 2.8% over FY00-05,clearly representing the shift in growth trajectory for overall rural consumption. FMCG market growth data also shows rural growth catching up with urban growth as compared to the pre-2006 era where rural growth lagged urban growth by a wide margin. The FMCG market growth has seen a strong correlation with nominal agri-GDP growth.
Rural is a substantial portion of the total sales: Rural consumption dominates categories like detergents and soaps with over 50% volume share. In personal care categories,the rural share of revenues is also substantial in the range of 30-40%. It is only the packaged foods category where rural contribution to revenues has dipped below 25%.
The headroom for higher-than-market growth for FMCG categories in rural areas continues to be substantial as the gap in penetration of various FMCG companies between urban and rural households is still very high in personal care and foods categories.
Analysing trends on penetration,growth of premium segments and trends in consumer behaviour change,we expect categories like skin care,shampoos,insecticides,hair oils and packaged foods along with relatively new categories,including deodorants and face washes to outgrow the broader FMCG market. Companies that have a large share of revenues coming from leading brands in these categories would grow ahead of the broader FMCG market. GSK,Marico,GCPL,Nestle and Emami are likely to outperform on revenue growth.
Companies with dominant positions will show margin resilience: Most of the companies have seen only a marginal dip in Ebitda margins in the past two years despite the steep commodity inflation. We use a framework to assess the pricing power of companies looking at each brand for relative market shares,growth headroom,presence of deep-pocketed competitors and unbranded competition. We believe ITC,GSK,Marico,GCPL and Emami have over 50% of their revenues from brands that have very strong pricing power.
Bet on managements investing in innovation and execution capabilities: Successful brand innovation and execution capabilities like distribution and supply chain are the key to consistent growth in the FMCG business. Managements at ITC,HUL,GCPL,GSK,Marico and Emami have significantly increased the pace and success rate of innovations in the past three-four years. These companies have also augmented their distribution systems through enhanced use of technology and new models for rural expansion.