FMCG Sector Loses Its Excitement

FMCG Sector Loses Its Excitement

Taking about the FMCG sector, in this article, Geyatee Deshpande discusses about how the FMCG sector, once the most preferred by investors, has recently lost its glow

As the pandemic hit economies, investors got worried about the disruptions caused in the FMCG sector leading to loss of business. But it was the FMCG sector that subsequently gained a lot of attention of investors as well. While FMCG stocks enjoyed a strong rally in the equity markets in the year 2020 post the pandemic, soon they lost their shine. Looking back, the decade of 2010 proved to be a cheerful decade for Indian consumer goods’ companies, seeing vast amounts of investments pouring in. One considered these to have low risks and reward handsome gains.

With India developing at a fast pace, companies belonging to the FMCG sector witnessed generous increase in revenues, strong cash flows, few corporate governance issues, higher demand for their products and ever-increasing market share. As a result, investors have always preferred to include FMCG companies in the portfolios. Some believed that investing and holding for a few years shares of a few FMCG companies with strong financials and growth outlook could reward great profits.

The above table highlights top performing FMCG companies in the last three years. Shares of Hindustan Foods gained around 96.79 per cent while that of Varun Beverages rose by 35.13 per cent in the last three years. Tata Consumer Products has jumped by around 31.22 per cent in three years. Tasty Bite Eatables has given positive returns of about 21.47 per cent to its shareholders.

FMCG Sector in the Limelight

As the global economy was hit by the pandemic, the subsequent lockdowns and restrictions led to business disruptions in the FMCG sector. Overcoming these challenges, the FMCG sector continued to flourish during such difficult times. Essentials goods continued to see demand while healthcare and hygiene product segments received a boost. Even though sales volumes for prime products reduced, a demand shift in products was seen.

Food and beverage, oral care and over-the-counter FMCG categories outperformed in the recent quarters, supported by the heightened demand in the last few months. A few examples include that of Marico (especially its brand Saffola), Nestle and Britannia clocking in strong growth in the food and beverage segment while Dabur’s health supplements and Emami’s digestives witnessed higher growth trend in the over-thecounter FMCG segment.

Considering the top companies in the FMCG sector according to market capitalisation in the above tables, we can see that some of the FMCG companies have not only sustained during the pandemic period but have also managed to improve their sales and profits performance. United Breweries reported strong sales as well profit growth for Q3FY21 on QoQ basis. Net sales of Tata Consumer products increased around 10 per cent in Q3FY21 on QoQ basis. Moreover, positive sales volumes for FMCG companies were supported by increased rural consumption and demand.

It is understood that the rural economy has seen a significant recovery and hence have the money that they need to spend and buy. Additionally, the rural economy has now consisted of a significant share of demand growth which has encouraged FMCG companies to also include products and services benefitting the rural economy. With this, it can be said that the FMCG story is that of valuations reflecting reality.

Additionally, e-commerce continued to grow ahead of all other channels in the last year. Most companies significantly improved in e-commerce revenues. All these factors led to an optimistic view of investors about the FMCG sectors. Hence, with a strong confidence in FMCG sectors, investors opted for stocks of FMCG companies in 2020 which truly did reward investors with huge gains. The following table shows the top five companies posting solid increase in returns in 2020 post the pandemic.

Attention Fades Away

Apart from these, most regular traders prefer to include FMCG stocks in their portfolio because these are considered to be ‘defensive stocks’. So generally, it is seen that when there is higher risk-taking capacity amongst investors, the less of FMCG stocks are included in portfolio. The more diversified a trader is, cautious and careful enough to plan for ups and downs of the economy and the equity markets, the more he tends to stock upon FMCG stocks. While the post pandemic period remained volatile with continuous resurgence of corona virus cases and concerns regarding business growth and profits, investors as per their natural instincts had swayed towards FMCG stocks, chasing them since a basket of these stocks posed to be a safety allocation net. Given the growing phase of the India economy, these stocks do not exhibit much downside risks.

On the other hand, since the second half of 2020 and continuing even today, equity markets both domestic and global have seen strong rallies and continue to surge. With the intention of earning higher profits, investors in recent times have an increased risk appetite. In such situations, gains in shares of companies belonging to the FMCG sector are majorly news-based. With the economy currently having a positive growth outlook, investors are ready to bet on stocks to gain from as much profits as they can, hence shifting their focus from FMCG stocks to others.

But suppose if there would be a second wave of corona virus or if the vaccines were to fail or have negative side-effects leading to volatile situation in the economy, investors will take a flight to safety, thus accumulating as many FMCG stocks as possible. This phenomenon is simply due to a level of comfort existing in FMCG stocks. The products and services of these companies, no matter what situation will always continue to have core demand. They are generally considered to be cash-rich and low on debt with wide distribution networks.

Some investors enjoyed the upward trend in FMCG stocks and booked profits, benefiting from the rally in the sector to explore other investment options. The following table aptly supports our observation wherein the FMCG index gained in the post-pandemic period by around 45.4 per cent but as the risk appetite of investors increased, the index lost its shine, declining by 3.03 per cent on YTD basis. The Sensex has gained by 5.3 per cent on YTD basis while the index rose by around 41.45 per cent in the last one year.

Conclusion

Though FMCG companies have always been a safe bet, in thepresent times investors should be very cautious with selecting any stocks of FMCG companies. FMCG businesses which are diversified and have the capacity to quickly adapt to the changes around them are the real safe bets. Some segments in the FMCG sector bore the brunt of the pandemic. FMCG companies primarily focusing on footwear, cigarettes and liquor categories were some of the most impacted in the past four quarters by the lockdown since March 2020. Additionally, the other main concerns for FMCG companies remain to be declining sales which in turn leads to lower return on equity (ROE).

Over a period of time, FMCG companies have not only been about top-line growth but also about margin expansion and profitability. Hence, along with profitability, volume growth is being considered as an important instrument to check the health of businesses. Market leaders such as Nestlé and Hindustan Unilever Ltd (HUL) benefitted over their peers through exhibiting consistency of their performance, neither being dependent on input costs. A diversified portfolio for HUL allows for the company to be able to bargain or demand better shelf space with retailers. Additionally, the company strongly stresses on a constant push towards repackaging and re-launching of its products to bring about excitement among its consumers as well as to attract new consumers.

Going forward, FMCG companies must continue to work on creating premium products as it is said that a start with a small share of the consumer wallet can gradually grow to cover the lifecycle of that customer. For example, a consumer that today buys the minimum priced product of the company will someday surely buy a luxury product since he is confident about the company and its sustenance. As over a period of time urban consumers continue to disproportionately shift to higher margin premium products, FMCG companies have a chance to cater to their needs and generate demand growth resulting in positive revenue trends. Though Indian consumer companies are likely to remain high-quality franchises, their return and growth path on a long-term basis remains to be a point of concern.

Hence, to conclude, our advice to investors would be to make minimal allocations to FMCG stocks. There are other sectors stocks which are getting rerated and can be looked at more aggressively. In case one is keen to include FMCG stocks in the portfolio, only those FMCG stocks with diversified product portfolio, attractive valuations and earnings visibility should be added.

Investors can especially hunt for opportunities within FMCG basket where the stocks are reflecting below industry average P/E, high earnings growth and above average industry RoE.

 

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