This article could also have been titled “How not to be fooled by the FMCG Index”? If you look at the FMCG index performance in the last 1 year, the returns are around 11%. That is really nothing to write home about. The real reason for this tepid performance of the FMCG index is the high weightage of 42% that ITC has in this index. Unfortunately, the cigarette maker continues to be an overhang and this stock continues to trade close to its 52-week low. If you take the next 2 stocks in the FMCG index in terms of weightage, then Hindustan Unilever and Britannia have given a return of 60% in the last one year. Now you do not have stocks like Hindustan Unilever and Britannia giving 60% returns in a single year without any reason. There is something happening in the demand for FMCG products, which is not captured by the FMCG Index. If you leave out the ITC effect on the index, this index should have been a stupendous outperformer. Here is why.
Boost to consumer demand
The combination of higher government payouts and payouts to the retired army personnel in the last 2 years has resulted in a major demand effect for FMCG products. That is obvious from the top line growth that companies like Britannia and Hindustan Unilever are seeing. Indian economy, even in the post demonetization period, has grown at close to 6.5% and is likely to cross the 7% mark once again. That means a huge boost to demand for FMCG products. That is finally showing up on the top line and bottom line numbers of FMCG companies. Forget about ITC and the cigarette effect; there is a subtle demand shift that is pushing FMCG companies higher.
Higher rural income levels
As agricultural income was falling over the last 4 years, most FMCG companies were genuinely worried. Rural markets are not only a big chunk of their demand but they are also the markets that get them the alpha. Companies like Hindustan Unilever, Britannia and Colgate are all heavily reliant on the rural market to boost their sales. Things have changed since the Union Budget 2017. In the last two budgets, the government has given a major thrust to rural spending. Assured MSP at 150% of the cost of production, massive infrastructure projects in rural areas, an unprecedented rural employment generation program; have all been instrumental in propping up rural demand in a big way. That story looks set to continue further.
Reduced price wars in the industry
Those of you who remember the famous price wars; they were all fought in the FMCG sector in the past. One of the earliest wars was fought between Nirma and Hindustan Unilever for the detergent powder market in the early eighties. Much later, in the mid 2000s there was the massive price war between Hindustan Unilever and P&G in the complete gamut of FMCG products. More recently, Patanjali did threaten to be a serious contender but it still has some way to go. The fact is that the FMCG market has become a lot more organized and balanced and players have realized that in a market like India, the potential is so huge that price wars may not be required. That has helped FMCG companies hold their margins.
Shift to organized retail
This is a shift that has been happening for some time but is likely to become more pronounced after the launch of GST since July last year. Under the previous excise duty system, many in the unorganized sector had a price advantage as they could produce at much lower cost without the duties. However, with GST, most of the players will come under GST and there will be a serious shift towards the organized sector. The price advantage that the unorganized sector enjoyed will gradually vanish. That shift is likely to result in a big value proposition for the large FMCG companies.
Greater outlets for faster churning
With the onset of ecommerce in a big way and multiple platforms, FMCG products are now available at the click of a mouse to be delivered at your doorstep. Instead of focusing on investing in outlets, the FMCG companies can now focus more on investing in logistics. In terms of fixed costs that will be much lower. Also greater demand off-take due to multiple channels will result in better utilization of resources for FMCG companies. For example, apart from their own ecommerce websites, FMCG companies can sell through Flipkart, Amazon, and Grofers etc.
GST and the logistics advantage
This is a very important advantage that is an outcome of the GST. In the past, the large FMCG companies had to handle a very complex interstate sales tax structure. As a result the entire logistics network of the FMCG companies was structured on the lines of making the sales tax management simpler. That is no longer the case. All these taxes have now been subsumed into a single GST and that is going to be positive from a logistics perspective. Now the logistics network and structure of the FMCG companies will be based on competitive advantage and optimal delivery rather than based on sales tax considerations. This is likely to add to efficiency.
In a nutshell, there is a subtle shift that is happening in the FMCG space. In the medium to long term this is likely to be value accretive. The pegs are all falling in place after a long time. It could be a true blue value creation story in the coming months.