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FMCG Vs durables

Arun Rajendran & Vikram Srivastava | August 25, 2003

"HLL is faced with the challenge that FMCG markets, after growing in strong double-digits throughout the nineties, are now declining in value for the last couple of years.

Why is this happening? In urban India, consumers are now being exposed to, and are trying, several new categories, such as mobile phones, leisure, durables, etc, and are, therefore, down-trading their FMCG purchases.

Rural demand has been dampened by three unusually poor monsoons in the last four years. We believe that both these factors are transitory in nature and FMCG markets will surely find a new growth equilibrium."

M S Banga, chairman, Hindustan Lever, at the company's recent AGM.

Is there a message in Banga's statement for investors? If FMCG companies are feeling the heat from frenzied consumer spending on the other good things in life -- from TVs to refrigerators, ACs, washing machines, music systems, microwaves and even two-wheelers -- maybe you should rethink what this means for your investment in FMCG stocks.

If consumers are willing to get into debt to buy durables, but are scrimping on soap, toothpaste and shampoo as a result, maybe durables are the Next Big Thing on the bourses.

To be sure, the market's already taken note. In the last three years, all loan-driven sectors have taken off -- from housing finance to autos.

If Banga's lament is for real, the next sector that should take off is consumer durables. Will this happen? Most analysts do not seem to think so. And the reason has to do less with the industry's prospects than non-availability of good consumer durables stock.

Says Nikhil Vora, senior vice-president (research), ASK Raymond James, "There is a disconnection between the FMCG industry and the durables business.

The best companies in the durables business are largely controlled by the Japanese/Korean players like LG, Samsung and Sony, none of which are listed." Some big domestic players like Godrej, too, aren't listed.

Apart from traditional durables players like Videocon, BPL, Godrej Appliances and Onida, the damage in the marketplace is clearly being done by the LGs, Samsungs, Compaqs, Marutis, Hyundais and Tata Motors of the world which are pre-empting large chunks of disposable income for consumers of FMCG products.

And at the broad level, the numbers already show this even among listed companies. In terms of sales, the listed durables sector (including autos) is now nearly comparable to FMCGs -- Rs 34,424 crore (Rs 344.24 billion) in FY03 (including the newly-listed Maruti) versus Rs 35,989 crore (Rs 359.89 billion) for FMCGs.

But FMCGs clearly hold the upper hand in market cap. Compared to the Rs 76,330-and-odd crore market cap of FMCG companies as on June 30, 2003, the auto/durables group had less than a fifth of that (excluding Maruti, which hadn't been listed then).

One reason is that over the last three years, while revenues have grown faster in the auto and consumer durables segments put together (compared to FMCGs), profits have been patchy.

Exclude the auto sector, and consumer durables as a standalone have been seeing profits dwindle.

But the markets are clearly looking ahead, and the most telling indicator is probably the change in relative P/Es. Around mid-2001, FMCGs had a sector P/E of 24; autos and durables together were 16.

At the end of the last quarter (June 2003), the P/Es were closer at approximately 17 and 12.

Market value has begun to migrate away from FMCGs.

Thus far, though, only autos have benefited. Will consumer durables follow?

Not anytime soon. One reason is poor bottomline. Of a sample of around 35 companies in the auto and consumer durables sector, half of them were making losses as at the end of June 2003 (calculated on a rolling 12-month basis) while the number of losers among FMCGs was much lower at just four out of 31.

The other reason is, of course, the absence of market leaders from listed stock. While players like Videocon, BPL, Mirc and Voltas are there, missing are the Korean and Japanese companies, not to speak of Godrej.

Analysts also believe that the durables players -- whether autos or consumer durables -- are going through their own competitive pressures akin to the FMCGs, which makes them as vulnerable as the latter.

In the last few years, prices of consumer durables have fallen sharply as players have been fighting to snatch market share. Says Prashant Mulay, analyst at brokerage and research firm Stratcap: "A whole lot of erstwhile premium consumer durables products have seen a rationalization of prices. Now one can get a 29-inch TV for almost the same price a 21-inch TV was available a few years ago."

Price cuts and easy credit have propelled demand for durables, but these do not signal the best times for companies in the segment. "When competition intensifies most managements tend to behave irrationally, and that invariably affects their financial performance, which is bad for investors," says Rajat Jain, chief investment officer, Principal Asset Management.

Competition in the two-wheeler industry has also led to price wars. Analysts, however, keep faith in the managements of the largest two-wheeler makers -- Bajaj and TVS Motors -- although with a wee bit of doubt.

However, the same does not hold good for many durables players. That's one reason why FMCG companies continue to get better valuations on the bourses even today.

"If FMCG companies are quoting at relatively high valuations in spite of the low growth phase that the industry has witnessed in the last few years, it shows that the markets retain confidence in the quality of FMCG companies' earnings and their managements," says an analyst.

"Just because consumers' budgets are skewed in favour of consumer durables, it doesn't mean that valuations are also in their favour," say Mulay.

The Smart Investor takes a look at the relative merits of investing in the FMCG and consumer durables sector. Since autos have already been in the thick of news and analysis, the focus here is only on durables.

FMCG is bread and butter: Many funds managers and analysts are of the view that FMCG companies still hold promise. In fact, some of these stocks are necessary for a stable portfolio.

In recent times, price-sensitive consumers have been demanding more value for money spent on non-durables. As a result, large multinational companies, which have dominated the FMCG segment for many years with their solid brands, are now facing unabated pricing pressure.

These FMCG players have also had to contend with the availability of local brands, which often provide comparable quality offerings from biscuits to toothpaste.

Says Mulay, "People are definitely downgrading their purchases of premium FMCG products. It is clear that people won't pay a premium for using FMCG products as cheaper alternatives are available and regional players are offering the same quality and packing."

Thus, topline growth among the established players has been pretty subdued this year. In fact, Gillette India, Colgate Palmolive, HLL and Britannia have shown negative growth in their toplines.

However, their bottomlines continue to be robust due to continuous supply chain innovations and cost cutting.

The sluggish rural demand on account of poor monsoon for the last three years has worsened the case for FMCGs. But expectations of better monsoons have already prompted investors to take a relook at the sector.

In the recent rally, the BSE FMCG Index has gained 32.58 per cent, though that has been lower than the overall gain in the Sensex (40.04 per cent) from April 25 till date.

With good monsoons likely to improve performance, analysts do not see a chance of big downsides. But over the medium to long term, FMCGs will have to seriously re-examine the price-value equation and drop their fixation with high operating margins and return on investment.

Their strategies will have to be oriented towards market expansion -- like knocking down prices, providing value, thwarting competition, recapturing market share and raising per capita consumption, say analysts.

"All these measures could build up a platform for secure long-term growth, which would be impossible to ignore," says Vora. Most analysts recommend ITC, Colgate and Gillette as top picks in the sector.

Durables can be the toppings: Overall, listed consumer durable makers (other than auto makers) have not shown impressive performance either, though due to a different set of reasons.

"In spite of the rosy growth projections among consumer durables, the fact remains that it is an extremely challenging market. The advertising and promotion expenses and high level of competition have reduced margins substantially. The entry of newer foreign players has also intensified the race," says Mulay.

The erstwhile kings of the consumer durables space like BPL, Philips and Kelvinator have been languishing and showing negative growth in toplines, thanks to the invasion by Japanese and Korean players.

However, Mirc Electronics and Whirlpool India have seen good growth in their toplines though the latter and BPL have shown negative bottomline growth.

If one looks at the segment product-wise, companies in the air-conditioner segment have shown the best results followed by television makers.

The television industry has undergone a sea change in the pricing scenario due to the emergence of local players Salora and T-Series. Big players like Sony, Mirc and the like have had to undertake a series of price cuts which have pushed television sales overall.

Besides, the cricket and football World Cups have helped boost sales in 2002 and 2003. Industry sources say the colour television market is pegged to grow at 15 per cent annually over the next two years, despite high penetration levels currently.

Firstly, technological advances have made new technology -- such as flat-screen TVs --available to consumers at affordable prices. G L Mirchandani, chairman, Mirc Electronics, says, "Flat televisions should provide a boost to television sales in the country."

More importantly, the appreciating rupee should make television sets cheaper, as about half the raw materials used by the industry are imported. This should help build volumes.

Similarly, in air-conditioners, the growth has been mainly led by retail buyers. The retail sector accounts for a 60 per cent share of the overall market, up from 40 per cent two years ago.

Over the last five years, the retail air-conditioner segment has grown at an estimated 20-25 per cent annually. The growth projection for the coming years looks optimistic.

Says K J Jawa, vice-president, Voltas, "The retail air-conditioner segment is expected to grow by 25 per cent over the next three years because of lower prices and easy financing opportunities. However, I do not expect any major dip in prices because it would become unviable for many players to remain in the industry in such a scenario."

At a recent meeting with The Smart Investor, Ashok M Advani, chairman and chief executive director, Blue Star, had pegged the growth rate of the large corporate systems at 15 to 20 per cent.

Analysts say that the companies to watch out for in the consumer durables segment include Mirc Electronics, Voltas, Blue Star, Salora International and Videocon Communications.

The mood is still bullish among passenger car and two-wheeler makers. Analysts say that Maruti is a good bet, but is currently looking stretched on valuations. Bajaj Auto and TVS Motors are stocks to watch out for among two-wheeler makers, though both shares have had a dream run over the last 18 months.

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