Though the defensive nature of the business has kept the ball rolling for FMCG stocks, investors should be cognizant of the potential vulnerability of companies with higher dependence on one or two categories, especially non-food, for revenues and profits.
While the food segment is expected to perform well, companies like Colgate, Gillette India, Marico, and Bajaj Consumer Care may witness pressure as these companies earn 60-90 per cent of revenues from their respective core categories of home and personal care. Experts believe the threat in these core categories could impact their performance. The Covid-19 led disruption has severely impacted the non-food segments, which were already under pressure even before the pandemic.
Marico and ITC have also been focusing on other segments including food but their contribution is still low. For ITC, over 80 per cent of its operating profit comes from its cigarette business, which is exposed to regulatory risks. That’s also one of the reasons for its stock being available at historically low valuations.
According to Deepak Jasani, head of retail research at HDFC Securities, “Companies, which are highly dependent on single category are exposed to the risk of decline in market share with stiff competitive intensity or a risk of category decline or obsolescence and these risks can drag their overall performance and valuations.” The other word of caution is that stocks of some of the above-mentioned companies are still trading at a 14-17 per cent premium to their five-year valuation mean. While many of these FMCG players, which are leaders in their respective categories, have reported market share gains in their latest quarterly results, experts see a potential threat to their dominance.
G Chokkalingam, founder of Equinomics Research & Advisory, says the risk of losing market share is more for single-category players which have a large base and are leaders in their respective categories. Colgate is a good example of how competition has eaten into the leader’s market share. The toothpaste market leader lost close to 400 basis point market share in three years until June 2019. The company has stopped giving market share data since then. Analysts believe larger companies, such as Dabur and Hindustan Unilever, have turned very aggressive in categories like toothpaste and hair oil.
In the case of Gillette, the concerns stem from a change in consumer preference -- from shaving razors (and hence, creams, gels, etc) towards electric trimmers. On the other hand, although ITC is a well-diversified company, apart from the influx of illegal imports, VST Industries and Godfrey Phillips are impacting its main-stay cigarette business volumes.
Emails sent to the above-mentioned companies did not elicit any response.
Limited direct distribution is another factor hurting some companies. Naveen Kulkarni, chief investment officer, Axis Securities, says: “Some of these companies have high exposure to the wholesale distribution channel, which impacts the products’ saleability given the availability of other options.” Thus, access to direct retail distribution is crucial, he adds. Companies like Colgate, Marico, and ITC have the large direct reach, and hence are better placed than some others.
Apart from competition, down-trading (customers shifting to lower-priced products and brands), along with reduced demand in certain categories, is making the task harder for some of the less diversified companies, say analysts. According to Varun Singh, analyst at IDBI Capital, “Categories like hair oil are witnessing deceleration in the last one-two years.” He also believes companies with high dependence on non-food-categories may find it difficult to sustain high stock valuations. Companies, however, are taking various measures, such as launching new products in their core categories, as well as in newer segments, and expanding direct reach to improve their overall performance and market share. And, many of them enjoy strong brand equity which, in fact, will help scale up their businesses, both old and new. Some analysts though believe companies may have to compromise on margins to gain volumes. The jury is out on how much gains will accrue from these efforts, and how soon.