ERODING BOTTOMLINE: Price wars will lead to profit-less growth for the sector. That's bad news for investors

The Rs 40,000-crore fast moving consumer Goods (FMCG) sector has under performed the benchmark Bombay Stock Exchange (BSE) Sensitive Index (Sensex) by as much as 43 per cent in the last one year. And this at a time of a broad-based rally in the market, when Sensex has zoomed almost 2,500 points-from 3,284 to 5,823 in the 12 months to February 2004. No wonder then that the sector's bigwigs such as Hindustan Lever, Procter & Gamble, ITC, Colgate-Palmolive, Nestle, and Tata Tea show up at the very bottom of Business Today-Stern Stewart Wealth Creators survey. Shockingly enough, as many as 26 companies, out of a total of 44 FMCG companies in the survey, figure amongst the biggest wealth destroyers. "For investors, the sector is as good as dead," declares Nikhil Vora, Vice President (Research) at Mumbai-based brokerage house, SSKI Securities.

The sector's lack of value and volume growth sit at the heart of the problem. Macro economic factors in either agricultural slowdown in 2001 and 2002, changes in disposable income and near-complete penetration in many of the product categories only partly explain the reason either for shrinking growth or wealth destruction. "You can't always have double-digit growth. And wealth creation is a function of comparative expectations and opportunities," defends Percy Siganporia, Deputy Managing Director of Tata Tea.

Well, to some extent what Tata Tea's Siganporia is saying is true. For there are very compelling opportunities for the investor at the stockmarket, what with the surge in core sectors such as oil and gas, metals, shipping and power, and the rise of new economy stocks in either pharmaceutical or information technology. A measure of the sector's fall from grace is its declining weight in the Sensex. In 1998, FMCG's contribution to the market capitlisation of Sensex (Rs 1,81,886 crore) was a high 41 per cent. Fast forward to the beginning of 2004, and you find the contribution plumetting to just about 14 per cent. "The entire FMCG sector cannot be said to be ailing, although some leading players may be experiencing a negative topline growth," argues Milind Sarwate, Chief Financial Officer, Marico Industries.

UNDER SIEGE: With margins falling across categories, brand equities are under threat

True again. For, barring Hindustan Lever (see HLL: A Victim Of High Expectations?), most big FMCG players have posted at least low double-digit topline growth in 2003. Shouldn't this, coupled with a very defensive nature of the sector (the demand for essentials like soap and detergents is relatively inelastic), at least make it a hedging favourite with investors looking to broadbase risk and, therefore, be net positive on wealth creation? For that is the experience in most markets across the world, where consumer staple companies such as Unilever, Nestle, and Johnson & Johnson are on top of the wealth creators league. "Earlier you bought into consumer staples because of cyclical hedging. But now, there is no merit left in that too," says SSKI's Vora.

He may be right. The economic downturn that started in 2001 and continued right till the middle of last year, quickly degenerated into negative growth for supposedly demand inelastic FMCGs. "With agriculture improving, more (consumer) money should come into the FMCG sector, though past observation points out to a lag time," says a sanguine A. Satishkumar, Managing Director of Chennai-based Henkel Spic. So is it that the stockmarket has over-reacted to a bad macro-economic environment where FMCG has suffered, and that the sector will automatically be back on the pecking list once high, double-digit sales growth return on the back of agricultural revival and thus an economic upswing?

V FOR VOLUME: Thanks to the regional brigade, volumes and not value will drive growth

Very unlikely, for two reasons. For one, there is little correlation between general economic and agriculture growth and demand for FMCGs. Surprised? Well, that's what numbers seem to indicate. For instance, between the late 80s and the mid-90s, agriculture growth averaged 5.88 per cent, according to National Council of Applied Economic Research (NCAER), and FMCG growth galloped twice as much at 12.4 per cent. This disproportionate growth was solely penetration-led and, therefore, unlikely to be repeated, even though agriculture looks set to cross production record of 220-million and the economy is clipping at 8 per cent-plus currently.

So saturation does seem to be the industry's bane. For instance, between 1987-88 and 1995-96, penetration of soaps in rural households grew from 86 per cent to a near-saturation level of 98 per cent. And that of detergents went up from under 40 per cent to over 60 per cent. This boom was partly due to the conversion of large population from non-consumers to first time consumers of manufactured products. With penetration growth nearly over by mid- to late 1990s, FMCG growth started slacking, even as agriculture growth touched 9.3 per cent in 1996-97, dropping to 7.2 per cent in 2001-02. In the current fiscal, agri growth could touch 10 per cent.

There's another strand to FMCG's tale of woes. Even if the sector were to come back to high double-digit growth, it will necessarily have to be at the cost of profitability, because there are just no other growth drivers left. There is a virtual commoditisation of brands in FMCG, with every selling proposition, save price, flogged dead and with it, consumer involvement. "With brand equities under threat, complacency is a thing of the past and margins are coming down," bemoans Sunil Duggal, Chief Executive Officer, Dabur India. A direct fallout is the price war that has erupted in the detergents and shampoo market, and which is threatening to spill over to other FMCG categories. "Though intensity and width of consumption is set to grow, topline growth won't be reflected on the bottomline because of price wars," says Dabur's Duggal. And there is nothing more than profit-less growth that investors love to hate. "The FMCG sector will not be a value creator. Only volumes game (for mere survival) will be played out," says R. Subramanian, Managing Director, Subhiksha Trading, a Chennai-based discount retailer.

And sadly, from the stockmarket's perspective, successful new FMCG formats such as direct selling, with industrywide sales of over Rs 2,000 crore, or the emergence of strong regional players in either Kanpur Detergents or CavinKare, is nothing short of a double whammy. They not only took growth away from under the noses of some listed FMCG biggies, but by virtue of being privately held, denied investors the opportunity to partake in their success. "We do not directly compete with traditional FMCGs for shelf-space. The competition, however, is there to grab the mindspace and the space in the consumers' home," says William S. Pinckney, Managing Director & CEO, Amway India. Bottomline: For India's beleaguered FMCG giants, respite may be long coming.

-additional reporting by Arnab Mitra, Nitya Varadarajan, Abir Pal, Kushan Mitra and Dipayan Baishya