The sector is divided into two distinct

segments - the premium segment

catering mostly to the urban upper
middle class and the popular segment
with prices as low as 40% of the
premium segment, catering to mass
segments in urban and rural markets.
The premium segment is less price-
sensitive and more brand conscious.

 India's rural markets have seen a lot of

activity in the last few years. Since
penetration levels are pretty high in most
urban areas, future growth can come only
from deeper rural penetration and higher
consumption. As rural income increases
and distribution network improves (in line
with road development projects), the
penetration levels are set to increase. At
present, urban India accounts for 66% of
total FMCG consumption, with rural India
accounts for the remaining 34%. However,
rural India accounts for more than 40% of
the consumption in major FMCG categories
such as personal care, fabric care and hot
beverages.

 The industry is volume driven and is

characterised by low margins. The products
are branded and backed by marketing,
heavy advertising, slick packaging and
strong distribution networks. Also, raw
material prices play an important role in
determining the pricing of the final product.

 Despite the strong presence of MNC

players, the unorganised sector has a
significant presence in this industry. In most
categories, the unorganised sector is
almost as big if not bigger as the organised
sector. Unorganised players offer higher
margins to stockists in order to gain
marketshare.
 Key Points
Supply Abundant supply in metros. Distribution networks are being
beefed up to penetrate the rural areas.

Demand FMCG sector poised to grow 4-fold to $95 billion in 10 years,

says Federation of Indian Chamber of Commerce and Industry-
Technopak report.

Barriers to entry Huge investments in promoting brands, setting up distribution

networks and intense competition, but the sector is not capital
 intensive.

Bargaining Some of the companies are integrated backwards, which

power of reduces the supplier's clout. Manufacturing is largely
suppliers outsourced.

Bargaining In case of branded products, there is little that the consumer

power of can influence, but intense competition within the FMCG
customers companies results in value for money deals for consumers (e.g.
buy one, get one free concept).

Competition Competition: Competition is faced from both domestic, MNCs

and also from cheaper imports, which are increasingly visible in
urban markets. Price wars are a common phenomenon.
TOP
 Calendar Year '09-'10

The Rs 1161 bn FMCG sector grew by 13.4% YoY in 2009. Higher penetration,
per capita consumption, increasing population base, and household income
continued to drive growth. The willingness to spend backed by the ability to do
so was also instrumental in bolstering growth. The sector got further impetus by
several tax sops, greater focus on infrastructure development as well as a boost
to rural income.

The rural markets were the main growth drivers. The number of households in
rural areas using FMCG products went up from 136 m in 2004 to 143 m in 2007
implying a CAGR of 1.7% on the back of higher penetration. In 2009, the rural
areas grew at a robust rate of 18% as compared to 11% growth in urban retail
market. According to a McKinsey, rural India, would become bigger than the
total consumer market in countries such as South Korea or Canada in another
twenty years. While the per capita income in rural areas is lower than that in
urban areas, the customer base is thrice that of urban areas.
Most of the companies had faced competitive pressure during 2009. The
companies had to take judicious price increases and also reduced the packet
sizes and stock-keeping units (SKUs). Hence the growth seen by FMCG
companies was almost entirely volume led. During the first half of the year, the
raw material prices saw a fall. Hence in order to maintain the market share and
volume growth the FMCG companies passed on the benefit of lower raw
material prices to the consumers. Further, the reduction in excise duties also
aided their performance. However, a sustained inflationary environment hurt
margins.

With the economy on a high growth flight, robust consumerism, greater rural
penetration and rapidly growing organised retail, we remain bullish on the
growth prospects of the FMCG space. While rural regions would drive
consumption due to higher penetration, organised retailing in urban markets
would help increase value growth led by demand of premium products. The shift
from unorganised to organised and from unbranded to branded will add further
impetus to growth in this segment. However, concerns remain with respect to
the increasing competitive environment, input cost pressures and infrastructure
bottlenecks. Companies, which have the ability to maintain and increase the
market share, offset cost pressures without sacrificing volumes would stand to
 benefit.
TOP
 Prospects
Rising per capita income, increased literacy and rapid urbanisation have caused
rapid growth and change in demand patterns. Apart from the demand for basic
goods, convenience and luxury goods are growing at a fast pace too. The urban
population between the ages of 15 to 34 years is expected to increase from 107
m in 2001 to 138 m in 2011, an increase of 30% per annum. In fact by 2020 it is
expected that the average age in India will be 29 years. This would unleash a
latent demand with more money and a new mindset. With growing incomes at
both the rural and the urban level, the market potential is expected to expand
further.

While the homegrown companies are looking to expand beyond the Indian
shores, the MNC subsidiaries are likely to look for greater leverage of their
respective parent's strength. Since India is a big potential market, none of the
big MNCs can afford to ignore the region for long. The decade ahead is likely to
see more MNCs looking to enter India, as organised retailing picks up.
Due to the large size of the market, penetration level in most product categories
like jams, skin care, toothpaste, hair wash etc. in India is low. This is more
visible when a comparison is done between the rural and the urban areas.
Existence of unsaturated markets provides an excellent opportunity for the
industry players in the form of a vastly untapped market as the income rises.
Another key positive for the sector is the current government's focus making
India the hub of agri-processing.
FMCG products are witnessing a retailing revolution in recent times. While some
retail chains have large retail formats enabling huge volumes, some are focused
on affordability which has resulted in margins getting squeezed. The Indian
market is dominated by more than 12 m small 'mom and pop' retail outlets.
However only 4% is in the organised sector, thereby reducing the reach. With
FDI expected to be allowed, the share from the retail formats is expected to
increase.
Rather than look at the various segments, prospects or market shares of the FMCG sector, this week let
us take a look at ways to identify a good FMCG stock. With the markets currently on an upswing, it is
even more important to differentiate the chaff from the wheat. Here goes…

Key drivers
As we all know, India’s per capita consumption of most FMCG products is well below the global average.
That is largely because of the economic conditions, i.e. the purchasing ability, and also because of lack of
awareness of these products. A look at the chart below gives a snapshot of the key growth drivers for the
FMCG industry.

Logistic strength
While the purchasing ability is a function of economic growth, awareness is a function of the product
reach and its usability. It is in this context, that a company’s logistics strength gains importance. But
logistics does not only mean a company’s reach in terms of retail outlets, it also means the level of
sophistication of this distribution reach. How intelligent is this supply chain, how well geared for the
company’s future growth?

For example, Company A products reach 1 m retail outlets, but the reach is largely people intensive using
the traditional dealer stockist method. Also, the retail outlets are largely small provision and shop owners.
On the other hand, Company B has a retail reach of only 0.5 m retail outlets, but almost 70% of its
stockists are electronically networked.

In the above case, even though Company B reaches out only to half the number of retail outlets as
compared to A, it is likely to be more efficient and profitable for the company’s growth going forward. For
an FMCG company, once a distribution chain is set up, it is the quality of that set up that gives it an edge.
Using the same chain, an FMCG company can introduce more products and brands at a faster pace and
at a lesser cost, and optimize the channel benefits. In the long run, such a distribution network will be
more profitable as it helps the company to keep adding to its product folio at more or less the same fixed
cost.

Product folio
MNC companies form almost half of the branded FMCG industry in India. In case of MNC companies,
therefore, it is relevant to look at the parent support and commitment to its subsidiary before taking an
investment decision. Again, support and commitment alone is not enough. Have a look at the parent’s
product profile and what are its plans for its subsidiary in India. If the parent itself is present only in a few
categories globally, all its support is of little help owing to the product hindrance.

For all companies, be it domestic or otherwise, a look at the company’s product introduction track record
is an eye-opener. How many products has the company introduced in its years of existence, how relevant
are they to India’s consumer habits. What are the future plans of the company?

Competitive strengths
FMCG companies’ success is often attributed to their marketing and branding skills. Ability to
continuously create successful brands and advertising which gets the message across often spells
success for a company. Once a brand is successful, it easier for a company to piggyback on its initial
success introduce more products and associate them with the known brand. As they say, ‘nothing
succeeds like success’.

As said earlier, the more the number of product offerings, the more each resource is utilised, be it the
distribution channel, the marketing or branding strengths. It is in this context, that single or a few product
companies are risky. Number one, they have to continuously be wary of competitors coming in and
weaning away market share. Therefore, they have to continuously spend higher on advertising and
marketing. This is a double whammy for a company under pressure. On one hand, revenues are under
pressure and on the other, costs go up and margins are squeezed. Also, due to this, the company is often
shy of investing in new products and expanding its distribution network. Bottomline, future growth
prospects get stunted.
We talked of MNC companies earlier. One very important thing that an investor should look at is the
number of subsidiaries the parent has in the same country. For example, P&G and Glaxo SmithKline,
both have a few other subsidiaries, beside the listed entities. If the parent has another subsidiary,
especially if it is unlisted, then it is likely that the foreign parent would be inclined to introduce new brands
and products through the 100% subsidiary. As such, shareholders of the listed subsidiary will not be able
to reap the rewards of the product portfolio expansion.

Investors should be wary of investing in such companies where parent focus and plans are under a cloud.

Key financials and valuation ratios to look at

 Last 5 years revenue growth (CAGR) and what is the reason for the said growth. If encouraging
growth has come about due to continuous new product introductions and growth in market share,
it is an encouraging sign.

 Operating margin trend What sort of margins is the company earning, vis-à-vis its peers.
Whether the trend is improving or is there a continuous decline. Find out reasons for both. If it is
improving due to efficiencies in supply chain and product focus, it is encouraging. If it is declining
continuously due to hike in advertising spends etc., it is a sign of the company facing intense
competition. However, if the margin decline is a blip and has come as a result of a new product
introduction, it is a good long-term sign.

 Look at the company’s cash flows and the working capital efficiencies. It will give you an idea
of the company’s bargaining power as well as its ability to utilize its resources and supply chain.

 Look at the return ratios, especially ROCE (return on capital employed) trend. It will give you an
idea how effective the company is in optimising its resource strengths. Also, look at the dividend
paying track record. A healthy dividend payout, i.e., the ratio of dividends to earnings, is also a
good indicator of the company’s willingness to share wealth with small shareholders.

 It is also important to look at the P/E (price to earnings multiple) and market capitalisation to
sales, which the company is trading at vis-à-vis its peers. Growth oriented companies’ will most
likely be trading at a premium to peers based on these parameters. If so, then one has to gauge
whether that premium is justified. If the premium is unrealistically high then it may not be a good
idea to invest at that juncture. After all, valuations have to justify the company’s prospects.

Above all this, look at the past record of the management, its vision and its integrity. For it is the
management finally, which is decision maker and therefore the guardian of your interests in the company.
So if the management has a track record of being on the sly or slow to react to market conditions, then
the biggest distribution channel and the most diversified product folio may not give you your rightful share
of the company’s growth and profits.