The economic downturn of 2008/09 hit every sector under the sun, but some were less affected than others. One such sector was fast moving consumer goods, or
FMCG , which remained a relatively safe haven for investors. The reason is apparent - in the FMCG sector, there is no cyclicity involved. FMCG scrips rarely soar, but they do not fall steeply either. (The same is true of pharmaceutical stocks.) The demand for these goods may not be entirely immune to market-moving factors like GDP growth, inflation or interest rates, but it is not wholly dependent on them either. People will keep buying soap and toothpaste, for instance, or medicines, even if the prices shoot up. Thus FMCG and pharma stocks are termed 'defensive stocks'.
In India too, FMCG scrips appeared relatively sluggish when the markets were booming from late 2006 to early 2008. But, all through the financial crisis and even thereafter, FMCG scrips have either performed better than, or been neck and neck with, the broader BSE Sensex.
Stock Taking
FMCG scrips outperformed the Sensex during the slowdown...
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But there are leaders and laggards too within the FMCG space. What sets the former apart from the latter? Brand equity obviously brings higher revenues and profit, but innovation makes a big difference too. Driving brand equity helps companies build long-term success stories. For instance, sustained investment over the last 25 years in Nestle's Maggi, a household name, has led to the creation of a brand worth about Rs 800 crore.
However, innovation matters just as much. "Innovation is what sets apart the best consumer companies from the average ones in the long term," says Manish Jain, FMCG analyst at Nomura India.
A strong innovation-led approach is critical to the long-term success of a consumer company. It is not only the Maggi brand, but also constant innovation that has seen a company like Nestle India's price to earnings, or P/E, multiple expand manifold over the last 10 years (See Stock Taking). Compare this to, for instance, Hindustan Unilever, whose P/E multiple has contracted on the back of less successful strategies around innovation. "Innovation is an important growth driver," agrees Vijay Chugh, Director of Research at Ambit Capital.
Chugh, who tracks the sector, believes innovation is a necessity now with global competition entering in a big way.
"The track record of successful innovation is equally important," says Abneesh Roy, analyst at Mumbai-based Edelweiss Capital. Roy too cites Nestle India - the most expensive stock in the FMCG space - noting that the company's instant pasta became segment leader in India in just one year with 70 per cent market share. "This is the quickest Nestle's has got to top position in its global history," he says. Though Sunfeast was already present in the instant pasta space when Nestle entered, the former has not been able to make much room for itself. Given Nestle's larger spend on research and development, Roy believes smaller companies cannot make a very big difference. "However, small companies can use their innovation capabilities to lead in niche spaces," he adds.
Innovation need not always mean new products. It could mean new packaging or ingenious pricing. For instance, the move to sachets has been a big positive for FMCG companies, roping in a large, new section of buyers and enabling penetration into non-urban markets. Jain also cites GlaxoSmithKline Consumer Healthcare India, or GSKCH, as another company that has reaped the rewards of innovation. Its P/E multiples expanded significantly, from 16 times in 2007 to 32 times now, as it changed track from being a purely malted beverage company to include other products such as instant noodles, energy bars and drinks in its portfolio.
Unlike in the pharma sector, however, no FMCG innovation can transform the fortunes of a company. A strong innovation pipeline in an FMCG company excites investors, but they wait for long-term consumer reaction. The timelines are more stretched for FMCG companies; they need to keep investing in marketing to ensure buyers come back, says Jain of Nomura India.
"For a new product to meaningfully contribute to revenues and profits, it has to grow at a fast clip for a number of years," he adds. "It can be a very different story for pharma companies, where one new drug, if successful, can double the company's existing revenues in a matter of years." Jain cites the example of the Rs 400-crore oats market in India. Marico Industries launched Saffola Oats in June 2010 and it has already become a Rs 30-crore brand. But the product still has a long way to go before it starts contributing meaningfully to the Rs 2,061 crore revenues of Marico.
Invariably, FMCG companies bringing in regular innovations command better valuations than their not-so innovative peers. "The innovators always tend to trade at much higher valuations, as a strong innovation pipeline gives investors more confidence about the long-term health of the company," says Jain.
Again, in India, within the FMCG space, food companies trade at much higher valuations than those in the home and personal care space, as the former tend to have a stronger innovation pipeline. For instance: In the last four years, P/E multiples of Godrej Consumer Products has increased from 27 to 32 times whereas that of Britannia Industries more than doubled from 29 to 62 times.
"Commercial innovations drive growth. Valuations respond to growth and profitability," concludes Chugh of Ambit Capital.
