Indian FMCG companies find themselves in a sweet spot after initial years of turbulence in this decade. If FY06 was a good year, then the current year promises to be equally good, with positive GDP growth, rising disposable incomes and jobs leading to an uptrend in FMCG demand.
Structural changes like modern trade and the introduction of VAT too have benefited branded companies.
In the quarter ended June '06, overall FMCG sales growth was up by about 10.2%. The September '06 quarter too is expected to end with similar good rates. Both rural and urban demand is on the uptrend, and rural demand in FY07 is on the fast track. That spells good news for companies like Hindustan Lever, Colgate-Palmolive, and ITC who sell products in both the mass and premium categories.
There will be pressure on margins too, though price hikes in categories like soaps, detergents and shampoos have cushioned the impact. The main areas where raw material prices have been rising are petro-based intermediates like packaging material, linear alkyl benzene, which is used in detergent production and chemicals for other personal care products.
Palm oil prices too have been behaving in a volatile manner, which could affect soap companies to some extent. In the foods segment too, wheat prices are up, though sugar prices are moving lower.
The sustained fall in crude prices will no doubt rub off on raw material prices, improving profit margins in the process. More so, as companies are unlikely to reduce prices amidst rising demand. One trend worth watching is advertising/sales ratios of companies, and whether they are able to sustain the levels reached during FY06.
As per the average of five brokerages' estimates, Colgate and HLL are expected to report strong growth in net profit on a year-on-year basis (Y-o-Y), while Tata Tea's bottomline growth is seen muted. "Colgate's sales are likely to grow 16% Y-o-Y led by strong volume growth on the back of rural demand," said a note by brokerage house ICICI Securities.
"Further, the full impact of a 4% price hike in toothpaste (effective mid-May '06) would be reflected in Q2FY07 (July-September). We believe that accounting in Q1FY07 was conservative and expect profitability to be significantly better in Q2FY07.
Despite factoring in the change in accounting practice related to netting of reimbursement from group companies, we expect operating profit margin to expand 46bps (basis points) on a Y-o-Y basis," the note added.
Dealers do not expect big surprises from any of the frontline FMCG stocks on the earnings front. These stocks have been underperforming the 30-share Sensex over the past one month. Compared with a 7% gain in the index, Colgate, ITC, Dabur and HLL have gained between 2% and 4%, while Tata Tea has shed 3%.
"There is little scope for margin expansion due to reduced space for price hikes, lower incremental fiscal benefits and no significant respite on raw material prices," said a preview note on the sector by Man Financial. The brokerage has said that current valuations in the sector are "fair", and there is no scope for further re-rating.