FMCG Stocks: The Truth & myths of so called “Safe Bets”

Every now and then readers have suggested that I write about the FMCG sector and in particular, FMCG funds. Since I know next to nothing about this, I requested Krishna Kishore who writes a refreshing blog on stock investing at tyroinvestor.com to discuss some of the myths surrounding FMCG stocks. This is his second post at freefincal. He had earlier written about a Guide to Understanding Stock Screeners, helped me (along with Indraneal) design the Freefincal Excel Stock Screener, spoke twice about equity investing at the Bangalore DIY investor meets and was part of the organizing committee in all the 5 meets held there.

I thank him for immediately accepting my request. As always his striking clarity of thought shines through. Over to him.

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Imagine a Cat chasing a Mouse. It’s all about the "dinner" for the Cat, but it’s a "race for Life" for the Mice.

Colgate being the market leader in Oral Care for decades (Forhans was the challenger brand but it is completely forgotten today. Binaca, which later became Cibaca and finally got taken over by Colgate, was another challenger.), had to actually run for its Life when HUL came up with Close-Up.

Here the Cat is HUL, as Tooth paste is just one segment of its over all huge portfolio. But for Colgate it’s the bread and butter.

But ever wondered why Colgate is a Paste and Close­Up is a Gel??

The reason is, HUL knew that, it can NOT take market share from Colgate (which also have equal financial strength) by competing in the SAME segment (i.e Paste). Hence it changed the strategy and came up with a new segment all together called a GEL. (If you can't change the field, change the game 🙂 )

It is high on freshness ingredients, the transparent look and the youth-centric approach gave Colgate some sleepless nights at the time. Close­Up gained a significant share of the market, forcing Colgate to launch a similar product and alter its strategies for some time. Colgate has regained its share since then, but Close-Up continues to hold a majority share in the gel category, with Colgate Gel remaining a distant second.

Well, by now you must have understood that, the theme of our today's post is "FMCG stocks", the truth & myths of being it called as an "All Time Safe Bets".

Let’s try to discuss few points which are mostly true with some hidden myths in them:

1) People always need FMCG products. Our money will be safe here.

2) They pay hefty dividends & have very high ROE & ROCE ratios.

3) These gives our portfolio required stabilization during carnages.

4) There will be less competition for already established brands.

Let’s get into these points:

1) People always need FMCG products. Our money will be safe here:

To a major extent it is true. But the catch here is, "At what stage did we board the company?" and "How much more is the growth runway ahead?”

Following are the 10-year CAGR returns for different FMCG companies:

India-FMCG-stocks-1

As we can see here, the returns are completely different and has NOTHING to do with the brand popularity. Colgate is surely the bigger brand than Emami in its respective segment. Horlicks is also a bigger brand compared to Dabur.  But why this discrimination?

By 2006, Colgate was already an established brand and the penetration from then was not in par with Emami. Emami being a fast grower (in fact in a process of building the brand) has huge runway ahead of them and is clearly the winner. Read more about stages of company growth here: Supporting Entrepreneurs

These are the different stages of any company vis-à-vis its growth prospects & market share:

(Low Market share, Low Growth) -->Pet

(High Market share, Low Growth) --> Cash Cow

(High Market share, High Growth) --> Star

(Low Market share, High Growth) --> Question Mark!

The Investors will surely benefit from buying a company at Early Growth or Rapid Growth when compared to the Maturity stage. This is exactly what happened.

HUL's, Colgate's, P&G's are big fat white elephants and it’s really difficult for them to run fast. The environment doesn't make easy for them.

Krishna, do you mean that the companies with high Market Cap cannot grow fast?

Not exactly. I am Market cap agnostic. Let me give you an example.

The market cap of Colgate is around 25000 Cr. Agreed that there are still majority of people who have not even used toothpaste for the first time. So Colgate can grow on volume basis (Slowly but surely over a long period of time)

At the same time, another company HDFC bank which is 10 times of Colgate on Market cap basis, will grow much faster than Colgate. The Market share (not market cap) of HDFC bank vis-a-vis Indian banking system is around 5%. Long way to go for them. The value migration from Public banks to Private Banks will happen much faster than Colgate penetrating to un-reached.

So, thinking that Big Brands from FMCG will provide us good returns over a period of time has to be taken with a pinch of salt. We have to consider what stage of the company we are entering into it, and what the available runway for growth is.

2) They pay hefty dividends & have very high ROE & ROCE ratios:

Very true. Even most of the companies operate on Negative working capital. There Capex needs are minimal. Throwing huge cash piles of dividends every year to the Investors. The reason for this again comes from the above image. Low Growth companies which had almost captured the entire market will become Cash cows and there is nothing wrong playing a Dividend game. In fact few stalwarts (as Peter Lynch call them) in the core portfolio is always a good strategy to play, provided we understand what to expect from them. Expecting a doubler from P&G in a year or two may not look realistic (in optimal market conditions).

3) These gives our portfolio required stabilization during carnages:

Following will vaguely depict the consistency of earnings for different companies:

Consistency of Earnings (not stock performance) for HDFC bank > HUL > ITC > Tata Motors > ACC > Tata Steel etc.

During the time of Carnages, the low beta stocks like Colgate, HUL, Gillette will help us to fall less and surely an important point to be considered.

4) There will be less competition for already established brands:

This is where the things gets interesting 🙂

Till date, all the MNC's are enjoying lion share of Indian Consumer market. Now an underdog has entered into each and every segment of them and giving them sleepless nights. The "Patanjali effect".

Watch this video to understand how Patanjali is effecting the volume growth of Colgate, bringing it down from 7% to 5% now.

PAL is really becoming a HUGE threat to both Indian and MNC companies. It already have revenues at around Rs 20 billion and targeting to achieve a top line of Rs 50-100 bn which is a target of 5 times of top line in next few years, the number any FMCG company (well established) couldn't even able to achieve even in wildest dreams.

CLSA recently came up with a report titled "Wish You were Listed" sums up the growth potential of PAL and the exposed threat of other companies. Download the report from here: Baba Ramdev: Patanjali-AyurvedaHere is a screenshot from the report.

India-FMCG-stocks-2

BTW, Patanjali is using an "Emotional" connect called "Make in India" on the Urban people mostly. This is part of what is called as "Guerrilla Marketing".

Any company which is trying to market in an unconventional, low-cost, high impact using emotional connect to reach more and more customers.

Watch this video to understand this strategy:

So, finally here we have an unlisted company (CAT) making all others to run for their Lives (Mice).

The final point I am making here is, The Generic statement saying "FMCG is synonym of Safety" in the markets may not be always true.

Happy Learning & Happy Investing 🙂

-END-

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In case you are wondering, the "-END" is Krishna's signature :). If you wish to connect with Krishna, the simplest way is to join Facebook group Asan Ideas for Wealth.  Do join me in congratulating Krishna for a well-written article.

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10 thoughts on “FMCG Stocks: The Truth & myths of so called “Safe Bets”

  1. Anil

    Hi pattu sir, thanks for considering my request in fmcg, and writing a blog (Krishna). But, I feel it's inconclusive. No details on how much we can expose to fmcg, and other details would me much helpful.

    Reply
    1. freefincal

      It is a market! No one can write conclusive articles about it. If you want specific advice about whether you should invest or not and how much, this is not the place.

      Reply
  2. vijay

    Thanks, Pattu Sir,
    As usual lucid - even a novice like me can follow.
    D tell us how to read excel files and graphs too !!

    Reply
  3. indian

    Good article. I have noted my concerns below:

    (1) I wonder how much Patanjali can scale. These FMCG companies hire top graduates from IIMs, put majority of them into sales and give higher and higher targets with higher and higher bonuses till they burn out and quit... And the story continues with some new person. Will Patanjali be attract top employees, sourcing of raw materials, distribution, financial management ...

    (2) I agree with emotional pitches like Make in India and herbal/natural focus, Patanjali has an emotional connect with majority of *urban* Indians. But one or more issues with the products and all this advantages will vanish. As it is Ayurvedic medicines contain high amounts of arsenic etc.. Lead in Maggi kind of issues if seen with any of Patanjali's products will cause permanent damage to its image.

    (3)Though CBI/ED has given a clean chit to the top man running the show, with any change in the government -- these issues can come back to haunt him and the company.

    (4) GSK consumer -- moneycontrol shows the last 10 years stock has been trending up. I am not sure you have accounted for the bonus etc.

    Reply

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