Moneycontrol Pro Panorama | Justifying the FMCG sector’s premium valuations 

Dear Reader,

Hindustan Unilever’s results confirmed the worst fear of investors that things may get worse before they get better. The Street had not priced it in, however, as evident from the 3.3 percent decline in HUL’s shares as of 12 pm while the FMCG index was down by 0.6 percent. ITC was a relative outperformer with its share price trading flat, probably helped by the relative comfort provided by its cigarettes business.
The core issues facing FMCG investors remains. One is that premium products are doing much better relative to mass products. This is despite price cuts implemented by the industry to pass on the benefit of falling input costs. In fact, the December quarter saw the FMCG market price change turn negative, at around 0.5-1 percent. This is likely to continue as HUL too has noted that if the current commodity price situation continues, it expects prices to decline.

Therefore, well-off customers are remaining loyal to their brands while those whose incomes are under pressure are switching to cheaper brands. These could be brands from smaller, regional companies and perhaps even unbranded products. In tea, for example, HUL said it saw shift to loose tea, which means the price differential was enough for them to ditch their brands.

In fact, the FMCG market has seen much higher growth than HUL reported. As we mentioned in our analysis of HUL’s results, there was a time when HUL was outperforming the market when inflation was high, but now that has reversed. Therefore, a second issue is also that the large players, who mostly populate the listed universe of FMCG companies, are unwilling to cut prices as sharply as the smaller players have.
This is a marketing strategy as the large companies don’t want to drop prices sharply. What companies are doing instead is that they are investing the input cost savings not just behind some price cuts, but also in advertising and promotion. This will be visible across companies. This strategy gives them the leeway to better manage a future situation where commodity prices may move up, as they will possess an edge over the smaller players