Consumer sector: profitability to come into focus in fiscal 2012

Consumer sector: profitability to come into focus in fiscal 2012

Consumer non-durable stocks have a tough act to follow in fiscal 2012. In the past 12 months, the FMCG (fast-moving consumer goods) index on the Bombay Stock Exchange has risen by 31%, compared with the measly 11% rise in the benchmark Sensex. While two stocks—Hindustan Unilever Ltd and ITC Ltd—make up for a major part of the index, other stocks, too, have contributed their bit.

Fiscal 2011 saw some sensible thinking from companies faced with higher input costs, and concerns about what inflation might do to consumer demand. They focused on volume growth, not using inflation as an excuse to raise prices.

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Competition also played a key role in keeping prices down. In calendar year 2010, the consumer packaged goods market grew by 20%, a repeat of 2009, reaching a size of Rs1.43 trillion. Much of this growth would be volume driven.

But this growth came at a price that companies considered worth paying. Growth in profitability was affected by rising input costs. Companies combated it by cutting back on costs, moderating growth in wages, and by curtailing growth in other expenditure. Even advertising and promotion costs saw slower growth, especially in the second half of fiscal 2011.

That brings us to the current fiscal. Inflation from petroleum-related products can be expected to continue. While detergent makers will be worst hit by this, plastic packaging costs for all companies will be higher. Malaysian palm oil prices have fallen by 11% from their highs of January, but are still higher by 40% over a year ago. That’s bad news for soap companies—which use palm oil intermediates—and for packaged food companies.

On the positive side, food prices have moderated significantly. Some of it is attributable to government policy and others to a good crop. Unless this year’s monsoon turns into a disappointment, the outlook on the food prices front seems benign. Sugar prices are up by 3.5% year-on-year in April, wheat prices are unchanged, and milk is up by 5%, according to government data.

On the consumer front, inflation has become more broad-based (earlier, it was mostly basic food-related), and interest rates have begun rising. In the past, this has affected spending on discretionary goods, and it could be repeated. Consumer companies don’t have much leeway to make the price level more attractive, without hurting margins.

Their scope for cost controls, too, appears diminished. In 2012, salary hikes are likely to be sharper, to compensate for inflation. It is impractical to expect advertising and promotion costs to be under control for too long. The need for growth and the effect of competition will result in selling costs increasing.

A sharp hike in interest costs may not affect consumer companies, which sell on cash (except to modern trade), but the trade will feel the heat from higher interest costs. A demand for higher commissions could affect margins as well.

In sum, the macroenvironment remains a challenge for consumer companies, more so for home and personal care firms. Food companies may have it better though, especially the ones such as Nestle India Ltd and GlaxoSmithKline Consumer Healthcare Ltd.

And, the consumer packaged goods market may find it difficult to repeat 20% growth for the third year in succession. Rural markets could continue to make a difference, as they did last year.

The consumer sector could live with a little slower growth in fiscal 2012, but needs costs to come under control. That will add more heft to profit growth, which is what investors are ultimately concerned about. If sales growth and margins both show cracks, it would spoil investor sentiment.

Graphic by Yogesh Kumar/Mint

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