India has become the much-debated country in boardrooms around the world and an integral part of their growth strategy. The economy is expected to grow around 7-8 per cent into the future. Unlike China, personal consumption accounts for about 55-60 per cent of GDP. This implies that consumption can grow at 7-8 per cent in real terms for decades. What excites investors is the size of the middle class, according to an estimate, is expected to rise from about 50 million in 2007 to about 550-600 million by 2025, with a significant amount of reduction in poverty.
With the improving standard of living, people are likely to spend more and thus, in turn, help the economy grow, creating a virtuous cycle. This increased spending, i.e. consumption, is expected to reflect in the growth of profitability of Indian companies catering to consumption, and through it allow the stock market to grow with it, making it an attractive proposition and a solid bet.
A look at the historic performance of the FMCG sector (or consumer staples) reveals that it has been the silent star performer of the Indian equities market. The index is up by 17.9 per cent CAGR over the last ten years compared to 12.2 per cent CAGR for the Sensex over the same period. Moreover, India also has a significant demographic dividend which has a huge role to play. India is a young country; and entering a demographic sweet spot where the population in the working age which will far exceed the population which is not in working age.
According to UN estimates, the Indian working-age population will peak around 2040-2045, giving it an edge over other countries which have an ageing population. In addition, there are a number of other factors which can drive consumption going forward such as increasing urbanization, lower inflation (expected to remain below 4 per cent), rising per capita incomes which should grow by 5-6 per cent per year and lastly availability of cheap credit which is likely to boost consumption and the overall economy.
However, there are dark clouds that are a cause for concern. The recent numbers released by the consumption-oriented companies have been disappointing. Experts are trying to assess whether the slowdown is cyclical in nature or structural. Therefore expecting a company to do well and outperform solely on the above would be a mistake. The consumption story leads to revenue growth but for the equity market, profitability matters. Consumption-based companies are exposed to market uncertainties and have the potential to falter, just like any other company. Since the last decade or so, the consumption stocks have been on the rise but in the future, there is a distinct chance of a slowdown in the sector.
About 70 companies out of the NIFTY 200 Index have declared their results in the last few weeks and more than 20 companies have belied their estimates for the net profits while only 22 have surpassed them and about 26 have managed to meet the estimates. In the consumer staples and the consumer durables space, the fourth quarter of FY19 looks extremely bleak coupled with weak management commentary on the volume outlook for the coming quarters. This has resulted in consumption stocks losing some steam. The average Indian consumers today are changing their spending pattern to mirror the current economic events. They are becoming more cautious in their consumption choices. This is a widespread concern among the people thereby weakening the very backbone of the economy.
Exacerbating this crisis is the lack of capital. The shadow-banking sectors have created a cash crunch; as a result, India has faced an unexpected slowdown in the consumer demand leading to an inventory build-up. An Inventory correction, which is likely to be under progress, can exaggerate the extent of the slowdown in final demand. There was a growth of 16 per cent in the last quarter of 2018 for the consumer goods but it fell to almost 13 per cent just in the first three months of 2019.
India's largest FMCG Company by market cap, Hindustan Unilever announced their Q4 results, where the domestic consumer business growth stood at 9 per cent. The company said that the slowdown in the rural demand has led to sluggish sales volume growth in the last six quarters. Dabur's growth this year stood at 4.3 per cent compared to 8 per cent last year and their profit margins have fallen as well. Godrej Consumer Products have reported 1.5 per cent declines in their net profits in Q3.
According to the company it was because of the 'unfavourable season' and the rise in advertising cost and promotional expenditure due to low demand. Voltas'reported a fall in consolidated net profits by 27 per cent. The income increased by a mere 1 per cent with 7 per cent increase in expenses in the last year.
Low income for farmers has led to decline in rural demand. Fear of below-average monsoons, postponement of purchases and lesser focus of government expenditure during elections, sustained high-interest rates and liquidity shortages have curbed credit availability. Insufficient increase in the fixed investments and lower exports added to the woes of the sector and another reason why the domestic demand is weighing down and impacting consumer stocks.
The growth in Private Final Consumption Expenditure (at current prices) stood at 10.6 per cent over 2017-18 vs. historic levels of ~ 12 per cent in the recent three years. Even the extended winter and forecast by IMD that southwest monsoon is likely to get delayed this year has also triggered uncertainty over the rainfall for the year, thereby depressing the consumption story further. Rainfall is expected to be in the range of 96 per cent of the long term average, doubts remain over the even distribution across regions. As a result, Nielsen projects revenue growth of 11 per cent - 12 per cent in the FMCG segment in CY2019, down 2 per cent from CY2018, with volume growth in the range of 8.5 per cent to 9 per cent for FY2019. Consumer expenditure has also slowed down and is below historic levels.
As per the market consensus, the demand is likely to pick up in the coming quarters after the formation of the new government at the centre as the focus will again shift to the economy.
Hopefully, going forward while consumption may recover, the FMCG sector is likely to underperform the broader market over the next couple of years. One main reason being valuations, the BSE FMCG index trades at a 12-month forward Price to Earnings Ratio of 31.9X which is extremely high and is at a considerable premium to the Sensex which trades at a 12-month forward Price to Earnings Ratio of 18.4X. It is also clear that the new government has its task cut out and faces a major challenge ahead that will need deft handling to get the consumption and the economy back on its feet irrespective of whether the slowdown is temporary or not.
[Rajiv Singh is the CEO of Stock Broking, Karvy. The views and opinions expressed in this article are those of the author's and do not reflect that of International Business Times, India]