19 August 2008

Buoyant topline growth and easing input cost pressures bode well for the sector ALCHEMY EQUITY RESEARCH

Nitesh Momaya
This update is an attempt to take stock of the strong topline growth momentum and easing raw material cost
91-22-6639 9181
pressures in the FMCG sector. nitesh.momaya@alchemyonline.com
FMCG SECTOR
Strong growth momentum continues
The sector continued its strong topline growth momentum with 20% yoy and 5% qoq growth in 1QFY09.
The growth was led by both price hikes (5-7%) and volumes (13-15%).
Table 1: Quarterly sales growth
Company Rs mn yoy (%) qoq (%)
Colgate-Palmolive/India 4076 16.2 4.2
Dabur India 6040 16.0 -0.4
Godrej Consumer Products 3616 26.3 33.0
Hindustan Lever 42157 21.1 11.1
ITC 38997 18.4 -0.9
Marico 6009 28.1 28.5
Nestle India 10356 23.5 -5.1
Tata Tea 11347 12.3 -3.6
Source: Company
In 4QFY08, the sector has reported 19% yoy growth in topline. In addition, growth has been broad based
with both rural and urban markets growing over the last two years.
Chart 1: FMCG market growth rate (Rural + Urban) %
15

10

0
CY01

CY02

CY03

CY04

CY05

CY06

CY07

1QCY08

2QCY08

-5

Source: Industry

(Please refer to disclaimer at the end of this report)

 Alchemy Equity Research
19 August 2008
FMCG Sector

We believe the sector is poised for sustained growth considering the following growth drivers:
h The favorable demographics, higher incomes, low penetration and growing per capita consumption. India’s per capita consumption remains the lowest in the world
across categories (refer annexure for details).
h Strong rural growth backed by higher agricultural incomes and increase in the value of land which is leading to more money in the hands of farmers. The recent revival
in monsoon augurs well for the sector as it would help keep rural growth intact.
h Increase in pricing power as most companies have passed on the cost push inflation to consumers via a judicious blend of price hikes, package size reduction and
change in product mix.
h Proliferation of modern trade which currently accounts for 5% of sales but is growing at around 25-30% yoy.

Recently, a ‘Mahabachat Ke 5 Din’ was organized by the Future group. Its CEO, Kishore Biyani, said “In the midst of an inflationary scenario, crossing the Rs1bn turnover mark
on a single day has reassured our belief that our retail operations are able to provide the best value to Indian consumers. More importantly, this could be a vital indicator
that consumer confidence continues to remain buoyant in India.”
Source: Economic Times
h Increased innovations and forays in new fast growing categories by most players. FMCG companies create value through product differentiation, package innovation,
differential pricing and by highlighting the functional aspects of products.
EASING PRICES OF COMMODITIES TO HELP BOOST MARGIN
Though the sector reported strong double digit topline growth, its margins have remained under pressure due to unprecedented rise in input costs. The gross margin of the sector
dipped 200bps in 1QFY09. The prices of key raw materials continued to firm up in the quarter.
Table 2: Increase in prices of key raw materials
in % 1QFY09 FY08
Products yoy qoq yoy
Palmoil 18 -3 16
LAB 49 22 -5
Wheat 13 -2 4
Sugar 11 2 -19
Milk -1 5 20
Copra 29 8 -2
Coffee 29 5 23
Source: Industry, IAS
However, some raw materials prices are witnessing a declining trend on a month-on-month (mom) basis. For example, prices of crude palm oil (CPO) declined 37% from its
high of 4,203 ringgit in March 2008 to 2,635 ringgit in August 2008 due to rising palm oil reserves and worries of overseas demand slowing down. CPO has given up all gains
and prices were lower by 15% since January 2008. But on an annual basis, CPO prices were still higher by 8%.

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19 August 2008
FMCG Sector

Chart 2: Crude palm oil data

4500.00 2500
4000.00
3500.00 2000
3000.00

000' tonnes
1500
2500.00
MYR

2000.00
1000
1500.00
1000.00 500
500.00
0.00 0
1-Jan-01
27-May-01
20-Oct-01
15-Mar-02

1-Jan-03
27-May-03
20-Oct-03
14-Mar-04

31-Dec-04
26-May-05
19-Oct-05
14-Mar-06

31-Dec-06
26-May-07
19-Oct-07
13-Mar-08
8-Aug-02

7-Aug-04

7-Aug-06

6-Aug-08
Crude palm oil prices Crude palm oil inventory

Source: Bloomberg, Alchemy

Similarly, wheat prices have fallen by 10% mom in July 2008.
Besides, the recent fall in crude oil prices to US$113 per barrel (from the all time high of US$147 per barrel) would lead to price softening of other petro based products like
LAB and HDPE. In this background, any decrease in raw material costs would directly benefit the sector as it will drive up overall margins. However, it is difficult to quantify
the extent of increase in margins.
Chart 3: Soap prices vis-à-vis palm oils
150.0
140.0
130.0
120.0
110.0
100.0
90.0
80.0
May-04

May-05

May-06

May-07

May-08
Mar-04

Nov-04

Mar-05

Nov-05

Mar-06

Nov-06

Mar-07

Nov-07

Mar-08
Jan-04

Jul-04
Sep-04

Jan-05

Jul-05
Sep-05

Jan-06

Jul-06
Sep-06

Jan-07

Jul-07
Sep-07

Jan-08

Jul-08

Palm Oil Lifebuoy

Source: Bloomberg, Alchemy

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19 August 2008
FMCG Sector

OUTLOOK
The Indian FMCG sector is trading at a P/E of 20.5x FY09E and 18.6x FY10E. The BSE FMCG Index has outperformed the BSE Sensex by 30% since the beginning of 2008
due to its defensive niche.

Chart 4: FMCG sector PE vs Sensex PE Chart 5: Sensex vs BSE FMCG

(x) FMCG Sector PE Vs Sensex PE
45.0 170
40.0
35.0 150
30.0
25.0 130
20.0
15.0
110
10.0
5.0
90
May-00

May-07
Apr-96
Nov-96

Aug-98
Mar-99

Apr-03
Nov-03

Aug-05
Mar-06
Jun-97
Jan-98

Oct-99

Dec-00
Jul-01
Feb-02
Sep-02

Jun-04
Jan-05

Oct-06

Dec-07
Jul-08

May-07

May-08
Apr-07

Aug-07

Nov-07

Mar-08

Apr-08

Aug-08
Jun-07

Sep-07
Jul-07

Oct-07

Jan-08

Feb-08

Jun-08
Dec-07

Jul-08
FMCG Sector - PE (1 yr rolling fwd) Sensex - 1yr fwd rolling P/E Sensex BSE FMCG

Source: Bloomberg, Alchemy

We are not seeing any immediate demand slowdown in the sector but one needs to be cautious as price hikes that may be effected in 2QFY09 could pose a risk to growth. The
overall profitability of the sector would improve if raw material prices decline further and companies are not compelled to roll back product prices due to competitive pressures.

Thus, in the wake of strong and sustained demand with easing input cost pressures, the outlook for the sector looks encouraging. Hence, we are upgrading Hindustan Lever to
'Accumulate' from 'Market performer' - by virtue of it being a leader in several FMCG categories. Therefore, it would be a major beneficiary of any softening in commodity
prices. We have kept ratings of the other FMCG companies in our coverage unchanged.

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19 August 2008
FMCG Sector

Table 3: Valuation summary

Company name Price Mkt Cap Ratings P/E EV/EBITDA (x) RoE (%)
(Rs)
CMP (Rs bn) FY09E FY10E FY09E FY10E FY09E FY10E
Colgate Palmolive 419 56.9 MP* 20.9 17.5 20.8 16.7 124.3 90.5
Dabur India 90 77.8 MP* 20.5 17.6 16.4 13.7 53.3 48.1
Godrej Consumer Products 132 34.1 MP* 17.0 14.6 12.3 10.5 49.5 34.3
Hindustan Unilever 243 529.9 Accumulate 26.5 22.6 23.0 19.9 126.9 126.2
ITC 184 692.5 Sell 19.9 16.8 13.5 11.2 27.1 28.1
Marico 62 37.7 MP* 20.0 16.8 13.5 11.3 49.4 42.0
Nestle 1718 165.7 MP* 30.8 25.8 19.7 16.5 120.4 127.6
Tata Tea 728 45.0 MP* 10.3 9.0 7.7 6.7 12.2 12.8
FMCG 1639.6 Neutral 20.5 18.6 15.4 13.7 39.7 37.7
Source: Company, Alchemy * Market performer
Table 4: FMCG stock price performance
52 week Absolute (%) Relative (%)
CMP
(Rs) high low 1M 3M 6M 12M 1M 3M 6M 12M
Colgate Palmolive India 419 521 324 13.9 -6.1 9.0 13.1 6.8 12.6 35.5 9.9
Dabur India 90 134 72 1.3 -9.1 -8.8 -8.3 -5.0 9.0 13.4 -10.8
Godrej Consumer 132 158 94 11.1 -3.8 15.0 -2.9 4.2 15.3 43.0 -5.5
Hindustan Unilever 243 256 170 10.8 -0.1 10.1 26.7 3.9 19.8 36.8 23.2
ITC 184 239 152 4.2 -19.0 -10.5 19.8 -2.3 -2.9 11.2 16.5
Marico 62 83 47 14.2 -4.1 -4.8 8.2 7.1 15.0 18.4 5.2
Nestle India 1718 1880 1140 11.2 -6.6 28.2 45.9 4.3 11.9 59.4 41.9
Tata Tea 728 1014 586 -0.7 -23.1 -11.5 9.4 -6.9 -7.8 10.0 6.4
Source: Bloomberg, Alchemy

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 Alchemy Equity Research
19 August 2008
FMCG Sector

Annexure I
Chart 6: Favourable demographics

2003 2013
181 mn hhlds 231 mn hhlds

3 Rich 11

46 Aspirers 124

131 Strivers 96

The shape of India is going to change…

from a pyramid to a diamond

Source: Industry
Chart 7: GDP growth and per capita income

Source: Industry

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19 August 2008
FMCG Sector

Table 5: Penetration – an opportunity to grow

Category All India% Urban% Rural%

Deodorants 2.1 5.5 0.6
Toothpaste 48.6 74.9 37.6
Skin Cream 22 31.5 17.8
Shampoo 38 52.1 31.9
Utensil Cleaner 28 59.9 14.6
Instant Coffee 6.6 15.5 2.8
Washing Powder 86.1 90.7 84.1
Detergent Bar 88.6 91.4 87.4
Toilet Soap 91.5 97.4 88.9
Source: Industry

Chart 8: India’s per capita consumption is the lowest in the world across categories

Personal wash Oral care

20 18.5 18.9

8 Market size 1496$mn 18 Market size 592$mn

6.7 16
7
14
6
in US $ 12 10
5 4.3
in US$

10
4 8
3 6
2 1 1.2 4
0.5 0.7 1.4 1.5
1 2 0.6
0 0
China Indonesia India Germany USA Brazil India China Indonesia Brazil Germany USA
Per capita consumption Per capita consumption

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 Alchemy Equity Research
19 August 2008
FMCG Sector

Detergents Shampoo
8 7.5
25 22.9 6.7
Market size 2247$mn 7 Market size 542$mn 6
20 6
16.6
5

In US$
15
in US$

12.1 4
10 3
2 1 1
5 1.4 2.2 1.9 1 0.3
0 0
India China Indonesia Brazil Germany USA India China Indonesia Brazil USA Germany
Per capita consumption Per capita consumption

Skin care
Ice cream s
60 40 36.6
49.4 35 Market size 698$mn
50
30 26.9
40 33.9 25
In US$

In US$
30 20
15 12.2
20
10
10 5.9
3 3.2
0.2 1 5 0.8
0.3
0 0
India Indones ia China Brazil Germ any USA India China Indones ia Brazil USA Germ any
Per capita consum ption Per capita cons um ption

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19 August 2008
FMCG Sector

Report trail
Date Title
30 Jun 08 Inflation woes: Are we staring at a slowdown? Downgrading to neutral
2-Jan-08 Time to participate in India’s wealth effect

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 Alchemy Equity Research
19 August 2008
FMCG Sector

Sales / Dealing
Arun Singh arun@alchemyonline.com 91-22-6639 9125
Chetan Chitroda chetan@alchemyonline.com 91-22-6639 9134

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