Street bets on small and mid-cap consumer stocks

Rise in promotional activity and high input costs to eat into gross margins in FY15, which have been up in past 10 quarters.

Consumer sentiment in urban India continues to weaken even as rural consumption is expected to be buoyed by a good monsoon.

But is rural India enough to compensate for the declining sales in urban India?

While rural accounts for nearly 50 per cent total sales of large consumer companies, companies are doing their bit to get the reluctant urban consumer to spend.

To push demand, companies have stepped up promotional activity and freebies, which is expected to cause collateral damage to profit margins.

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Promotional activity had seen some reversal in October, but it back in a big way across categories, especially in shampoos, soaps, skin care and detergents.

Macquarie Capital believes high advertisement spend and innovation will be the key focus area for companies, as consumers’ preferences are changing rapidly.

Volume growth is expected to pick up only marginally in FY15.

A large part of this volume growth is expected to be driven by rural India, which has spent $69 billion on consumption between 2009 and 2012.

In contrast, urban India has spent $55 billion on consumption.

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Analysts say with India getting six per cent more rains this monsoon, the area sown under the kharif crop has gone up by 4.4 per cent, while the area sown under the rabi crop is up by 10.6 per cent (till December).

This coupled with increase in minimum support prices will buoy demand in the coming months.

Despite this trend in rural India, consumer companies have launched a slew of offers.

According to Sharekhan, Godrej Consumer Products has continued with its offers in its soap brand, while Procter & Gamble has been showering a myriad of offers in the shampoo category, maintaining some offers in the detergent segment.

Hindustan Unilever is not far behind with its ‘offers’.

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Given that soaps, detergents and shampoos are highly competitive, such offers don’t portend well for margins.

Over the past 10 quarters, gross margins of FMCG companies have been inching up steadily, but in FY15 there could be some moderation.

Prices of copra, fatty acids and palm oil have risen sharply in the past six months and companies are unlikely to pass this on to consumers.

Despite underperforming the Sensex over the past six months, FMCG stocks continue to trade at a significant premium.

The Street is no longer betting on the big companies, ITC being an exception to this rule.

The market’s betting on players in the small- to mid-cap space like Godrej Consumer, Emami, Marico, Jyothy Laboratories, and Tata Global Beverages.