High quality management teams that are focused on market share gain over the medium term
It was obvious going into FY23 that margins would come under pressure due to high input cost prices and that the rural markets would struggle to absorb excessive price hikes. What these management teams did in FY23 was to accept the situation for what it was and instead focus on capturing more market share over the medium term. If we had to capture the common trends across all businesses –
- Cemented dominance in their markets, took price hikes to the extent possible to defend margins
- Spent more on A&P as a % of revenue to gain market share
- Invested aggressively into distribution in the semi urban and rural markets while increasing digital spends by 30%+ to cater to the urban audience
- Put in place a growth roadmap for digital first brands – some through acquisitions
- Kept new product rollout plan intact and tested out new concepts (to their organization) even in the face of high inflation
As input prices started moderating in Q3 & Q4, they have started rolling back some of the price hikes to develop the market on the back of higher brand spends. This is pretty much the playbook of how organized players take market share away from unorganized players in India in any business segment. Focus on market share gain over the medium term while managing the short term numbers satisfactorily.
As we head into FY24, raw material prices are expected to be stable or slightly lower unless something plays spoilsport (supply chain disruptions, bad monsoon). These businesses are likely to balance their priorities across earnings growth and revenue growth. If input prices fall, revenue growth may be muted while margins improve by 100-150 bps at the operating level across the board. Digital spends are likely to stay high as traditional A&P channels (print media, TV) are losing relevance to the affluent, urban Indian consumer. Good time to be a social media influencer who has raked up a large follower count..
The big question for investors in FMCG has always been valuation since 2017. Businesses got rerated by more than 30% on PE multiple since 2017 while growth rates have largely stayed the same. Anyone who prioritizes business quality over entry valuation will always have 2-3 FMCG stocks in their portfolios, just that we aren’t in that camp. We love these businesses but we don’t love these stocks all the time.
We were happy to buy Marico in 2019 at an entry valuation of 35 TTM PE and were happy to exit once the PE multiple crossed 55. We happily loaded up on ITC at a TTM PE of 14.5 and dividend yield of 5%+ in 2020 & 21. But such full tosses only come by on rare occasions.
We believe that many business segments that have struggled to deliver healthy growth in India through the 2011-20 decade will deliver healthy growth over the next few years. None of them can ever match the business quality of an FMCG business, but they offer a much better risk reward bet right now.
