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Betting on Consumers

Rising income for the rural and urban consumers has helped the sector fare well says Sohini Andani, fund manager, SBI Mutual Fund

In the first of the three part interview; Sohini Andani, fund manager at SBI Mutual Fund discusses the prospects in the FMCG sector with Sanjay Kumar Singh

Over the one-year horizon, your fund has produced a very strong return of 41.92 per cent. The category average return for all FMCG funds is 31.65 per cent, while the BSE FMCG index is up 29.09 per cent. To what factors would you attribute the strong performance of this sector, and of your fund?
In the last one year the sector has done well because of strong volume growth and the pricing power enjoyed by these companies. Also the base was low in the year before and that helped. When the slowdown happened, it affected these companies as well. But structurally Indian consumers did not have a problem. So the moment the uncertainty ended, they started spending once again. Besides, rural income has grown, helped by programmes such as NREGA., Minimum support prices (MSPs) were also increased. In case of urban consumers, overall income levels have been rising. All these factors helped the sector register strong growth.
As for the fund, we followed a strategy of diversifying away from the benchmark. In the benchmark about 70 per cent weight is allocated to just two stocks — ITC and Lever (HUL). Our portfolio is much more diversified. We have less than 20 per cent allocation to these two stocks put together. We have diversified across the many stocks that we like. Some of these stocks, such as Glaxo Consumer, Zydus Cadila and United Breweries have done much better. Lever, on the other hand, delivered a return of only 17 per cent. It is these stocks that helped raise the fund’s performance above that of the sector.

To an investor with a five-year investment horizon, what rationale would you offer for investing in this sector?
The basic reason would be the structural positive trends that we are seeing in consumption. This is evident both in rural India and urban India.
Some of the factors that have led to this are increase in the size of the working population, and rising per capita income. The female working population has also been increasing. In households where you have working women, the latter take more decisions regarding spending in the consumer category. These structural positive trends in consumption will continue over the next five years. Companies that come out with new products that suit Indian consumers will do well. So there is a good rationale for people to invest in an FMCG fund with a five-year investment horizon.

You made a point that companies which come out with products that suit the Indian customer will do well. Could you elaborate on this with an example or two?
This is happening both in the listed and the unlisted space. Today McDonalds wants to introduce a burger that suits the Indian palate. Nestle has introduced dahi and other companies have also introduced sweetened milk products. Nestlé has also introduced multi-grain noodles and atta noodles. So whenever a company thinks from the perspective of the Indian consumer, it will do well in this market.
I also want to emphasise on the increase in female working population. That is also an important trend for the consumption space that will only get stronger over the next five years or so. Working women want to buy products that will save them time and effort. So they tend to go for packed and ready-to-consume products. The popularity of such food will grow. Within FMCG space, food is one segment that we are positive about. We are going to see a lot of innovation in this space.

This year inflation is expected to rein high. The market fears that the Reserve Bank of India (RBI) may raise interest rates. Further, there are fears that FIIs may withdraw funds (or invest less than in 2010). Both these factors could negatively affect the equity markets. In such a scenario, do you expect the FMCG sector — largely viewed as a defensive sector — to do well this year?
The FMCG sector does have a very strong defensive character. Companies within this sector have strong balance sheets, strong return ratios and strong cash flows. That insulates them from the interest-rate environment. Moreover, consumption doesn’t get impacted so much when interest rates move up.
Inflation could have an impact on the end consumer’s spending capacity, especially that of the mid- to low-income consumer. The portion of their income pie that is available for consumption, especially on discretionary products, shrinks. In the short term, the sector may see some impact on volume growth. But overall the impact on this sector will be much lower than on some other sectors.
Of course, current valuations within the FMCG sector factor in a robust growth environment. So, while the growth prospects over a five-year period are positive, we’re not going to see straight-line growth. In the short term, stocks within this sector could disappoint. Volume growth may not materialise over the next quarter or so. In that sense, this sector may not act as the ultimate defensive sector as it has in the past.
Moreover, in the past, this sector would not participate strongly in the rally, and so it would also not fall significantly when the rally ended. So it was defensive. But in the last one year it has been one of the important sectors that have driven the overall market rally. Hence, this sector will be less defensive than it has been in the past.

Read Second part of this interview on March 11, 2011