Sunday, December 2, 2012

Consumer Stocks – Do Product characteristics of business matter?

There is a lot spoken about the boom in consumer stocks, the hyper valuations these consumer stocks are quoting at in the markets, demographics of Indian economy, ever growing middle class, etc.  In all this noise, one aspect that I find generally ignored is that there is very little discussion on the product characteristics of business or consumption patterns from the investing standpoint.
I mean all “consumer facing” businesses cannot be clubbed into one large basket with skyhigh price multiples assigned. After all, they are different breeds and animals which will find their own paths over a longer period of time. Let us analyze this little deeper from view of consumption pattern:
  1. Consumables vs Durables – The most obvious distinction to be made when discussing consumer businesses is consumer goods in contrast with consumer durables.  While both the segments are witnessing growth, it’s the consumer goods (FMCG) theme that keeps adding new product categories that were not present before. For instance, we see in the marketplace a host of anti-ageing creams, beauty products, differentiated food supplements, health drinks with a thrust on premiumisation not seen before. FMCG industry in India is projected to become Rs 4 lakh crore industry by the year 2020.
  2. Brand stickiness – With rising per capita income and growing rural prosperity (relatively speaking), there is a structural shift in consumer demand towards brands and organized products. Brand play is more evident in consumer products that any other product category one can think of. The chances of your changing your toothpaste or soap brand every single time one purchases is very less. Generally, consumer tend to stick with their brands as they get conscious of the segments and lifestyles.
  3. Repeat purchase – To put it simply, the consumables vanish after one use, necessitating repeat purchase. You need a toothpaste, soap, detergent, hair oil (ok, till you have hair on your head) pack after pack all your life. That sounds simplistic, isn’t it? But that’s a fact and the business opportunity these guys are looking at. On the other hand, in durables segment with longer shelf life there is an onslaught from the Koreans & Chinese making life difficult and margins thinner.
  4. Fashion & technology trends – Consumer preferences change with the times and need for innovation is a constant. Growing youth population is very conscious of what they consume.  At the minimum, re-packaging in different SKUs and appealing advertising is a must. We have seen even some of the giant companies of yesteryears (like Kodak) getting marginalized due to not keeping pace with ever-changing technology.
  5. Target User group – I include it here from the viewpoint of total addressable market and the ultimate growth. If you’re talking about shaving blade & products, half of the population (female folks) is straightaway not the market. Of the remaining, you have below 16s who don’t need to and beard-sporting who don’t prefer to shave. Come to think of it, a toothpaste or soap company has no such limitation on its addressable market – entire country is its market. So the point is, other things being equal, would you like to give a PE multiple to a razor company as high as to a toothpaste company.
  6. Staple vs Discretionary – Another important distinction to be made is consumer staples vs consumer discretionary products. Demand for consumer staples doesn’t decline appreciably with seasons and cycles. With increase in inflation and pressure on disposable incomes, discretionary spends are the first to be curtailed by consumers. Jewellery is one such discretionary spend, except for marriage type of purposes. Of course, the recent spurt in jewellery stocks doesn’t seem to support my view, and these are rocketing like no tomorrow.
  7. Market positioning – Leadership in market position backed by brand power ensures steady growth. The market leaders have generally the first-mover advantage in introducing new products and break-through technological processes given their superior product portfolios. It imposes high entry barriers for new players.  With competitive intensity in consumer space, market leader companies are constantly looking for volume growth, maintaining their market position and guarding that distance from their next competitor (in market share).
  8. Pricing Power – Strong consumer companies are in dominant position in their respective categories and command significant pricing power. For example, tobacco & IMFL (I personally avoid both segments for reasons of socially responsible investing) companies demonstrate that kind of pricing power since their consumers are habit forming and keep coming back. Similarly, baby food is a near monopoly for Nestle that gives them pricing power.
There are a lot many factors however, in financial and management terms, and some of the determinants of PE we discussed in a previous post here and here.
In conclusion, I’d say it’s important for a retail investor to be mindful of the product characteristics of the business and consumption patterns while analyzing a business : the addressable market, the seasonality & cyclicality attached to the products, strong brand or absence of it, market positioning & pricing power, any moat that protects the premium positioning.


  1. Hi Shikhar,
    Again excellent post.
    Writing after long time.
    Hats off to you for the details on FMCG.Specially differences in consumer staple and discretionary and of course, target group and repeat purchases.

    Now I have a query.
    Its about HUL.
    For me I have an anchoring bias that I missed it at 250.And now having another bias that if its going up, it will go up.

    But all things said and done, I seriously think current PE of 33 is justifiable for business like HUL.
    For ex. Nestle was PE 45 in 2000 and now also its PE 45. But in these years it has become multi-bagger.

    As such I am not comparing both, but I think HUL can give say 15 to 20% yearly returns in coming say 5 yrs.

    Whats your opinion.


  2. Hi Vikas,

    Appreiate your comments.

    HUL as a business is great, though stock performance catches up in spurts I'd say. Moot point is it operates in multiple product categories and at topline of 25k crore, can it grow beyond 15%, may be no.

    Why not look at a colgate instead. It keeps growing its market share y-o-y in spite of such a mature business, it's more focussed, has solid financials.

    I loaded both in 2009, they were expensive then too, and stay that way.


    Discl: invested.

  3. Thanks Shikhar for the quick reply.