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Sector report: Consumer Goods - Distribution is changing; demand softness transitory…

The FMCG sector has seen volume growth moderate in Q4FY19 compared to 9MFY19. We interacted with more than 15 multi-brand FMCG general trade (GT) distributors across Pune, Bangalore, Delhi and Kolkata, who cited the phenomenon is likely to be temporary. Distributors highlighted liquidity constraints, soft consumer sentiment, lack of uptick in the rural economy, unfavourable weather conditions and benefits of price cuts post GST 2.0 now in the base. We noticed that the GT distribution landscape is rapidly changing but since it has the largest salience to sales, it will continue to remain a focus area. The competitive intensity continues to remain high and companies are strongly driving the premiumisation agenda for profitable growth. We reinitiate coverage on the consumer goods space with a constructive view; in light of the current growth moderation, we believe it is best to stick to companies with diversified portfolios, strong new product development (NPD) pipeline and strong direct distribution.

Growth moderation appears temporary: While currently demand moderation does not seem structural, we expect the current slowdown to trickle down to Q1FY20 as well. Although it would be difficult to call out when demand would revive, we do see chances of sentiment improving post elections. Further channel liquidity should also improve, which, in tandem with a likely normal monsoon could revive demand.

Distribution landscape is changing: Our checks conclude that GT distributors are under pressure due to a) consumer shift to MT, b) disruption from D-Mart and Reliance C&C, as retailers also buy daily requirements from them due to deep discounting, c) increased cost of doing business, due to higher compliance costs (post GST), manpower shortage (competition from Zomato/Swiggy) and higher working capital and d) undercutting from wholesale channels. The GT channel will remain an important cog in the distribution wheel, as it is the only window to rural India. As a result, companies continue to focus on direct reach.

Competitive intensity high; premiumise for profitable growth: Our channel checks indicated a) increasing focus on protecting market shares, b) realignment of regional brands to a new structure post GST, c) continuing growth in the Naturals category, which has seen the entry of many midsize players, while Patanjali continues to face challenges, and, d) Consumer willingness to try premium products; however, a timely refreshing portfolio, adequate market support, price point and size of access pack are key constituents that would drive consumer upgrade.

Bet on players with superior execution – Our top picks are HUL (well levered to beat slowdown), Nestle (strong core & focus on NPDs to drive volume growth) and Titan (biggest beneficiary of the formalisation of the jewellery space), all reinitiate with an Outperformer rating.