Are consumers beginning to mobilise in India to the exponential degree seen in other emerging markets, or are the structural issues that have held India back still too entrenched?
India is a massive country with a large and diverse population - about 65% of whom still live in rural areas. It has always been a consumption-led economy and we believe it will continue to be so, given: its improving income pyramid – whose shape has now changed from a pyramid to a diamond with the rising middle class, increasing urbanisation, the strong demographic dividend - with one of the youngest populations in the world (about half of India’s population is under 25), the declining dependency ratio, and a rising preference for better goods and services. Structural issues do exist, given low per capita incomes and the still relatively high dependency on monsoon. However, the Indian consumer sector is witnessing one of the fastest growths vs. other geographies across the world, developing or developed, and we do see some structural changes.
The Indian consumer sector has been a stock market darling, outperforming the Sensex by over 25 percentage points over the last two years. What are the megatrends to drive growth in the next five years?
We identify three megatrends that will drive strong high-teen earnings growth for next five years, with a more meaningful impact in FY21-24e.
Firstly there is the rise of direct reach in India. This is essentially increasing sales servicing to mom & pop FMCG retail outlets in Tier 2 & Tier 3 towns. We expect this to structurally propel volume growth higher for longer.
Secondly there is the rise of e-tail, which is creating a market for niche and premium products. Online retailing is breaking down distribution barriers, and brand managers are excited, as this is helping them to test new categories and different products, which otherwise would not have been made widely available and would have fallen short of a commercial launch. We see an avalanche of new product launches – which will act as a new engine for sales volume growth.
The third megatrend is the rise of Ayurvedic products – with a second wave discovering new opportunities and markets. We believe the second Ayurvedic wave will be created by mainstream companies, as these products continue to grow by twice the sector average, as the category is accepted both at the premium end and in the mass-market.
How are companies incorporating Ayurvedic products into their offering?
Ayurvedic products essentially means products made from natural ingredients that have health benefits. It is just another branch of the organic/naturals trend that is rising across the world. Consumer companies in India had to do R&D and launch Ayurvedic-based products to insulate themselves from the rise in this trend. Now, having invested in R&D and products, we expect companies to create a new revenue stream by taking these products global and leveraging their investments.
If we combine all these things, what does this mean for volume growth for the sector?
We expect companies that are key beneficiaries of these megatrends to see a leg up in volume growth. For the next three years, we expect average volume growth to be about 10% vs. 6.5% for the past 10-year average.
Is there much evidence of companies premiumising their products? Does this feed into it?
To an extent this is at work. Companies are becoming more sophisticated about providing premium products at accessible price points, to recruit consumers. Premiumisation of the portfolio adds c.2-3% to sales and also improves margins. The margins of almost all consumer companies have increased over the past decade on the back of this strong underlying trend.
So has the sector peaked?
We don’t think so. We see the sector undergoing structural changes: companies are increasingly premiumising their products, lowering costs and consolidating logistics, and they are becoming more sophisticated about their online offerings and boosting gross margins above physical retail. After a long time, we are seeing additional new growth vectors for the consumer sector. We believe all these factors will continue to drive elevated c.18%-20% earnings growth.
Once Indian companies catch up with some of the management and investor techniques that have been established in more developed markets for some time, will the potential will also dry up, or are there Indian-specific factors that are driving the sector?
It is true that some Indian companies are catching up to international norms (on data analytics, tech, diversification, etc) but there are several India-specific factors, including a strong R&D and innovation pipeline and investment in direct reach, which differs enormously in its potential compared with developed markets. We believe there are three ways to increase sales of consumer staples products: 1. Increased penetration; 2. Frequency of use; and 3. Premiumisation. India continues to benefit from all three, unlike developed countries, which will have premiumisation as the main driver. We believe India’s consumer story is a multi-decade one.