Brokerage house HDFC Securities remains underweight on the FMCG sector on the back of low liquidity, higher inflation and poor consumer demand. In this space, the brokerage has a 'buy' call only on ITC, while maintaining reduce calls for HUL, Nestle, Britannia, and Emami. Meanwhile, it maintained 'add' recommendations on Dabur, Marico, Godrej Consumer, and Colgate.
Among these stocks, only ITC and Colgate have given positive returns in 2022 year-to-date (YTD). ITC has risen 22 percent in 2022 so far while Colgate is up 2 percent. Meanwhile, Godrej Consumer has lost the most, down 23 percent in this time followed by Emami, which lost 20 percent. Nestle and Dabur have also shed over 10 percent each in 2022 YTD while, HUL, Britannia and Marico are down between 3-10 percent.
The Nifty FMCG index, however, has outperformed the benchmark in 2022. It is down early 2 percent this year so far versus a 9 percent decline in benchmark Nifty.
According to the HDFC Securities report, the consumption environment in India is under pressure, given high inflation and near-term challenges will test direct-to-consumer (D2C) brands’ business models. It added that while D2C is here to stay, omnichannel is what most players will adopt to scale up and stay relevant.
D2C or Direct to Customer is deemed a low barrier-to-entry eCommerce strategy that enables businesses to reach out to their existing customers directly. It aims at eliminating the middlemen to boost business-customer relationships. Omnichannel commerce is a strategy that provides a seamless shopping experience from the first touchpoint to the last, regardless of the channel your customer is using.
Going ahead, the brokerage maintains its view that D2C and new age brands would scale up and gain size (~8-10 percent of the FMCG basket) over the next five years, however, it added that this may be impacted in the near term by headwinds like lower liquidity, high customer acquisition cost in digital, and higher inflation, which would impact unit economics. Thus, new-age businesses will need to pivot to self-sustaining business models, noted HDFC.
"The D2C space is seeing additional pressure as venture funding is drying up with rising interest rates, which have led to selective funding. Given the D2C space is still nascent, companies need external funding to expand and funding constraints may cause a slowdown in the near term," explained HDFC. Further, selective funding may lead to consolidation within the D2C space and it could favour companies that (1) have a sharply-defined customer offering and (2) focus on profitability, it added.
It further pointed out that there are about 600 to 800 digital-first companies in India and while D2C companies are beginning to gain size, many traditional companies are also adopting the digital route. While an online presence gives customers easy access to the products, offline help products achieve sustainable growth, it added.
"While mortality of smaller brands is possible in the near term, with the evolving ecosystem, we expect the inception journey of new brands to become easier. This could lead to a long tail of brands adding up while only a few will be able to scale up beyond their niches," it noted.
The report said that category leaders will not be able to sustain high market shares, impacted by competition from niche offline players and relevant product, pricing, and communication will continue to support new-age brands for customer acquisition.
As per HDFC, brands like Marico and ITC are very active in this space. Further, D2C brands are acquiring other D2C brands to work at a ‘house of brands’ strategy.
"The existing brands of traditional players are not digital-friendly, so we doubt the scalability of this mode. Companies like ITC have been very active in launching new products. Almost all the listed companies are exerting efforts to improve their e-commerce mix," it said.
