Marico

Not content with merely catching up, some mid-cap FMCG stocks have actually moved into a premium over their larger rivals in recent months. At current market prices of Rs 131, Marico Industries now trades at a PE multiple of 33 times its trailing 12-month earnings. Not only is this at a huge premium to a behemoth like Hindustan Unilever (24 times), it is also at the outer boundaries of Marico's own historic valuations. Despite the company's strong fundamentals and quality management, investors should use this opportunity to book profits in the stock.



Even assuming that benign raw material prices and a growing international presence allow Marico to manage a 27 per cent annualised growth in profits over the next two years, the stock appears to capture much of the upside. The stock price discounts the company's estimated FY11 and FY12 earnings by a stiff 27 and 20 times respectively.

Boost from benign inputs

Marico Industries managed exceptional profit performance in 2009-10, closing the year with a 42 per cent expansion in its consolidated net profits (23 per cent after exceptional items) and a 11.4 per cent sales growth.

While other players struggled for volumes, Marico's 14 per cent volume growth showed robust demand. A 20-22 per cent correction in the prices of Marico's key raw materials (copra and safflower seed) from their peaks of 2009 also helped. It allowed the company to provide for disputed excise duty claims, expand its advertising budget (from 10 to 13 per cent of sales) and yet improve operating profit margins (from 12.7 to 14.1 per cent) for 2009-10.

The year 2009-10 saw all three key segments of Marico deliver strong volume growth. The coconut oil franchise grew by 7 per cent overall (Parachute and Nihar in bottles growing by 9-10 per cent and flexipacks remaining flat), with volumes accelerating in the fourth quarter after the company took price cuts on its smaller packs.

Despite Marico's dominant 53.3 per cent market share in coconut oil, pricing power in this segment is constrained by the price differential of its brands with loose oils. In fact, it was to reduce this price gap and promote a shift to its brands that the company took its recent price corrections.

Base effect

While these price cuts have had the effect of kick-starting Parachute volumes, their base effect on sales will continue to play out over the next three quarters. Marico's price reductions were also aided by relatively benign prices for copra, its key raw material, through last year.

However, after dropping 20 per cent between June 2008 and 2009, copra prices have since firmed up by about 10 per cent. Though a sharp spike like in 2009 appears unlikely, overall margins from this segment in 2010-11 are likely to be lower than those enjoyed in 2009-10.

Prospects for Marico's other key segments — hair oils and Saffola — are brighter this year. Value-added hair oils, where it owns brands such as Parachute Advansed, Nihar Naturals, Shanti Amla and Hair & Care, managed a 16 per cent volume growth in 2009-10 as higher penetration and aggressive promotions helped drive category growth. Here, Marico's newly-commissioned manufacturing unit at a tax-free zone may enable lower pricing without an impact on margins. Premium edible oil brand, Saffola, too has made a strong comeback, taking its volume growth to 16 per cent for 2009-10.

The brand's strong positioning on the ‘wellness' plank, its extensions into other food products such as low glycemic rice (Saffola Arise) and the rising prices for edible oils, augur well for this business in the coming year.

Global foray pays off

While domestic FMCG brands have delivered a reasonable show for Marico, its international business (Rs 600 crore) has been its star performer, contributing 23 per cent of sales after growing 36 per cent in 2009-10.

The company's strategy of stitching together several small overseas acquisitions into a strong presence in new regions such as Bangladesh, Africa, West Asia and South-East Asia have paid off well, with brands such as Hair Code styling products acquiring dominant market shares in these regions.

With the company streamlining its manufacturing base to reduce costs and using a newly acquired distribution network to market its Indian brands overseas, this business may sustain a 20 per cent-plus growth over the medium term. However, the strengthening rupee and the rising uncertainty about the global economic recovery peg up the uncertainties associated with Marico's global operations at this juncture.

Summing up, Marico may sustain better-than-sector growth in both sales and profits over the medium term. However, risks to that growth do exist, and the stiff stock valuations do not offer much margin of safety.