We expect FCL to be India’s fifth-largest FMCG company in revenue terms by FY21. Future Group’s retail ecosystem yields a unique competitive advantage that allows FCL (Future Consumer) to launch innovative products with a disruptive go-to-market strategy.
The global fast-moving consumer goods (FMCG) arena is facing multiple disruptions…
Amid a rapid shift in consumer preferences, purchasing channels are evolving as is media consumption (digital) and value perception. Meanwhile, investors are pushing for higher business/capital efficiency. The result: an extreme focus on profitability, a temptation to milk existing products, and incremental innovation rather than radical new launches. …that should benefit smaller, more agile companies We think of Future Consumer as a start-up, building its business on the FMCG 2.0 platform – launching innovative products in emerging categories, leveraging digital assets, and focusing on consumer acquisition closer to the point of sale. Our proprietary study of the performance of brands in Future Group hypermarkets increases our confidence in our estimate of a 3.2x rise in FCL revenues, FY17-20.
…but what about distribution?
FCL is Ebitda positive in just its third year of operation as an FMCG company. The opportunity to leverage Future Group’s store network, consumer insights/data, and supply chain is a distinct competitive advantage. Future Group, in turn, benefits from higher gross margins, a unique merchandise mix, and better fill rates. In our bull case, we see an opportunity for 1.5x our base case revenues, based on the success of the group’s small format store strategy. The potential for further upside lies in an omni-channel play in this established retail ecosystem and calibrated expansion in general trade.
Initiate at OW with 63% upside
Scale-driven efficiencies, better fixed-cost absorption, and product mix improvement should drive an operating margin expansion. In our base case, we forecast 470bps of cumulative Ebitda margin expansion, FY17-20. Given the early-stage nature of the business, we believe EV/sales is the most relevant valuation measure. To derive our PT, we assign an EV/sales multiple of 2.8x on our FY20 revenue estimates. This multiple is at a 50% discount to the average of our India FMCG coverage and a 10% premium to Morgan Stanley’s global food and HPC coverage. FCL has a nascent business model with growth upside only partly captured in our bull-case value (3.3x stock upside). The bear-case value is 39% below the CMP, which we believe reflects favourable risk-reward.
Key risks: (i) Dependence on FRL store expansion for growth, (ii) organisational capability to manage rapid growth, (iii) limited history of successful product launches in home and personal-care category, (iv) relatively high working capital deployment, and (v) food safety control.
The traditional FMCG model is changing
Financial analysts and global industry experts often attempt to plot the trajectory of India’s consumption by drawing parallels to global markets and aggregate incomes. However, we think it is likely that Indian markets will follow a different growth path – even as structural changes are underway, Indian consumption behaviour is affected by relatively low income levels, low proliferation of modern trade, and deep-rooted social and cultural influences that are unique to India. We think there is a two-pronged opportunity in India that involves: (i) driving growth in mass market segments with better value propositions to capture new consumers, and (ii) driving premiumisation and category segmentation/expansion to retain relatively affluent consumers as disposable incomes rise.
We highlight a structural shift in purchase channels (online), a shift in media consumption (on demand, mobile), a shift in value perception, and a shift in consumer preferences (natural, herbal, personalised, specialised, etc.). With this, the ability of start-ups to produce, brand, market, and distribute customised products/benefits, especially in a country like India, has never been more cost efficient.
Think of FCL as a start-up consumer products company…
FCL is the food and consumer products arm of the Future Group and the only sourcing-to-supermarket food company in India. With its subsidiaries, international brand tie-ups, and joint ventures, FCL is launching innovative products across the Home & Personal Care as well as Food & Beverage categories in India. To be clear, FCL is not being developed as a private label company for Future Retail stores but as a branded consumer goods company with a product architecture that relies on a combination of improved value in relatively mature categories where competition tends to be high.