Nestle, Britannia – these stocks may suffer with standard weights norms

I will share my views on why I feel certain FMCG stocks, with attention to Nestle and Britannia, could be under pressure in the next 1-2 years. They have been big beneficiaries of non-standard weights for their products for the last 6 years. This has changed now. And customers will not get fooled this time around!

Background

The Ministry of Consumer Affairs, Food and Public Distribution is responsible for the standards and weights in consumer products like soaps, biscuits and food consumables. The Standards of Weights and Measures (Packaged Commodities) Rules, 1976 is responsible for framing the use of kilogram as a unit or for the fact that you have 1, 2 kg packs instead of 1.23 or 0.8 kg. Essentially standard weights and measures as compared to non-standard weights and measures.

Why standardization?

  • Consumers can easily understand price increases and price decreases of products that they use frequently.
  • Comparisons can be made across different brands and companies. Its easier to compare products of 2 companies if their weight is same rather than if one weighed 0.8 kg and one weighed 1 kg with different prices respectively.
  • Let us not forget that India has still not got rid of illiteracy. Its only fair towards this segment of the population that there are standard weights.

Ministry of Consumer Affairs goes anti-consumer

  • Maybe under pressure from industry lobbies or because of some bad decision-making, the government made amendments in the Rules and allowed manufacturers to make merry with non-standard weights and measures.
  • The excerpt of the amendment is given below:

Provided that if a commodity specified in the Third Schedule is packed in a size other than that prescribed in that Schedule, a declaration that ‘Not a standard pack size under the Standards of Weights and Measures (Packaged Commodities) Rules, 1977′ or ‘non standard size under the Standards of Weights and Measures (Packaged Commodities) Rules, 1977′ shall be made prominently on the label of such package.’.

FMCG companies make hay while the sun shines

The pack of biscuits that you buy has got smaller over the last 6 years as companies have used this amendment and have progressively reduced the weight of the packs used while keeping the price constant. FMCG companies have had to cope with rising costs of raw materials as India has faced high inflation in the last few years. What better way out for them?

The poor consumer does not notice the decrease which happens over a long period of time. Like the story of the frog that was boiled to death.

If you still have not noticed it, please recall how big biscuits packs or noodles packs or soaps used to be in the recent past and see how much they have shrunk to.

If you want to have a look right now, click to see live prices from an online grocery store.

FMCG companies are asked to get back to standard weights

Please read this Outlook article.

From November 2012, the government has asked them FMCG companies go back to standard weights for a wide range of products. This is after delaying by the industry and the government giving them a deadline extension. In a nutshell, the merry days are over for FMCG companies. I personally used to hate the fact the government ever allowed something like this anyway. It has a lot of political implications with respect to inflation. I am sure there would have been greater hue and cry if the middle class actually caught on to what companies were up to. But then again, not many people turn the pack over to see what is written at the back.

Its good that consumers will finally be able to make better choices and see price inflation for what it is in reality.

The FMCG companies will have no option but to pass on price increases in raw materials to consumers. Even if food and soap are basic consumption items which we cannot do without, the consumer will think twice. Housewives will pay greater attention to price increases on packs. Consumers have the option of curtailing certain purchases or shifting to cheaper brands or lower cost brands of the same company.

Addition on 26 Dec 2012: Based on comments from Ravindra, I am updating this to cover the fact that products below Rs. 10 will not be affected.

I am attaching a link for the amendment in 2011 at the end of the article that covers this point.

FMCG stock views

What is good for consumers might not be good for stock investors.

Britannia derives close to 85% of its revenue from biscuits segment. Reports talk of wheat price having remained roughly steady in the last financial year. Operating margins are steady. The interesting part is a slide I saw in the Nestle presentation that you can download from a link in the section below. Post June 2012, there has been an increase of 18% in wheat prices. Wheat is an important raw material for bakery products. Sugar has not come down either.

Nestle has a lesser concentrated mix of products.

Nestle product-wise revenue breakup - Jan-Jun 2012

Source: Nestle investor presentation – Aug 30, 2012

Maggi noodles, soups and ketchups come under the prepared dishes and cooking aids category. Many Maggi products have non-standard weights. Chocolates by Nestle had non-standard weights. Beverages and milk products were mostly proper round figures rather than funny numbers like 83 gm and 178 gm when I last checked.

I cannot define how much exactly of the 28% of prepared dishes category and 13% of chocolates category is non-standard right now. The only way to roughly check it out is to go to a physical or online grocery store. A cursory view tells me that there is enough that will now face standardization.

Again, wheat is used in Maggi noodles. Milk and sugar are key ingredient in chocolates. Milk prices too have been rising in the last few years.

Update on 26 Dec 2012: An important point to note is that products below Rs. 10/- will not be affected by this government move. Still trying to understand how much of the above figures fall in the below Rs. 10/- category where they will not be affected by the new rules. Readers, please share inputs if any. Some of you surely might have knowledge of this sector!

We might see increased margin pressure and earning surprises with standard weight re-introduction in both these stocks.

Today’s Bloomberg data tells met that Nestle is trading at a stratospheric price to earning ratio of 54 times. Past 10 year data tells you that Nestle has traded at an average P/E of around 32 times with most of the P/E increase happening post the credit crisis of 2008 as investors have flocked to “defensive” FMCG stocks.

Similarly, Britannia is trading at a relatively high P/E ratio of around 29 times earnings. Past 10 year data for Britannia gives us a 10 year average P/E of around 24 times earnings.

Nestle is a fine company but the stock seems poised precariously at these valuations. Britannia could also cause disappointment for investors.

In other product categories, I did not see red flags in toothpastes. So, Colgate should not be hit as much if raw material prices increase. I will be looking at soaps and shampoos next. Scuttlebutt investing is fun. And yes, as you saw in this article, anyone of us can do it. You don’t need to be working on Dalal Street or have a fancy MBA degree. This is information that all of us are exposed to and it affects us everyday. Learn from your environment! Happy investing!

More reading

Nestle – Investor communication

Read the Shanghai presentation and the one titled Analyst’s meet, Aug 30, 2012.

The Standards of Weights and Measures Act, 1976

The 2006 amendment, GSR 425 (E)

Join the Start Stock Investing E-Course. It's free.

15 lessons over 15 weeks. Over 500 people who have already signed up. Start off. Learn how to invest in stocks for the long-term.

Comments

  1. Ravi says

    The weights and measures act applies only to products upto and below the Rs.10/unit mark. This is where price points really matter. Consumers who buy stuff at these price points are not really bothered about slight variations in the quantity. As long as the reductions are subtle and gradual, they don’t tend to notice.

    A substantial chunk of a number of FMCG categories – Chocolates, Biscuits & Shampoo in particular operate below the Rs.10/unit mark. As long as this is not touched, a number of companies will not really be bothered.

    The other thing that Weights and Measure act doesn’t address is in categories where sale happens by counts (the first think that comes to my mind is San Naps). This is another highly price sensitive category and companies have played very nicely tweaking counts.

    • says

      I am not sure that the Act does not apply below the Rs. 10 mark as you are saying. It applies to all weights, From what I read, it seems that the government is still letting the manufacturers do what they want in the less than Rs. 10 mark. Its an exemption.

      Yes, I don’t have a percentage figure of the sales that are below Rs. 10 to total sales. That’s a tough one to get. Parle says that 50% of their sales are in the below Rs. 10 category.
      http://business.outlookindia.com/article.aspx?282955

      IF I use the same figure for Britannia, it would mean that close to the balance 50% of their biscuit sales would be affected. That means that 40% (half of of their sales will still be affected).

      If you know roughly what the data might be for Nestle and Britannia, do share please.

  2. says

    This article reminds me of the lays chips packet that use to be almost full to the brim when I was a kid.This explains why a packet of lays still cost just Rs 10 over a period of so many years.

    • says

      Kunal, the fact that anti-consumer norms were not changed for so long is disturbing. Even today, products costing Rs. 10 and below are not affected by the new norms.