Number one thing to know about consumer goods company or FMCG company is that it consists of various industries such as food & beverages, tobacco and household products. These companies are typically large and grow slowly or no growth at all. However, consumer goods companies tend to be stable in terms of profitability which is suitable for long term investment.
There are few criteria where we can use to identify potential consumer goods companies. In this post, I will be using Nestle Malaysia as benchmark.
1. How FMCG company make money? Via Distributors or Direct Retailers?
Nestle Malaysia either deals directly with their Distributors and Retailers. Large retailer such as Tesco, Giant and AEON usually deals with Nestle’s supply chain directly. On the other hand, small retailers or small business will be penetrated by Nestle’s Distributor. So why there is such segregations? This depends on Nestle’s manpower and cost structure. If Nestle were to handle their sales without Distributors, they will experience a hard time dealing with these small thousands of individual retailers.
In 2017, Nestle Malaysia’s market share grew from 15.2% to 15.5%. This means that for every RM 100 Food & Beverage product, Malaysian will spend RM 15.50. The 15.5% market share is stated in Nestle Malaysia’s annual report but it did not mention the source. With my personal FMCG background, their market share data comes from Nielsen.
2. Are they performing any market share ‘stealing’?
‘Market Share Stealing’ is where we steal the sales from other competitors. In general, there are only 2 methods for FMCG companies to perform ‘Market Share Stealing’ and that is either introducing new products or acquiring other product brands.
With the growth of market share, it shows that the relationship between Distributors and Large Retailers (i.e. Aeon Big, Giant, Aeon and etc.) with Nestle Malaysia is strong. Their strategy is somewhat simple. To grow revenue, you need to grow market share. To grow market share, Nestle’s products need to be on shelf for shopper to buy. So, if the relationships are good, Nestle’s product will occupy large percentage of shelf with better and clearly visible to invoke consumers into buying it.
The below table shows the revenue generated based on different categories. “Food and beverages” and “Others” include Nutrition, Nestlé Professional, Nespresso and Nestlé Health Science (2016: Nutrition, Nestlé Professional, Nespresso and Nestlé Health Science).
The below are statement from Nestle’s Malaysia CEO on their innovation.
Chief executive officer, Alois Hofbauer said the company would be launching between 40 and 50 new products annually including on-the-go consumption segment mainly in confectionery and culinary products.
“We churn out healthier products for consumers. We always innovate and reinvest into our brands, while continue to improve the efficiency across all our supply chain,” Source, New Strait Times
3. How are FMCG Company reduces their operating costs to boost profit margins?
Usually, large companies are not fast-grower instead they are slow grower or stalwart. Since one large FMCG company can only grow so little due to market saturation, it makes a lot of sense for the management team to boost their profit margin by reducing its operating costs.
Nevertheless, investors must be wary with cost-cutting strategies as well because there is a limit to how much cost you can cut. That is why FMCG companies should not only focus on cost-cutting but also strategies to introduce new strong brand/products or at least maintain revenue growth.
Let’s take Nestle for an example. Based on their annual report (see table below), it seems Nestle is on the right track with their operating cost cutting strategies.They are doing it by cutting their ‘Selling and Distribution Expenses’ (also known as Supply Chain segment) as stated by CEO, Alois Hofbauer below.
“Whilst 2018 will continue to be challenging, we will work towards ensuring our company’s sustainable growth through our focus on continuous efficiency increases throughout our supply chain, while reinvesting the realised savings into future growth,” its chief executive officer Alois Hofbauer said.
4. Free Cash Flow
Free cash flow is basically operating cash flow minus capital expenditure. Unlike fast growing company where most of the cash flow is reinvested into its business for expansion and continuously creating their own moat to meet market demands, large FMCG company is in good position of making high surplus of free cash flow. This is because large FMCG companies are already enjoying wide economic moats and we can expect them to continue earning good returns as a surplus to their cost of capital.
Lastly, by tracking how much dividends out of the free cash flow paid to investors can be a good way to assess whether management team addresses shareholder’s interest.
Here’s Nestle financial figures. Their FCF has been very healthy with an average of RM 568.8 million and have been paying generous average dividend of RM 607.2 million. If an investor encountered any large FMCG companies with negative FCF or decreasing dividends, you have take note and find why this is happening.
5. Business Risks – Stronger Retailer’s Bargaining Power
We’ve been outlining few top criteria to look at to understand FMCG companies but now we will look at the ONE MAJOR RISK which investors must take note.
Most of the time FMCG companies sells their products to retailers such as Tesco, Giant and etc. In our generation, there are too many products to be shelved in a hypermarket and this only means that these retailers can dictate many of the terms which it will sell these products including products’ selling price. In other words, retailers will demand for more margins from FMCG companies and even rental to display products. If this is the case, FMCG companies will continue to be squeezed by retailers and margins will erode.
Nestle for instance, their market share is 15.5% for F&B products. The high market share presence gave them the upper hand because shopper/consumer unable to live without Nestle product (Milo and Maggie for instance). Hence, Nestle’s risk of being squeezed by retailers is quite low but investors need to take note on any new product launch by Nestle. New products usually have low market presence; thus this allows retailers to dictate on whether to shelf the new product.
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