FMCG companies lead in capital efficiency | Economic Times

ET Intelligence Group: Fast-moving consumer goods (FMCG) firms such as Hindustan Unilever (HUL), Procter & Gamble Hygiene, Colgate-Palmolive dominate the top ranks of India’s most capital efficient companies for FY20, a study by the ET Intelligence Group shows. Among manufacturers, the top prize for capital efficiency goes to Crompton Greaves Consumer Electricals followed by Honeywell Automation, Abbott India and Asian Paints, India’s largest paints company.The study was done in the context of a rapidly changing post-Covid world where capital efficiency has become increasingly important with companies such as Mahindra & Mahindra and Tata Steel refusing to support loss-making or poorly performing businesses. Investors are also keeping a close watch on companies with high return on capital employed (RoCE) ratios as a way to differentiate between the ones who will survive the harsh realities of the post-Covid world and those who will not.RoCE is a measure of how efficiently capital employed is used to generate revenue. It fairly captures the strength of a company in dealing with uncertainty in demand for its products and goods. The RoCE metric tells you the profit generated by each rupee employed in the business. A high reading indicates that a large chunk of profit generated can be invested back into the company into new business again at a higher rate of return to produce higher earnings per share (EPS) growth, or in case of the limited amount of new business opportunity the extra cash could be returned to shareholders as dividend.Analysts typically exclude FMCG companies from the pure manufacturing universe when evaluating companies based on the RoCE as they don’t require massive capital expenditure to expand capacities and their payback period is shorter.“RoCE is a better way to measure the performance of capital-intensive companies such as infrastructure and allied sectors like cement and steel,” said Mayuresh Joshi, fund manager at Angel Broking. In the current fiscal year, the RoCE matrix will gain prominence to gauge how cost optimisation has impacted financials, particularly at a time when revenue contraction could be more than profit decline, he added.ET Intelligence Group did an exercise to identify companies that have consistently scored well on this metric. For this, the universe of the BSE 200 index was selected. Of the top 10 companies, which scored well on RoCE parameters, nine are consumer-facing. These companies recorded RoCE in the range of 44-89 per cent based on the financials of FY20.It must be noted that Indian FMCG companies had five-year RoCE of 37.98 per cent, which is higher than Apple’s RoCE of 28.35 per cent in the same period. Apple is the world’s most valuable company, according to Bloomberg.The median RoCE of the BSE 200 was 17.66 per cent in FY20, the lowest since FY11. About 118 companies in the BSE 200 index are pure manufacturing companies. Of these, 58 have RoCE of below 15 per cent, a theoretical minimum rate considered to approve any new investment.Castrol India, a lubricant maker with an FMCG business model, tops the chart of the Indian companies that use capital most efficiently. Castrol is followed by HUL, Procter & Gamble, Colgate-Palmolive, Page Industries and Nestle India.Consumer staples have enjoyed superior RoCE because the share of the sales of their premium products is increasing. This has helped these companies at a time volume growth is moderate. They have also benefited from outsourcing their expansion, which has boosted their RoCE.“The higher RoCE than their global parent companies, coupled with the superior earnings growth has caused many foreign funds to invest in Indian FMCG companies. That has expanded the price-earnings multiple of the FMCG companies,” said a sales head of a leading MNC brokerage.Among pure manufacturing companies, Asian Paints, Pidilite, ITC and Bajaj Auto posted high RoCE of 30-34 per cent in FY20. In comparison, the RoCE of leading automakers such as Hero MotoCorp, Maruti Suzuki, Ashok Leyland and Tata Motors dropped sharply in FY20 compared with FY19. 78158554Home improvement companies have been able to maintain superior RoCE despite weak consumer demand. This is largely because they benefit from high levels of automation which reduces labour and fixed costs.In the BSE200 index universe, companies such as Tata Motors, DLF, IOC and Apollo Tyres recorded the lowest RoCE reading.Given these facts, the street has rewarded consumer staples companies for their high RoCE. Share price of FMCG companies grew annually 16.5 per cent in the past nine years compared with a 6.5 per cent growth for the pure manufacturing companies.