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India has over the years been touted as a large, growing consumer market. With its burgeoning middle class and increasing per capita incomes, the Indian market presented a mammoth opportunity. Signs of stress in the system had however started emerging in the past 18-24 months. With economic growth slowing down, per capita income growth was slowing (~ 4.3% in FY20 in real terms) while private consumption expenditure was increasing (~up 5.7% yoy in FY20). This was led by increased borrowings at the household level (estimated at ~21% of GDP) and a lower savings rate (18.2% of GDP in FY19 in nominal terms). A large part of the consumption binge was financed by retail consumer loans, unsecured and micro loans. Consequently, while growth of consumer and consumer finance companies was significant in this period, the edifice which was driving this growth was on shaky ground. With the Covid-19 pandemic, the entire consumption cycle has been disrupted – deeply and extensively.
Income and wealth have been both been significantly impaired and are likely to stay that way for some time. The lower middle class and above the poverty line consumers, which form the bulk of the consumption pyramid have been affected even more significantly. With several industries under a medium-term existential threat, massive unemployment is a distinct possibility impacting consumption expenditure significantly. Lending institutions like banks and NBFCs which were focused on consumer loans are likely to slow down disbursements as concerns on repayment ability abound. In most cases, lenders will need to recapitalise their existing balance sheets to account for the asset write offs from existing loans. Consequentially, India has to be prepared for a cycle of demand contraction – certainly in the short term but possibly also in the medium term.
Discretionary consumption will bear the maximum brunt of this contraction. Categories like branded apparel, white and brown goods, ‘non-essential’ food items, services like tourism, hospitality, restaurants, movie theatres, saloons, gyms are likely to witness significant demand contraction. In most other categories, the market is likely to witness ‘downtrading’ – consumers opting to buy cheaper options of the product/service. In the short term, there may be a spike in sales - largely due to restocking of inventory in the distribution channels. However, once the spike is over, the true impact of demand contraction is likely to be visible.
This is an unchartered territory for most consumer companies which have witnessed a decade of growth. Focus will shift to cash generation/preservation rather than chasing growth. With revenues contracting, there will be a microscopic focus on costs. This may take the form of reduced headcounts, smaller/negligible advertising budgets and deferred capital commitments (fresh capacity/new outlets/new categories). Revenue enhancement by creating demand is also likely to be a key focus area. This will entail relooking at the ‘value for money’ proposition afresh. Most consumer companies are likely to bring out product offerings which are scaled down, ‘value’ offerings in order to retain customers. In the next few months, consumer companies will also have to overcome significant supply chain challenges –raw material shortages, labour disruption and distribution related challenges which may impair their ability to ramp up sales quickly. This will reflect in negative/ flat sales for most consumer companies for this fiscal.
Consumer companies have long been the favourite of investors. Most large consumer companies traded in the 40x + PE multiple range. With the impending demand contraction, a contraction of valuation multiples is likely, although being defensive stocks incremental buying may act as an implicit floor on the valuations. Nonetheless, given the bleak growth prospects in the short to medium term, value contraction is a given.
It will take a massive and periodic fiscal stimulus for consumption to revive and thrive in India. Given the fiscal state of the economy, that is unlikely. Consumer companies – brace yourself for some turbulence ahead.