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ICRA Rating Feature

Rating Methodology for Entities in the Fast Moving Consumer Goods
(FMCG) Industry
This rating methodology updates and supersedes ICRA's earlier methodology note on the sector, published
in October 2015. While this revised version incorporates a few modifications, ICRA's overall approach to
rating entities in the sector remains materially similar.

This methodology note describes the key factors considered by ICRA in assessing the credit risk of entities
in the FMCG industry. The objective of this note is to help investors, issuers and other market participants
understand how ICRA analyses creditworthiness of entities in the FMCG industry. This methodology does
not include an exhaustive treatment of all factors that are reflected in ratings, but enables the reader to
understand the rating considerations that are usually the most important. ICRA’s analysis focuses on the
following key rating factors that are common for assigning ratings in the sector:

Business Risk Assessment

• Scale

• Diversification
o Geographic Diversification

o Segment/Product Diversification
• Market Position
o Distribution Channel

o Brand Strength

o Product Category Attractiveness

• Raw Material Sourcing

Management Risk

Financial Risk Assessment

• Revenue Growth
• Profitability
• Working Capital Management
• Financial Policy & Capital Structure
• Adequacy of Future Cash Flows & Liquidity Position

Other Considerations
• Parentage
• Event Risk
ICRA Rating Feature Fast Moving Consumer Goods (FMCG) Industry

Business Risk Assessment

The Indian FMCG industry, at an estimated market size of Rs. 3 trillion, accounts for the fourth largest sector
in India. Items in this industry are meant for frequent consumption and generally have inelastic demand
dynamics, resulting in fairly stable revenue generation as well as profitability for industry participants.
Moreover, thanks to a largely stable regulatory environment as well as lucrative long-term growth prospects,
India is also becoming one of the most attractive markets for foreign FMCG players due to easy availability
of raw materials and cheaper labour costs in comparison to developed markets.

The Indian FMCG industry can be broadly classified into—household care, personal care, healthcare (over
the country i.e. OTC), and food and beverages (F&B). Among these, the F&B sub-segment accounts for the
bulk of the sector’s revenues, followed by personal care and household care. The sector is characterised by
a strong presence of multi-national corporations (MNCs), supported by their well-established distribution
networks. The sector characteristically attracts high competition between organised and unorganised
players. Branding plays an important factor in consumer purchase decisions and a strong brand position
generally allows premium pricing of products over that of weaker players. Consequently, to support/enhance
brand visibility, industry players incur sizeable (12-15% of revenue) investments towards advertising,
marketing, packaging and distribution costs.

Some entities outsource less capital intensive products to vendors, wherein quality control at vendor level
also becomes one of the critical factors in maintaining brand equity. In such instances, an entity should have
strong quality control processes in place to ensure consistency in quality output.

The Indian FMCG sector is highly fragmented and volume driven, with the largest player accounting for less
than 7% of the domestic FMCG market. ICRA believes that an entity’s revenue base and market position are
key factors in determining its business strength and operating flexibility in this particular industry. The scale
of operations generally reflects large volumes enabling economies of scale, cost absorption and ability to
offer competitive pricing. Size allows entities to leverage costs of all kinds, including advertising and
promotion expenses towards consumer awareness of brands and products. It also lends entities more
bargaining power with distribution channel partners, and provides them with a cushion during any production
disruptions with adequate inventory in distribution channels.

Diversification and scale of operations are closely linked with an entity having large scale of operation is
generally well diversified. Diversification can be broadly classified as—i) geographical diversification, and ii)
segmental and product diversification.

a) Geographical diversification

An entity that is well represented across multiple regions or geographies will be able to perform more
consistently during various demand scenarios. A diversified revenue mix between rural and urban India can
also mitigate the adverse impact of an uncertain monsoon in the rural market as well as an economic
slowdown in the urban market. Geographic diversification is a positive factor because it mitigates changes in
customer preferences and the impact of regulatory, product liability or safety issues in a specific region or

b) Segmental / Product diversification

Segmental diversification mitigates the impact of change in consumer preferences, product obsolescence,
slowdown in a specific segment and weakening of an individual brand. Typically, the most diversified entities
are present in several product segments, while smaller entities often depend on only a few segments. Over
the long-term horizon, an entity with a diversified product portfolio will have a relatively stable top-line growth
and profitability as against a company dependent on a specific product segment.

An entity may not have segmental diversification, but can still have large scale owing to its presence across
various geographies and strong brand equity in its core segment. In some cases, an entity may have only

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ICRA Rating Feature Fast Moving Consumer Goods (FMCG) Industry

one brand, which it can diversify across geographies and product range. While assessing the credit profile
of such entities, a strong market position in their core operational area as well as long-term segmental growth
prospects may allay concerns related with geographical and product diversification disadvantages.

Market Position
Market position of an entity is a key determinant of sustainable growth. An entity’s ability to expand market
share over the medium term indicates its ability to outperform underlying industry growth rate. Generally, the
FMCG industry displays modest top-line growth and an entity’s ability to outperform its competitors and
sustain profitability reflects its product / brand strength as well as a stronger negotiating position with its
distribution channels. Competitive intensity is usually high across most product segments, with entrenched
players as well regional challengers. A regional player may not enjoy the product bandwidth or economies of
scale benefit of larger players, but it might still enjoy a decent market share in a specific region that can
mitigate diversification concerns to some extent. Nevertheless, a wider product portfolio lends pricing
flexibility and helps entities in maintaining market share by addressing customer requirements at various
price points. The key determinants of a strong market position are—i) distribution channels, ii) product
category, and iii) brand equity and product quality.

a) Distribution channels

Strong distribution channels lend competitive advantages to FMCG players. A wide distribution network also
supports quick ramp-up in production/sales in case of new product launches, as companies can leverage
their existing distribution channels. FMCG entities may also need to adapt to underlying industry trends to
maintain their market position and competitive edge. For instance, FMCG companies have begun to focus
on alternative distribution channels like e-commerce due to the steady increase in mobile internet penetration
and smartphone usage. E-commerce platforms are location agnostic and can provide vast geographical
access to new entrants that could have taken multiple years to establish for a traditional brick-and-mortar

b) Product category

Based on end-usage of consumers, an FMCG product can be classified as (i) discretionary and non-
discretionary, or (ii) economy and premium. For instance, toothpaste and soap are non-discretionary products
but a packet of chips and a soft drink are discretionary items. Typically, an FMCG player has better pricing
flexibility in premium product categories and non-discretionary items where brand equity plays a crucial role.
Categories like infant food and personal care might be relatively less price sensitive and have higher brand
loyalty than the laundry supplement (washing powders and detergent bars) segment. Moreover, some
product segments like deodorisers, processed dairy products (cheese, curd, dairy whitener) and instant-mix
foods have stronger growth prospects due to changing lifestyles and preferences of customers. Entities with
a presence in these segments may outperform the overall industry growth trend. Hence, the attractiveness
of a product category could be a key differentiator for a company’s growth prospects as well as its profitability
vis-à-vis the overall industry trend.

A regulated product category (such as tobacco products and alcoholic beverages) is relatively less attractive
than other segments (such as soaps and toothpaste). Growth rate and profitability of regulated segments
could be influenced by changes in regulatory policies.

A company’s ability to innovate and refresh its product portfolio at regular intervals remains crucial for
maintaining its market share. Historically, new entrants have capitalised on product innovation to challenge
entrenched players. The revenue share of products launched over the last 3-5 years is a good indicator of a
company’s track record in product innovation.

c) Brand Equity and Product Quality

Product quality determines a company’s ability to benefit from growth in the segment as well as maintain its
market share. Advertising and marketing expenses account for a sizeable share of a company’s cost
structure. Strong brand equity and brand loyalty entails lesser spending towards advertising and promotional
activities, resulting in better profitability. In addition, stronger brand equity acts as an entry barrier, where new

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entrants have to make sizeable investments for customer acquisition, promotion and branding to challenge

Raw Material Sourcing

For product segments depending on commodities like oil, cereals and crude oil derivatives, efficient raw
material management becomes a crucial factor, especially in segments where operating margins are thin
and competitive intensity is high (such as edible oils and soaps). Risks pertaining to raw material price
volatility as well as supplier concentration are also analysed by ICRA. An entity with a wider supplier base
might have better negotiating power with suppliers and mitigate supplier concentration risks to an extent.

Management Quality

All debt ratings necessarily incorporate an assessment of the quality of the entity’s management, as well as
the strengths/weaknesses arising from the entity as part of a “group”. Also of importance are the issuer’s
likely cash outflows arising from the possible need to support other group entities, in case the entity is among
the stronger entities within the group. Usually, a detailed discussion is held with the management of the entity
to understand its business objectives, plans and strategies, and views on past performance, besides the
outlook on the (entity’s) industry. Some of the other points assessed are:

• Experience of the promoter/management in the concerned business sector

• Commitment of the promoter/management to the concerned business sector
• Attitude of the promoter/management to risk taking and containment
• The entity’s policies on leveraging, interest risks and currency risks
• The entity’s plans on new projects, acquisitions, expansions, etc.
• Strength of the entity’s other group companies
• The ability and willingness of the group to support the entity through measures such as capital
infusion, if required

Financial Risk Assessment

The various financial metrics assessed by ICRA could be divided into four categories—profitability, leverage,
coverage and liquidity. This document provides a summary of why ICRA considers these ratios to be
important. For a more detailed description, readers may refer to the note titled, “Approach for Financial Ratio
Analysis”, published on ICRA’s website. In case of groups consisting of entities with strong financial and
operational linkages, various parameters such as capital structure, debt coverage indicators, and future
funding requirements are assessed at the consolidated / group level.

Revenue Growth
Sustained volume and revenue growth above the industry average is a strong positive. Such growth reflects
an increase in market share and / or diversification across various products and geographies. On the other
hand, a trend in declining revenues during a period when the industry is growing could be indicative of a
failing business model or depleting market primacy. ICRA attempts to analyse growth because of increase
in volumes and realisations separately. Increase in realisations, attributable to price increase by a company,
however, does not reflect real growth and is typically reflected in flat or declining operating margins.

In addition to revenue growth, sustainable profitability throughout a business cycle is one of the key factors
that ICRA incorporates in its analysis to differentiate between entities. As the FMCG industry is generally
characterised by stable demand and well-established competitive dynamics, revenue growth and profitability
are in large part dictated by an entity’s specific market, its product portfolio, and its brand strength. As a
result, there tends to be limited scope for significant margin increases over time. In this context, a key
differentiating factor among competing FMCG entities is the ability to maintain efficient operations, pass along
price increases (pricing flexibility) and maintain market share. This rating factor, therefore, aims to gauge the
level of control that a given entity has over its profit margins, and to offset the impact of hike in input costs.
The two primary measures of profitability are—i) operating profit before interest, depreciation and taxes
margin (OPBDIT margin), and ii) return on capital employed (RoCE).
Working Capital Management

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ICRA Rating Feature Fast Moving Consumer Goods (FMCG) Industry

Generally, FMCG entities have a negative working capital cycle, as extended credit period from suppliers
and advances from customers/distributors are sufficient to fund working capital requirements. Select large
FMCG players in India have also invested in IT systems to monitor inventory levels at the retail stage,
enabling superior inventory and receivable management. A deviation from the general industry trend could
be a reflection of stress, as a company might be pushing inventory to its distributors or may have increased
its receivable cycle to push sales, which could result in write-offs in future, thereby affecting profitability as
well as the capital structure.

Financial Policy and Capital Structure

Entities that pursue an aggressive financial policy, including heavy reliance on debt financing, are likely to be
more vulnerable to cyclical downturns than entities that employ a lesser degree of financial leverage in their
business. ICRA takes into account the financing pattern of long-term and short-term assets with reference to
a firm’s long-term and short-term debt. FMCG entities have negative working capital cycle and generally rely
on long-term debt to fund their organic or inorganic growth plans.

Some other aspects that are also analysed for FMCG entities include the following:

• Foreign currency-related risks: Such risks arise if an entity’s major costs and revenues are
denominated in different currencies. Examples in this regard would include companies selling in the
domestic market but making large imports, and export-oriented units operating largely on the
domestic cost structure. The foreign currency risk can also arise from unhedged liabilities, especially
for companies earning most of their revenues in local currency. Forex risk also arises for companies
with exposure to foreign currency borrowings, which could pertain to part funding of capital
expenditure and/or working capital requirements. The focus here is on assessing the natural hedge
available as well as hedging policy of the entity concerned in the context of the tenure and nature of
its contracts with its clients (short-term/long-term, fixed/variable price) to mitigate such risks for net

• Tenure mismatches, and risks relating to interest rates and refinancing: Large dependence on
short-term borrowings to fund long-term investments can expose an entity to significant re-financing
risks, especially during periods of tight liquidity. The existence of adequate buffers of liquid
assets/bank lines to meet short-term obligations is viewed positively. Similarly, the extent to which
an entity would be impacted by movements in interest rates is also evaluated.

• Accounting quality: Here, the accounting policies, Notes to Accounts, and Auditor’s Comments are
reviewed. Any deviation from the Generally Accepted Accounting Practices is noted and the financial
statements of the entity adjusted to reflect the impact of such deviations.

• Debt servicing track record: The debt servicing track record of an entity is an important input for
any credit rating exercise. Any delay or default history in the repayment of principal or interest
payments reduce the comfort level for the company’s future debt servicing capability and willingness.

• Contingent liabilities/Off-balance sheet exposures: In this case, the likelihood of devolvement of

contingent liabilities / off-balance sheet exposures, and the financial implications of the same are

• Financial flexibility: The entity’s financial flexibility—as reflected by it unutilised bank/credit limits,
liquid investments, and the nature of its relationship with banks, financial institutions and other
intermediaries—is assessed. The comfort derived from a strong parentage also helps in improving
its financial flexibility.

Adequacy of Future Cash Flows and Liquidity Profile

Since the prime objective of the rating exercise is to assess the debt servicing capability of an entity, ICRA
draws up projections on the likely financial position of the company based on the expected movements in
operating performance, by factoring in capex and investment requirements as well as upcoming debt
obligations. Strong operating cash flows enable entities to undertake critical investments, without stressing
the balance sheet significantly. An entity’s capacity to generate adequate levels of cash flow relative to debt,

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ICRA Rating Feature Fast Moving Consumer Goods (FMCG) Industry

and earnings relative to interest is critical in evaluating its credit risk profile. In the absence of adequate
profits, an entity’s cash flow generation is likely to fall short of the levels needed to support the working capital
and capital expenditure needs that are associated with expansion.

Higher rated entities in the industry exhibit stable cash flows through revenue streams that are diversified
across business segments and geographies. In addition, an entity with strong liquidity is able to mitigate the
impact of any short-term exigencies or events that might impact profitability or cash flows in the interim. ICRA
also analyses other sources of financial flexibility available to an issuer, which could be the availability of a
portfolio of liquid financial assets, the strategic importance of the entity to its, along with the financial strength
of group entities, among other factors.

Other Considerations

The Indian FMCG industry is inhabited by global majors through their subsidiaries, as well as by a great
number of well-established domestic players. While international players bring in product innovation and
international market experience, they still need to establish a wide distribution network and accumulate local
market knowledge. In cases where the company is directly owned by a foreign parent, the rating of the Indian
entity is influenced by the parent’s standing and any formal support arrangements in place with the issuer,
especially during the gestation period when subsidiaries may require financial support.

Event Risk
ICRA also recognises the possibility of events, such as unrelated diversification, mergers and acquisitions,
business restructuring, asset sales and spin-offs, capital restructuring, and litigations, which could have a
material impact on the credit profile of an entity.

Summing up

ICRA‘s credit ratings are a symbolic representation of its opinion on the relative credit risk associated with
the instrument being rated. This opinion is formed, following a detailed evaluation of the issuer‘s business
and financial risks, its competitive strengths, its likely cash flows over the life of the instrument being rated,
and the adequacy of such cash flows vis-à-vis its debt servicing obligations. As the note has highlighted, for
FMCG entities, business risk assessment include analysis of market position, distribution channels, brand
equity, operations scale, operating efficiency, cost competitiveness, product quality, diversified sales mix,
regulatory risks, management strategies for managing cyclical downturns and an overall approach towards
investment and growth.

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