Varun Lohchab, Institutional Research Analyst, HDFC Securities and Naveen Trived, Institutional Research Analyst, HDFC Securities.
In continuation to our D2C thematic-Changing Landscape Not Fully Factored In- we recently hosted multiple founders and experts in the D2C space. The three-day event threw up many insights, some of which corroborate our earlier thesis that rise of digital native brands causes disruptions, while some give us insights into the rising focus of incumbents in the digital space. The participants of the conference held a unanimous view that while D2C is here to stay, omni-channel is what most players will adopt to scale up and stay relevant. While we maintain our view that D2C and new age brands would scale up and gain size (~8-10% of the FMCG basket) over the next five years, this may be impacted in the near term by headwinds like lower liquidity, high customer acquisition cost in digital, and higher inflation, which would impact unit economics. Thus, new age businesses will need to pivot to self-sustaining business models. We maintain our underweight view on the FMCG sector and maintain REDUCE on HUL, Nestle, Britannia, and Emami. We rate ITC as a BUY and maintain ADD on Dabur, Marico, GCPL, and Colgate.
Key takeaways from our D2C thematic
D2C is here to stay; omni-channel the way forward: There are about 600 to 800 digital first companies in India. While many of these companies are only present on digital platforms and marketplaces, companies that have achieved a certain scale are endeavouring to expand into the offline channel. Speakers were of the consensus that online and offline channels will coexist. Selling on own websites is beneficial in terms of cost-effectiveness and easy access to data (that helps develop products), while an online-only presence limits the scope of growth. Some companies like The Good Glamm Group are looking to expand their offline presence and compete with traditional giants. While an online presence gives customers easy access to the products, offline helps products achieve sustainable growth. Further, offline channels like GT are still the most efficient and profitable channels, followed by MT. Customer acquisition cost has sharply risen in digital space, which is a risk for D2C brands, if repeat purchases are not high.
Near-term challenges to test D2C brands' business models: Overall, the consumption environment in India is under pressure, given high inflation. Besides this, the D2C space is seeing additional pressure as venture funding is drying up with rising interest rates, which have led to selective funding. Given the D2C space is still nascent, companies need external funding to grow. The funding constraints may cause a slowdown in the near term. Further, selective funding may lead to consolidation within the D2C space and it could favour companies that (1) have a sharply-defined customer offering and (2) focus on profitability. While mortality of smaller brands is possible in the near term, with the evolving ecosystem, we expect the inception journey of new brands to become easier. This could lead to a long tail of brands adding up while only a few will be able to scale up beyond their niches.
Traditional companies adopting digital: While D2C companies start to become sizable, many traditional companies are adopting the digital way. It is done through incumbents acquiring existing D2C brands to enter new niches that the brands were present in. Brands like Marico and ITC are very active in this space. Further, D2C brands are acquiring other D2C brands to work at a 'house of brands' strategy. Incumbents are also entering the digital space either by launching their own D2C brands or foraying into ecommerce with their existing brands. According to one of the speakers, the existing brands of traditional players are not digital friendly, so we doubt the scalability of this mode. Companies like ITC have been very active in launching new products. Almost all the listed companies are exerting efforts to improve their ecommerce mix.