Holding on, fast: Basic staples weather political tribulations

The market for fast-moving consumer goods (FMCG) is in some ways a microcosm of Egypt as a country: established but also in flux. Egypt has one of the world’s largest and fastest-growing populations, and this rate of expansion will create new social demands as well as naturally increase the country’s consumer base. The market preserved a double-digit sales growth rate in 2011, meaning demand held up despite political uncertainty that began early that year.

CONSUMPTION ERA: This phenomenon reflects the demographics-based growth narrative as well as a truism seen elsewhere: consumers will demand staples regardless of politics or security, and often in larger amounts than during times of calm. In many cases, consumers will abandon larger-scale plans, such as vacations or investments in durable goods, redirecting spending toward daily needs. As such, it is not surprising that FMCG sales in 2011 rose by 11%, according to data provided by Unilever, a multinational consumer goods company.

“The more basic the product, the less impact it felt during the revolution,” said Mohamed Sultan, general manager of Procter & Gamble Egypt. “Detergents and diapers, for example, showed reasonable growth; but products like shampoo and conditioner suffered because many Egyptians still consider bar soap an alternative.’’ A 2011 HSBC study on retail and inflation environments of key emerging markets in Middle East and North Africa (MENA) and Turkey agrees. The study concludes that in Egypt – given the average discretionary income of consumers, inflation and population growth – the current market structure favours investment in staples.

In the wake of the global economic downturn, leading financial services firms and economic research groups are turning their attentions to the emerging markets as indicators of future growth. MENA markets are seen as zones with excellent expansion and penetration prospects, driven by these societies’ growing populations and rising income levels. Rasmala, an Emirates-based investment bank, highlights the MENA region as having “some of the best prospects globally”, in a 2012 report. In this study, Egypt was identified specifically as having some of the best long-term prospects for consumer markets worldwide.

NEW CONSIDERATIONS: One disadvantage, however, was the increase in costs in 2011, in some cases as a by-product of the revolution and inflation stemming from global economic trends. As they take stock of the changes in their businesses in 2011, FMCG producers report a greater need to heed margins and chase efficiencies. Some are also beefing up transportation security, fighting counterfeit products, and monitoring evolving cultural and religious sensitivities to inform advertising campaigns.

These emerging short- and medium-term concerns, however, do not deflate the compelling long-term growth narrative Egypt has to offer the FMCG industry. Growth will come thanks to the natural rate of expansion of the population, and also because of rising purchasing power and demographic changes. As more women join the workforce, for example, demand in the retail food industry will shift away from basic foodstuffs to more valued-added activities. Distribution channels are also expected to become an opportunity for growth, as Egypt undergoes a transition from traditional to modern retailing. Retailers such as Carrefour and Spinney’s are already finding a warm welcome with shoppers, and although the majority of the population cannot yet afford to shop in such a setting, these modern supermarkets are proving to be popular leisure destinations.

STRENGTH IN NUMBERS: The UN Department of Economic and Social Affairs projects that by 2050, Egypt’s population size will be between 110m and 140m. In addition to the sheer growth in size, Egypt’s middle class is expected to expand as well, meaning more consumers with more power to spend. The country is already among Africa’s most populous, and the chance to service a market this large and fast growing has led staples producers such as Kraft, Unilever, Nestlé and others to set up shop and manufacture locally. Furthermore, Egypt has already emerged as a regional base from which products can be distributed throughout the MENA region.

The country offers manufacturers a number of other advantages, including low-cost labour and access to a wide geographic scope without having to tweak the manufacturing of products for different domestic markets. Given the relative ease of shipping across the Arab world, from Morocco to the GCC countries, products there can be marketed to similar consumer profiles and typology, and using the same language. A recent arrival in the Egyptian FMCG sector to be taking advantage of these factors is India’s Emami, a maker of ointments, soaps and other health care products, which in 2010 chose Egypt and Bangladesh for its first international investments in production facilities.

NEED FOR CLARITY: One challenge for FMCG producers in Egypt is the inability to accurately measure future demand in certain market segments. Analysis typically begins at population growth, generally pegged at about 2% a year. With 85m people and a youth bulge in the under-25 range, demographics will define the market for years to come. The ageing youth can serve as a proxy for housing and FMCG demand in the country as this population segment grows older and begins marrying. More households mean more demand for mops, soap and other durable products, for example. As such, the rate of marriages is frequently used as an indicator of growth in Egypt. However, like in many market segments in the country, comprehensive studies or analyses can at best only estimate how many marriages take place each year, even at a broad range.

This is an indication of data collection challenges in Egypt, and a lack of transparency compounds this problem by making reliable information hard to obtain as even official statistics can be suspect. For example, Egypt’s Central Agency for Public Mobilisation and Statistics claims that 864,857 marriages took place in Egypt in 2010, up 13.9% from 2009’s 759,004. However, a number of private sector estimates peg the number significantly lower at anywhere between 400,000 and 600,000, although some have gone as high as 900,000, topping the state figures.

Should Egypt’s new government succeed in bringing increased transparency to the economy – one of biggest desires of the private sector and investors in the country – planning and forecasting would be made much easier.

NEW STRATEGIES: Operations for most FMCG firms were minimally affected by the political turbulence, despite losing some production time due to work stoppages, as workers across all sectors have turned to strikes. Companies reported that at certain points making deliveries became more difficult, particularly in both January and July 2012, when rumours of a fuel shortage twice led to hoarding and a reduction in reliable access to petrol.

However, companies are taking stock of their experiences and adjusting operations accordingly. Dahlia Zayed, head of consumer insight and strategy for Kraft in the MENA region, said that the company pulled television advertisements during the revolution and in the aftermath of the football-stadium violence in Port Said in February 2012 in which 74 people died, because people’s minds were presumed to be on matters other than what to consume.

Another issue is how to address the greater acceptance of religion in the public sphere in terms of product promotion. The overt expression of faith is no longer expected to be discouraged by the state, and a practical consideration for producers now, for example, is whether women depicted in their advertisements should have covered hair.

INFLATION: Macroeconomic trends have been heavily influencing the Egyptian consumer market in recent years. Foreign currency reserves fell by 60% between May 2010 and 2012 as the Egyptian pound depreciated by more than 4% in 2011. Inflation, driven by rising food prices, has had a particular effect on the segment. The food and beverages sector accounts for 38% of all consumer spending in Egypt, according to Rasmala. With 95% of households earning an annual income below $10,000), higher food prices cut sharply into spending capacity.

Egypt had one of the highest inflation rates in the region. At the same time, it was identified as the society least able to cope with inflationary pressures due to poor income distribution. Rising inflation has long been an issue, with the average inflation rate hovering at 9.1% over the last decade. It peaked at 23.6% in August 2008 in the midst of the global financial crisis, but well ahead of revolutionary unrest. In the wake of President Hosni Mubarak’s departure, inflation hit 11.5% in March 2011.

However, the inflation rate began to slow in the second quarter of 2012, and in July of that year it sank to 6.4% – the lowest in six years, according to Bloomberg and Reuters reports. This slowdown, attributed to smaller increases in the cost of food, coincides with the election of a new president and steps towards a new, more stable government. As the confidence in the market and economic policy grow alongside the new administration, so shall the incomes and ability of the average Egyptian consumer to deal with inflation and price fluctuations.

DEPRECIATION: The Egyptian pound fell about 4% in value between June 2011 and June 2012. Investors became increasingly worried over the state’s finances as foreign currency reserves plummeted, further exacerbated by the drop in tourism.

The decline could have been even steeper were it not for the support from the central bank, which used foreign currency reserves to keep the pound afloat and below the LE6:$1 value. However, in early July 2012, 12-month forward contracts on the pound were at LE7.45:$1, according to Bloomberg, giving the indication that investors expected a 19% drop by the end of the contract. This suggests that the market is expecting a devaluation of the currency, speculated as among worst-case scenarios throughout 2012. To allay these concerns, President Mohamed Morsy told international press at the end of August that he would not devalue the currency.

In the longer term, the currency fluctuations could cause some to reconsider their investments. “We plan to spend significant capital in Egypt in the coming years, but the concerns about the currency could have a serious impact on the success of any new industrial investments,’’ said Omar Mandour, regional general manager at Coca-Cola in Egypt.

However, as existing risks have not yet wiped out profits for the sector, margins will be the area to watch in 2012. “The currency depreciation has cut profits for any company that imports the majority of its raw materials,” Mohey Abdel Razek, the managing director of local paint and ink firm Pachin, told OBG.

Overall, in the post-revolution operating environment, cost control and access to credit are crucial. Companies can only pass so much of the increase in expenses to consumers, and must improve efficiencies, cut costs or accept smaller margins. Rising energy costs are a big factor motivating operational change, as long-time government energy subsidies may soon come to an end or be significantly scaled back, at least for some industries.

COUNTERFEITS: Perhaps the single biggest impact of the revolution on the FMCG market has been the proliferation of counterfeit goods. Though illicit products were a problem prior to the revolution, fake merchandise has become even more rampant since, with the government’s reduced capacity during transition making it easier for smugglers and domestic producers of knock-offs to peddle their wares. Domestically, counterfeiters have established factories in which empty bottles of legitimate products, such as shampoos or detergents, are collected and filled with fake liquids and then sold as the real good. Ahmed Fahmy, president and general manager of laundry and homecare at Henkel Egypt, a producer of detergents, cosmetics and adhesives, said that an estimated 40% of the laundry and homecare goods on sale in Egypt are counterfeit. “Police eventually shut down counterfeit factories, but the cycle continues as they reopen within days,” he said. “There needs to be serious awareness and legislation passed for harsher punishments for perpetrators.’’ Omar Bseiso, general manager of British American Tobacco in Egypt, estimates that the share of counterfeits in the cigarette market in early 2012 was roughly 20%, although he acknowledges that there is no way to precisely measure the pervasiveness of knock-offs. Smuggling goods into the country has also been an issue for the tobacco segment. Addressing this would require stronger laws against illicit importation, as well as increased security at ports and land crossings, said Bseiso.

The behemoth in the tobacco market is Eastern Tobacco, a subsidiary of Chemical Industries Holding. Eastern produces for both the domestic market and for exporting. Revenue remained steady in 2011, at LE3.7bn ($619.3m), 0.5% higher than in 2010. However, profits dropped by 26% to LE631.9m ($105.8m) on the year. The company has been on a capital expansion, opening a warehousing complex in 2012 and planning to spend LE500m ($83.7m) on two new factories over the next three years.

Other products that are also currently being heavily smuggled into Egypt include pharmaceuticals. More support from government and the police is expected in the future, as the newly elected government begins to take shape.

INPUTS: Despite the current conditions, the notable challenges in Egypt’s operating environment are not specific only to the country and its recent political evolution. Top on the list of pressing factors is commodity prices. Should the cost of basic agricultural inputs keep rising, or if Egypt’s currency continues to slide, making the import of inputs more expensive, companies may have to raise prices or take a hit on margins. Though consumers are price-sensitive, recent experience shows that hiking prices, and perhaps accepting smaller volumes and higher margins, could be a suitable strategy in some cases. Between 70% and 80% of sales in the confectionary market, for example, come from products priced at LE0.50 ($0.08). Some companies, such as BiscoMisr, Egypt’s largest domestic producer of biscuits, have been pushing these products to the LE1 ($0.16) price point and are finding that the margins make up for drop in volume sales of these products, or that consumers are willing to pay more. Kraft saw little change in buying patterns after shifting some biscuit lines from six-piece servings to eight pieces and doubling the price to LE1 ($0.16), said Zayed.

However, the price shifting has not been a universally successful experience, and some FMCG producers have found that price sensitivity remains a fundamental market trait. “The key to introducing new brands in the Egyptian market is walking a fine line between introducing a relevant, high quality product and at a good price,” said Sultan. “The Egyptian market is very price sensitive, so if you get the equation wrong, your product will be in trouble.’’ OUTWARD ORIENTATION: As Egypt overcomes its current concerns, FMCG producers are pushing for greater state support for export activity, which would lessen the need to match production precisely to domestic demand. Though exports from Egypt are already sold across the Arab world, more targeted government support could boost the total, said Hani Berzi, the CEO and chairman of Edita Food Industries.

“Non-petroleum exports account for approximately $25bn a year,” Berzi told OBG. “Exports are a great source of foreign currency and the government should realise that by supporting export subsidies, it will generate lucrative returns.” Indeed, for every LE1 ($0.16) in subsidies that is invested, the government yields $1 in returns, he added.

However, given Egypt’s huge domestic demand, production for export requires many firms to significantly expand capacity, said Aref Haki, chairman and CEO of BiscoMisr. “Exports are an attractive revenue source, but local demand is growing,” he said. “A product can easily lose its foothold in an export market if it cannot sustain its supply.”

FOOD: Food production is a particularly resilient FMCG segment. “With such a sizeable population, Egypt represents a market with considerable potential that cannot be ignored” said Suresh Narayanan, CEO and chairman of Nestlé Egypt. Food and beverages together represent the largest segment of the FMCG sector, as well as the overall consumer market, accounting for 38% of consumption as of 2009, according to Rasmala. Food retail sales grew at an average rate of 19.3% per year in 2006-10.

Food consumption jumps 30% during Ramadan, creating a trickle-down effect to other areas, said Khaled Akl, marketing director for the consumer staples manufacturer Unilever. Dishwashing liquid, for example, accounts for 50% of the firm’s profits during the month, he said. Ramadan also ushers in spikes in sales of certain foods. A traditional oat soup eaten during the holiday provides 92% of annual sales of Unilever’s Quaker Oats brand, Akl said.

GRADUAL UPGRADING: Within the sector, trends are pushing Egyptians away from traditional markets and toward modern retailing, such as the growing number of supermarkets and hypermarkets in Cairo and Alexandria, Egypt’s first and second largest cities, respectively. Although only a small portion of Egyptians can afford to shop in them today, the stores themselves have become a cultural phenomenon and a weekend entertainment option.

“People go there on the weekends to be entertained,’’ Zayed told OBG. “They do not necessarily buy anything, but they are looking around. It has become a family outing.”

In the process, the Egyptian public is also becoming more aware of modern retailing practices, like timed sales and promotions. Brand awareness and familiarity with the distribution channels best suited to packaged FMCG is on the rise, but in the short and medium terms, producers and distributors are keeping in mind that most sales still occur in smaller businesses, outside the modern retail sphere.

Covering all of Egypt would be difficult logistically, but it also means addressing multiple consumer segments. According to a recent study by the Central Agency for Public Mobilisation and Statistics, the food and beverages segment sees a large disparity in terms of purchasing power: it comprises 30.8% of spending for families headed by a person with a university degree, but jumps to 45.5% of that of an illiterate person. In between – those with at least a secondary school education – the number is 40.5%. An estimated 70% to 80% of sales come from small shops and traditional markets, with the rest occurring in modern retail spaces. The transition to the latter is certain to slow in the next several years, as most retailers have put off or scaled back expansion plans due to political concerns.

However, over the long term, modern settings are primed to play a larger role for FMCG. In Cairo retail supply reached 786,000 sq metres of gross leasable area (GLA) at the end of 2011, up from 610,000 a year earlier, according to market research from international real estate consultancy Jones Lang LaSalle. This total has been projected to reach 2.2m sq metres by 2015, with growth largely driven by major malls. By the end of 2013, an additional 260,000 sq metres of supply should be completed, although delays may push some construction to 2014.

FOOD PRODUCERS: Local food trends also provide opportunities for growth. Egyptians on a per-capita basis consume 33 kg of sugar per year, compared to 22 kg in Europe, and providers are struggling to keep up with demand, said Alaa El Bahay, CEO and chairman of Mass Foods. Delta Sugar, established in 1978, is the only cane sugar producer in Egypt, and in 2011 it ranked among the top 50 companies in the country by revenue. Revenue was little changed in 2011, ticking up from LE1.37bn ($229.3m) in 2010 to LE1.38bn ($231m). However, profits jumped, as the net figure went from LE298.24m ($49.9m) to LE391.79m ($65.6m), a 31.3% surge.

“Factors driving consumption growth change each year, but there always seems to be one,’’ said May Hashad, marketing manager at BiscoMisr. “Last year, people were stocked up in case things got really bad after the revolution. This year, people are directing some of their savings to food. There is almost zero risk investing in the Egyptian food market.’’ Tayeb Mouhcine, general manager for Egypt and Libya at French cheese producer Bel Group, said the cheese segment is continuing to grow. “The food industry, and specifically the dairy segment, has been growing in Egypt over the last year, and has not really been affected by economic instability, since food is essential. Also the population is growing by nearly a million every year and the gap in the nutrition needs are driving the consumption increase.”

One of the most successful companies in Egypt in 2011 was Upper Egypt Flour Mills, whose revenue jump on the year was the sixth largest among top-100 companies ranked in a study by Business Today Egypt. The firm’s revenue climbed to LE1.32bn ($220.9m), a 47% jump from 2010’s LE894.1m ($149.65m). Net profit was up 39.1%, at LE102.3m ($17.1m). On an earnings-per-share basis, the company, whose shares trade on the Egyptian Exchange (EGX), offered the fifth-best return on the year to shareholders among the top-100 group.

GROWING PAINS: However, recent setbacks in the migration to modern retail, including just-in-time delivery, have been an issue. In 2006, with the outbreak of bird flu, suspicion arose towards frozen and packaged chicken meat. Cairo Poultry, Egypt’s largest poultry producer, responded to public concerns with a widespread advertising campaign promoting the safety of frozen chicken and other frozen foodstuffs. Tighter margins, as with many FMCG firms, are also an ongoing concern for the company.

Cairo Poultry cited food prices as the main reason behind the drop in revenue and profit in 2011, particularly with regard to soybeans and corn, which are used as chicken feed. Corn had risen 79% to $296 per tonne by third-quarter 2011, according to a 2012 report by Business Today Egypt. Revenue dropped 3.9% to LE1.89bn ($316.3m), and net profit fell 16.8% to LE228m ($38.2m). The firm trades on the EGX, where its market capitalisation was LE1.45bn ($242.7m) as of May 2012, down 35.7% from 2010.

MORE MILK: Dairy stands out for its high market potential, both for of the general population trend guiding the Egyptian economy, and because it is still a relatively untapped market. Per-capita milk consumption in Egypt is among the world’s lowest, at 21.8kg in 2010, according to Rasmala. Additionally, Egyptians consume between just 1 and 2 kg of yoghurt a year, versus between 9 and 15 kg in Algeria and Morocco, said Floris Wesseling, managing director of Danone’s Egyptian operations.

The dairy market has grown at a relatively slow rate by world standards: 4.8% a year from 2005 to 2009 to a value of $2.5bn. Cheese accounted for some 38.5% of the total and milk another 28.2%. Leaders in the milk market are Dina Farms, which has a 60% share of the market for fresh milk, and Juhayna, which dominates the long-life milk subsector, where it controls approximately 50% of the market.

GROWING AROUND THE OBSTACLES: Food conglomerate Juhayna owns six plants and 21 sales and distribution outlets. It has a production capacity of 2900 tonnes per day and 3700 employees. The company reported an 18.4% decline in sales in 2011, which fell to LE186m ($31.1m) from LE228m ($38.2m) in 2010. Revenue was up 21%, and gross profit up 9% in the same period. Of the company’s four main product lines, dairy, juice and concentrate sales rose at rates between 9% and 16%, and yoghurt sales surged 53%. The firm claimed that costs were higher due to the impacts of the revolution, and shifts in consumer patterns.

Global food prices also played a role in the company’s financial calculations. Juhayna attributed the drop in its gross profit margin in 2011, from 33% to 26%, on the rising price of raw milk, a cost it said it passed on to customers at a gradual rate. “The shift in consumption patterns towards smaller package sizes and lower-priced products added to the margin decline,” the company’s earnings report states. Furthermore, sales to Libya, accounting for some 70% of exports, were nearly halved in 2011 on account of the upheaval there.

Two non-recurring factors also skew the year-to-year comparison: the company received LE20m ($3.35m) in 2010 from a land sale, and it took a LE40m ($6.7m) charge in 2011 after settling an insurance claim from a fire at a yoghurt plant.

LOOKING AHEAD: The third-quarter results for 2012 should offer an indication of future developments for the sector. This quarter is generally the most lucrative in the Egyptian consumer staples segment, and the fall of Ramadan in that period furthered heightened consumption.

The FMCG sector shows a number of positive growth prospects in the near term. As political tensions ease and the regulatory authorities resume stable oversight of the country and economy, investors and businesses can continue to capitalise on the numerous advantages offered by the Egyptian economy – its growing consumer base, geographic position and abundant low-cost workforce.