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Fifty, seventy, seventy nine… These are not just numbers, but percentage gains made by stocks of fast-moving consumer goods companies in a year. The index for fast-moving consumer goods has rocketed 41 per cent in a year. That’s leaps ahead of the 14 per cent notched up by the Sensex or Nifty. So, what’s driven this rally? And what should you do with your holdings in FMCG stocks?
Better than most
The reasons why FMCG stocks have soared in a volatile market are four-fold. One, FMCG companies have shown sales growth far ahead of the 4-10 per cent aggregate growth by India Inc in the past four quarters. Two, FMCG products account for a smaller share-of-wallet, and hence consumer demand here has shown better resilience to the slowdown than other consumer-oriented sectors, such as auto, retail or durables.
Three, demand for FMCGs comes from the entire spectrum of consumers and companies have been able to grow by pushing farther into rural areas. And four, FMCG companies are cash-rich and carry low debt.
Not cheap
But the problem is that all these arguments helped FMCG stocks soar to sky-high valuations. In fact, FMCG stock gains in the last one year have been driven more by rising PE multiples than underlying profit growth.
For example, valuations for GSK Consumer Healthcare are now at 42 times trailing earnings while they stood at 28 times in August last year. Meanwhile, Hindustan Unilever moved from a PE of 33 times to 40 times within the space of a year. That’s well above its five-year average PE of around 30 times. Both stocks received a boost from generous pricing of open offers, and not from promise of strong growth.
P&G Hygiene, having jumped from a 40 times PE last August to 50 times now, is also well above its average PEs. Earnings multiples for Britannia Industries and Nestle India are inching towards the higher end of their five-year PE band.
Overall, this has contributed to a hefty premium for the entire universe of FMCG stocks. The BSE FMCG index today trades at a PE multiple of 38 times. The Nifty and the Sensex, in contrast, trade at a PE multiple of 17 times.
Tapering growth
Growth prospects for these companies, meanwhile, have been diminishing in the last two quarters. These companies now have to contend with ebbing consumer confidence. Consumers are scrimping on spending, having to battle high living costs — consumer inflation has stayed above 9 per cent for the past year.
From a 17 per cent growth in the June 2012 quarter, growth dropped to 14 per cent in the March 2013 quarter. Of the companies that have declared results for the June 2013 quarter, some have seen sales growth drop to single digits.
Segments such as cosmetics and packaged foods, which aren’t as essential to consumers as soaps and detergents, are beginning to bear the brunt of consumers scaling back purchases. That companies pushed premium products in the segment to drive sales and margins also didn’t help when consumers began to cut back.
The personal products segment of HUL saw sales growth drop to 2 per cent in the June 2013 quarter from 12 per cent in the December 2012 quarter. Nestle India’s sales growth has steadily been declining over the past several quarters. Agro Tech Foods, which holds brands Sundrop and ACT II, had sales growth coming in at just 8 per cent in the June 2013 quarter.
What worsens the scenario is that volume growth has come off for all companies, indicating a definite demand slowdown. For personal care company Marico, volume growth dropped to 8-9 per cent in the second half of 2012-13 compared with the 14 per cent-plus growth of the quarters before. HUL’s volumes came in at a scant 4 per cent growth for the June 2013 quarter.
A muted job and salary outlook, persistent high food and fuel costs, still-high interest rates and thus high monthly loan payouts all indicate that discretionary incomes – and thus spending - are unlikely to expand much. Companies such as Britannia Industries and GSK Consumer Healthcare have seen more of price-driven sales growth.
Cheap inputs
One saving grace for FMCG companies has been the better profit margins from moderation in input prices. Among the range of materials used by these companies, those such as palm oil and acids, those linked to crude oil prices such as packaging, menthol and copra, among others, have turned cheaper over the past year. Those such as wheat and barley have evened out. A few companies, such as HUL, Dabur and Marico, even lowered product prices to spur sales.
Over the past four quarters, operating margins have steadily improved to 17 per cent by the March 2013 quarter from 15.5 per cent in the June 2012 quarter. Numbers declared so far for the June 2013 quarter show further improvement in margins.
But what may put the brakes on this trend is the depreciating rupee, turning imported materials, such as palm oil costlier. Prices of other inputs, such as tea, safflower oil and milk, are also rising. During previous high-cost input scenarios, such as in 2011, companies economised on advertising and promotion spends to keep operating margins in place.
That may not be an option now, with intense competition in most categories — biscuits, instant noodles, skin care, soaps, shampoos and toothpastes.
Ad-spend-to-sales ratio moved up from 11.5 per cent in the September 2011 quarter to 13.2 per cent by the March 2013 quarter. Big spenders are GSK Consumer Healthcare and P&G Hygiene, shelling out 17-20 per cent of sales in advertising. Ad spends have been creeping higher for Godrej Consumer, Marico and Dabur too.
What’s in store
FMCG companies, then, over the next few quarters will see sales moderate more, especially in discretionary segments. If raw material prices move higher, as they seem to be, companies will have to contend with lower profit margins. The leeway companies have to raise prices and sustain sales growth and protect margins is also narrowing with volumes already slowing and consumers unlikely to take kindly to higher prices.
Investors can make the most of the party and book profits in stocks which have run up well ahead of earnings growth. The price run-up also means that these stocks may lag others when the markets pick up. However, stocks which have shown resilience and hold good promise can be retained in portfolios.
>bhavana.acharya@thehindu.co.in
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