FMCG: Adopt a stock-specific approach

After two years of rainfall deficit, the Met department’s prediction that the monsoons will be normal this year is good news for rural consumption. Already, stocks, beginning from two-wheelers to fertilisers to agri-inputs, have seen renewed interest in recent times. The FMCG segment, too, will, no doubt, benefit from a pick-up in rural demand. Besides, urban consumption is expected to quicken its pace, with greater disposable incomes from interest rate cuts and payouts from the Seventh Pay Commission. But upbeat demand outlook alone may not be the deciding factor to add FMCG stocks. Valuations, for one, are not too conducive.

Consider this — while the Sensex trades at a trailing 12-month PE (price to earnings ratio) of 19.7 times now, the BSE FMCG Index trades at a dizzying 47.5 times. Though headwinds came about in the last one to two years, valuations did not correct much and even if they did, many of them still trade above their three- or five-year historical averages. Investor confidence in the sector as a defensive bet in troubled times (be it for the economy or the stock markets), apart from the overwhelming presence of MNC stocks in this space which are seen as superior bets to desi ones, is among the reasons for the high valuations accorded.

Given the high valuations, the sector merits a stock-specific approach at this juncture. Considering its pricing power, brand equity and improving volumes from higher ad spends, behemoth Hindustan Unilever (HUL) could benefit from a pick-up in demand. The stock’s valuations have corrected a bit to around 49 times trailing earnings from 52 times a year ago. Further corrections may be a good entry point for long-term investors. Godrej Consumer is another promising stock, trading at a discount to HUL and close to its three-year average of around 41 times. Existing investors can also hold on to Nestle, given that the worst is over and Maggi Noodles is back on the shelves.

Bajaj Corp’s valuations have corrected in the last one year, from 32 times to 24 times now. But it may not be a tearing buy as it has its constraints. First, given its mid-cap stature, it deserves to trade at a discount to giants and large-caps. It is also predominantly a single-product company, deriving 90 per cent of its revenue from Almond Drops oil, pegging up the risk a bit. And at 30 per cent for the December 2015 quarter, the best of operating margin expansions may have been done with for the company, with the price of crude oil already reversing from its lows. Liquid paraffin (LLP), a crude derivative, is used as input for such light hair oils.

Similarly, with prices of inputs such as wheat and sugar gaining in recent times, the best of margin expansion for Britannia may be over, although it may have the pricing power to pass on any increases. At 48 times trailing earnings, the stock is not cheap, though it remains among the promising bets.

There are also some stocks like Marico where benefits looked priced in. Falling copra prices helped it expand margins and post strong profit growth, no doubt. But the stock has now re-rated from the 30-35 times it used to trade at to 47 times now. It is now at a premium to bigger players, such as Dabur and Godrej Consumer, leaving not much room for upside from hereon.

Finally, although Dabur has been threatened by competition, the company’s wide product portfolio and market leadership in many segments will stand it in good stead. Even as Patanjali Ayurved targets ₹10,000 crore revenues in the next few years, it remains to be seen if it would still be able to adopt cost plus pricing (as it claims). A ramping up of production facilities, distribution network and advertising spends would require higher financing and more realistic prices. With Dabur having corrected to 39 times its trailing consolidated earnings now, from 46 times a year ago, it remains a reliable bet.

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