An ever-increasing consumption of personal and household products by the masses has made companies selling these products, stock market favourites. The index that tracks these stocks — the BSE FMCG index — has gained 22 per cent since January last year even as the Sensex lost 15 per cent. The FMCG index even hit 52-week high last week. Within this category, domestic companies and those in food products are preferred.

Other consumer-driven sectors — cars, apparel, durables and such — have fallen prey to rising inflation and shrinking spending.

But it is not so with soaps, skincare, haircare, processed foods and other staples. The premium the FMCG index is currently commanding over the Sensex and the broader BSE 500 is at its highest in seven years.

Widening premium

During the heady days of 2007, the FMCG index had only a narrow premium over the price multiples of the broader market. In April 2007, for example, the FMCG index traded at 21.5 times, the Sensex was at 18.7 times and the BSE500 at 16.8 times.

This gap remained narrow for most of 2005 to 2009. The premium began to rapidly inflate from 2010 onwards and has been in double-digits since mid-2010. In effect, investors are now willing to pay much more for every rupee of earnings from these companies. The BSE FMCG index is now at a price-earnings multiple of 35 times. In contrast, the BSE Sensex trades at 17.6 times, and the broader BSE 500 is at 19.1 times. Many factors explain this fancy for FMCG stocks.

FMCGs account for a low share in the consumer wallet. A good portion of the products are for frequent use, such as soaps, toothpastes, hair oil, detergents and so on. These factors mean that while big-ticket purchases slow, spending on these smaller items tend to hold up.

This also makes it easier for FMCG companies to increase product prices, mitigating the effect of pricier raw material. Marico, Dabur, Hindustan Unilever, Emami, GSK Consumer Healthcare, Godrej Consumer Products and others have effected price hikes and managed to sustain volume growth as well. Operating profit margins for FMCG companies have averaged a minimum of 20 per cent over the past five years.

These companies also operate on very low debt. This is a distinct advantage in a world of high interest rates and heavy interest outgo telling on profitability of other sectors.

Strong earnings growth and steady margins have meant consistent, superior return ratios. Return on equity has been in excess of 20 per cent in the past five years for FMCG companies. Only about a fifth of BSE500 companies have managed such consistent return.

Finally, the Government's steps to boost the economy during the downturn have aided these companies. Employment schemes lifting average wages and good harvests increased rural money. FMCG companies too have focused on increasing rural penetration.

Playing catch-up

Within the FMCG space, the market is now paying more attention todomestic consumer companies. In terms of price-earnings multiples, the premium multinationals command over domestic players is shrinking.

Domestic companies such as Emami have successfully introduced new brands, while Dabur firmed up presence in the herbal category. These companies went on a buying spree, picking up stakes in promising overseas markets such as Africa and Latin America, as did Marico and Godrej Consumer. These acquisitions, apart from broad-basing operations, shielded the companies from harsh domestic competition. Godrej Consumer, for example, gets more than a third of revenues from global operations.

Marico's PE at the start of 2005 was 16.1 times, against behemoth HUL's 28.9 times. The former's valuations rose to 28.4 times six years later, while the latter's inched up to 29.1 times trailing earnings. ITC's sedate multiple of 18.7 trailing earnings in 2005 ran up to the current 30.5 times.

Also playing catch-up were smaller companies relative to their larger counterparts. Consider Marico's example. Starting out with a niche product like hair oil where it has retained a dominant share, it has made successful forays into grooming and health foods.

Healthy foods

Companies, whose main offering is packaged and processed foods, have been dealt a generous hand too. The food segment is under-penetrated, especially when compared to categories such as soaps and detergents, and thus offers far more growth promise.

Segments such as noodles and health drinks have only lately seen new entrants; firmly established biggies such as Nestle and GSK Consumer Healthcare are at a distinct advantage.

Nestle, in fact, has been the highest rated stock among FMCG peers in the past five years. It shot up from a PE multiple of 31.7 times to 46.9 times in a space of four years to April 2012.

With healthy growth in premium brands, still-strong rural demand and good penetration in these markets, the growth story for FMCGs is not yet in its final chapters.

>acharya@thehindu.co.in

Related Topics
comment COMMENT NOW