Though markets have cooled a bit from the all-time highs they hit a month ago, valuations are still not cheap. The Nifty today trades at 22 times its trailing earnings, compared to 20.5 times during the March 2023 market lows. Valuations of the Nifty Consumption (of which FMCG, Auto and Durables are top weights), Nifty FMCG and Nifty Auto Indices are much steeper, at 43-47 times, riding on themes such as the cyclical upturn in auto sales, demand revival post-Covid, as well as the penetration potential for various consumer goods and services. Most stocks part of the Nifty Consumption Index are comfortably past their pre-Covid peak (January 2020), with some even doubling or trebling since then.
However, on the ground, the optimism is not carrying through. For one, private consumption expenditure as a percentage of GDP in the March 2023 quarter (latest available data, at constant prices) came down to 55 per cent, a level last seen in the Covid-hit first quarter of FY21. On a sequential basis, spends on this head had dropped by about 3 per cent in Q4FY23. Into Q1FY24, an analysis of the results of India Inc. show just low single-digit revenue growth year-on-year, indicating weak demand, though profits grew at about 50 per cent, aided by lower costs.
Thirdly, just as raw material prices have cooled off and rural demand seems to be gaining colour, consumer price inflation is rearing its head back again. The latest round of RBI’s Consumer confidence survey released on August 10 reflects some pessimism too. After persistent recovery for almost two years, the ‘current situation index’ stood lower than the previous survey round. While respondents showed improved sentiments on income and spending, it wasn’t matched by optimism on the general economic situation.
With the sector at a crossroads, what are companies doing and what should investors do?
How companies are playing it
For now, the headwinds are not yet showing up for FMCG players. Data from NIQ (formerly Nielsen) shows that in value terms, the Indian FMCG market grew 12.2 per cent year-on-year in April-June 2023, with a 7.5 per cent underlying volume growth. This is the highest value as well as volume growth in the last 5 quarters. The volume growth may sustain for the rest of the year for a few reasons: Going by management commentary, many FMCG players are still liquidating their inventory at higher prices and it may take one or two quarters for the benefit of price cuts (or higher grammage) to seep through to the end consumer. Thus lower prices may support volumes.
Besides, given the benefit of lower costs due to a cool-off in input prices, companies are using the savings to up their advertising spends, which could sustain demand. Ad spends for companies such as Colgate, Godrej Consumer and Hindustan Unilever, for instance, have surpassed pre-Covid levels (ie Q1FY20 levels) in Q1FY24. Ad expenses as a percentage of sales too are higher than pre-Covid levels for Godrej as well as Tata Consumer. Thirdly, smaller companies such as Jyothy Labs are also expanding their direct reach, targeting incremental volumes from higher touch points.
Consumer durables players such as Blue Star and Havells, who have already seen muted demand for consumer electricals/electronics, for instance, are riding on their B2B segments. Government capex and pick-up in infrastructure spending is already benefitting them.
And then, there is the ride on premium products, which is relatively immune to factors such as rural slowdown or inflation. Even if fewer products are sold, higher realisations and margins add to the bottom line. Commuter bike sales (75-110cc) – which is a big market for Hero MotoCorp – are yet to recover to pre-Covid levels. However, Hero is riding on the higher segment Glamour, Super Splendor XTec and Karizma for the next leg of growth.
While compact car sales are not quite exciting now, Maruti Suzuki, the erstwhile ‘small car maker’ is carving a niche in the SUV segment. As of FY23, UV sales constitute half the total passenger vehicle sales in the country and share of UVs in Maruti’s volumes now stands at over 20 per cent.
Also, if high inflation such as the one witnessed for July turns out to be transitory based on supply side, and not sticky, companies may not have to worry for long. Rural non-farm incomes, seeing good traction due to government capex/MNREGA, are expected to aid volumes, even if volatile monsoons affect farm incomes.
What investors can do
Given the demographic dividend as well as the population, consumption in India is often said to be an evergreen story for long-term investors. This is also one reason why non-cyclical consumer goods stocks such as FMCG or durables trade at high valuations. One thing investors can do today is to look for pockets of relatively lower valued stocks in these segments. For instance, bl.portfolio has been recommending mid-cap FMCG Jyothy Labs over the last few years. The stock is now beginning to play catch-up with its larger peers.
Similarly, among auto components, small and mid-cap plays with good prospects and reasonable valuations are still available. Fiem Industries, SJS Enterprises, Sansera Engineering and Lumax Industries are some examples. Some large-caps part of the Nifty consumption basket are trading at valuations below pre-Covid levels, Maruti Suzuki being a good example. Some FMCG behemoths such as Hindustan Unilever and Britannia too are trading below their pre-Covid valuations.
On corrections linked to broader markets, investors can bet on themes with long growth runway such as electric vehicles, within the auto space. Two new thematic funds focused on consumption have come out recently and there are a handful of existing active and passive ones too. Most of them have given double-digit returns over 3,5 and 10-year periods ( both point-to-point and SIPs). There are a couple of active and passive funds for the auto sector as well. But time your entry to thematic funds on a correction, limit exposure, and restrict them to your satellite portfolio.