Multi-national FMCG firms' valuation premium shrinks

Strong growth by domestic companies, higher royalty burden on MNCs bridges valuation gap between the two

Stocks of MNC fast moving consumer goods (FMCG) companies (HUL, Nestle, Glaxosmithkline Consumers, Colgate Palmolive) have historically traded at premium price/earnings ratios over their domestic counterparts (Marico, Godrej Consumer Products, Dabur).

The key reasons driving this premium have been higher revenues and earnings growth, access to hi-end technology enabling specialised product launches in short time spans, amongst others.

This has empowered companies with long term competitive advantage over their peers.

However, as Indian companies have started expanding aggressively in the overseas markets and with increasing royalty payments by MNC firms to their parents, this premium has come down.

"Within MNC companies under our coverage, Hindustan Unilever, Nestle India, GSK Consumer and Colgate Palmolive trade at an average 26.1 times FY15 estimated earnings, 23% premium versus domestic consumer companies. While they have historically traded at a premium to domestic companies, the premium has shrunk over the past five years. If over the longer term royalty rates continue to rise, MNC firms will likely become less attractive to minority shareholders, we believe", says Manish Jain, FMCG analyst at Nomura Equity Research.

Analysts believe, going forward, the earnings and sales growth of companies will be the key determinant of this premium. While technology is the key advantage enjoyed by MNC players, domestic companies too have some positives.

First, the domestic players do not have the royalty overhang which in addition to lowering earnings, also has an adverse impact on the stock price. Second, unlike their MNC peers, domestic companies can expand into other geographies and tap the inorganic route to push growth rates.

Godrej Consumer Products (GCPL) is a case in point. The company has been on an acquisition spree globally which has led to higher earnings growth as well as re-rating of the stock in recent times. At 30.78 times FY14 estimated earnings, the stock already trades at a premium to HUL (28.76 times FY14 earnings estimate).

Marico and Dabur too have performed reasonably well in their respective segments. Going forward as well, analysts believe this valuation gap is likely to narrow as Indian companies keep expanding profitably. Notably, while International operations will be a significant part of their growth story, growth in Indian markets will be significant and companies need to maintain their performance on the home front as well.

Abneesh Roy, FMCG analyst at Edelweiss Securities says, "We believe higher royalty may not necessarily be a negative especially if it is backed by more product launches, more R&D transfer and more factories being set up (with costs borne by MNC parent). That visibility must be there. Domestic companies will have to grow strongly in India as well as global markets to command premium valuations."