Investors prefer FMCG over IT, pharma

Rising demand expected to sustain former's high valuations

Fast moving consumer goods (FMCG) shares are in a sweet spot. Even as unfavourable structural changes such as digitisation and pricing pressure have battered two other 'defensive' sectors, information technology (IT) and pharmaceuticals, a host of catalysts in place for FMCG stocks.

Amid rising growth concerns for IT and pharma, incremental flows continue to perk FMCG shares. This is also reflected in the sharp jump in the BSE exchange's FMCG index’s one-year forward price to earnings multiple, as compared to the BSE IT and BSE healthcare indices.

This metric stands at 33 times for BSE FMCG, and 15 and 20 times, respectively, for the IT and health care ones. The BSE Sensex trades at 18 times the FY18 estimated earnings and there is no change in the FMCG index's premium versus the Sensex in the past one year. However, the premium versus the IT and pharma indices has jumped 116 and 61 per cent, respectively, over this period. These premium valuations are also expected to sustain.

Pramod Gubbi, head-equities at Ambit Institutional Equities, says: “Even if FMCG companies post a seven to eight per cent volume growth and five to six per cent realisation growth every year, their earnings could grow 15-20 per cent, with very little volatility. Investors are happy to pay a high price for such growth. FMCG is definitely a safe haven and we believe these valuations are sustainable.”

After a minor setback from the cash crunch arising out of demonetisation in the December 2016 quarter, most FMCG companies have seen improvement in their volume growth to pre-demonetisation levels in the March quarter. The expectation of a normal monsoon will aid consumption demand in rural markets, which has improved but continues to lag urban markets. As rural markets form 40-60 per cent of most large FMCG companies’ sales (Hindustan Unilever, Colgate, Dabur), improving consumption trends here will further aid volume growth.

Also, FMCG companies are among the beneficiaries from implementation of the coming (next month) goods and services tax (GST). It will lead to some near-term pressure, particularly in the wholesale channel, leading to inventory de-stocking in the ongoing quarter and perhaps the next one. However, it will also bring cost efficiencies in the form of savings in logistics costs, beside a lower tax rate on soaps, toothpastes and other categories. Most FMCG companies will pass on these benefits to consumers, to boost their volumes.

Also, as entities in the unorganised sector come under the ambit of GST, their compliance costs will go up. This will provide some edge to the organised ones. There could also be some shift of market share towards the latter in the mid to longer run. Stabilising input costs, particularly in crude oil and its derivative products, will also benefit FMCG companies' margins, believe analysts.

In this backdrop, most analysts are positive on the sector. Even as continued earnings momentum could drive capital appreciation for consumer stocks, their high dividend payouts will also add to the overall returns. While IT companies have raised their payouts in recent times, to compensate investors for slowing growth, pharma companies are still lagging in this. Vinit Sambre, fund manager at DSP BlackRock Mutual Fund, says, “Incremental money is not finding its way into IT and pharma stocks. It is flowing into banks, oil & gas and FMCG. Companies seeing four-five per cent volume growth have got re-rated in the past few months. These valuations are sustainable because the alternatives are limited and liquidity is chasing equities.”

Some are a bit cautious. Amar Ambani, head of research at IIFL Private Wealth, for instance, believes that rotation of flows into FMCG stocks and out of IT and pharma stocks could continue in the short term but investors should note the high competitive intensity for FMCG companies in most categories. While established companies have strategies to protect their turf, they could face pressure from companies with a focus on natural products such as Patanjali or Himalaya, expected to expand rapidly. It would be interesting to see how this unfolds. Among others, the outlook is still unclear on industrial goods, given the uncertainty around capital expenditure. Private banks, some non-banking financial companies and consumer discretionary stocks are also seeing high investor interest.