Pare expectations from FMCG stocks amid economic slowdown: Analysts

Consumer index underperformed the broader indices in November as investors looked at alternatives

Moderation in volume growth for the third consecutive quarter and high valuations seem to be catching up with the listed FMCG pack that has underperformed the broader markets in the past month. While the Nifty FMCG index has shed over 3 per cent, the Nifty50 has gone up around 2 per cent during the same period. 

The performance of Nifty 50 constituents shows that the gains in the last one month were entirely driven by non-FMCG players, such as State Bank of India (up 22 per cent), Bharti Airtel (up 23 per cent), and Grasim Industries (up 10 per cent).

Developments in other sectors have also started reviving investor sentiments in non-FMCG stocks. For instance, the recent Supreme Court ruling on the Essar Steel resolution plan and the overall improvement in asset quality augur well for banking stocks. The Nifty Bank index has gained about 7 per cent in the past month. Experts believe that investors could take some money off the table if alternative sectors start delivering. 

“If sectors which are currently under stress start performing, FMCG companies would see a good correction,” says G Chokkalingam, founder and managing director of Equinomics Research. 

 

The stress in other sectors has been one of the reasons for investors ascribing higher valuations for defensives, such as FMCG. Girish Jain, head of research-retail at Nirmal Bang, is also of the view that these stocks would underperform as other sectors fire going ahead. 

While investors were paying considerably more “growth premium”, this leg which was supporting the valuations has started to crack. Analysts are of the view that FMCG companies have to register accelerated volume growth in the latter part of FY20 (October 2019 to March 2020 or H2FY20) to justify premium valuations. 

According to Vishal Gutka, vice-president at Phillip Capital, “at present, FMCG valuations are stretched, given the volume growth moderation. And, to sustain such high valuations, at least mid-double-digit volume growth in H2FY20 is required.” 

Considering some macro issues, such as unseasonal rainfall and floods in some parts of the country, and sustained liquidity issues, achieving mid-double-digit volume growth looks difficult, 

he adds.

As mentioned earlier, volume growth remained subdued in the last two quarters because of muted rural sales. In fact, in the September 2019 quarter (Q2), this metric went from bad to worse.

Average volume growth of eight major FMCG players stood at 3.2 per cent in Q2, the lowest in the last 10 quarters. Notably, growth of the rural business, which was at par with that of urban till the June 2019 quarter and which contributes 30-35 per cent revenue of the entire FMCG universe, remained below urban growth in Q2. Hindustan Unilever, for instance, reported its rural business rising 0.5 times its urban business.

 

Though there are headwinds some analysts believe that there might not be a sharp correction in valuations. “Besides unavailability of other options, a likely robust earnings trajectory of top FMCG players would continue to provide valuation support. Even if other options open up, FMCG is unlikely to see significant valuation correction,” says V Balasubramanian, chief portfolio strategist at Mahindra Mutual Fund. Nitin Gupta, analyst of SBICAP Securities, too, believes that FMCG players are strategically handling the on-going slowdown with more focus on high-margin premium launches and their marketing, promotional offers and distribution expansion. Moreover, input costs are still benign for many companies, which can be used to push volumes. The jury is out if these efforts would help FMCG players to continue 

enjoying rich valuations for a longer time.

For now, investors are recommended to avoid the more expensive stocks in the FMCG space until the clouds over the consumption scenario are clear. For investors who have a higher risk appetite can consider Britannia, Colgate-Palmolive, and Dabur.