FMCG stocks: Fast movers

The sector has staged a comeback of sorts

The mediocre quality of earnings turned in by the sector over the past few years had led to a slight de-rating of stocks resulting in the sector lagging the market. Of late, however, the sector has staged a strong comeback in a weak market where investors prefer to hold defensive stocks.

The biggest problem that manufacturers of fast moving consumer goods have faced over the last few year is the soaring cost of inputs. The reasonably good volumes turned in by these firms have not translated into strong operating margins because not all of them have managed to pass on the higher costs, even in a booming economy.

A study by Morgan Stanley shows that firms like Colgate and Nestle have repriced products to more than take care of costlier inputs whereas companies such as Dabur and Godrej Consumer Products have found it difficult to do so.

Market leader Hindustan Unilever has taken highest weighted average price hike of 10 per cent, though that was not sufficient to offset the increased costs. The 2 per cent reduction in excise duties announced in the budget should help companies absorb some more of the costs.

As a result, they should be able to sustain margins or even marginally expand them over the next couple of years. Of course, a further sharp rise in prices of commodities will dilute their margins because they are unlikely to be able to raise prices in an economy that is slowing down.

FMCG firms are expected to grow their earnings at a compounded 13-24 per cent between 2008-10 with Nestle and Tata Tea leading the pack and ITC bringing up the rear.

The stocks are currently trading at multiples of between11-25 on 2009 estimated earnings: Nestle and HUL are the most expensive stocks while ITC and Dabur trade at around 20 times.

Share buybacks: The time is right

The Rs 789 crore Gujarat Fluorochemicals says it will buy-back its shares at a price not higher than Rs 300 per share. That's not surprising because the stock crashed to its 52-week low of Rs 175 last week and is trading at Rs 191.

Unless there is a very strong revival in the market, the stock is unlikely to climb back to Rs 300 in a hurry. So, the support for the stock may come in at far lower levels. The reasons why managements do buybacks is well known: they want to put spare cash to good use by picking up shares which may be trading below their intrinsic value.

The current weakness in the market is a great opportunity for managements to convince shareholders that their stock is worth more than what the market reflects.

It is also a chance for promoters to buy stock and shore up their holdings: a BSRB study of a sample of 2,858 companies shows that the percentage of firms where promoters own more than 50 per cent of the stock hasn't changed over the last one year and remains at around 51 per cent.

Companies flush with cash can also ask investors to tender their shares and pay them directly. When managements announce a buyback they should follow through. Shareholders would have been disillusioned with Reliance Energy's buyback in June 2004. Not a single share was bought back though an amount of Rs 350 crore was allocated at a maximum price of Rs. 525.

The firm kicked off another buyback at a maximum price of Rs 1,600 on Tuesday. With the stock price way below these levels""it closed at Rs 1,300 on Tuesday-- there cannot be any excuse for the company not picking up shares. Hindustan Unilever recently bought back its shares at an average of Rs 207.13 spending Rs 630 crore.