FMCG stocks: Going overboard

FMCG stocks valuations look stretched at the moment

Going by the mutual fund category rankings, FMCG funds have been among the top performing category for over a year.

Compared with diversified funds' 50.71 per cent returns over the past year, FMCG funds delivered 63.84 per cent. FMCG stocks are doing quite well on the bourses, and the bullishness is on expectations of higher growth.

There has been distinct improvement in FMCG categories since last year, when the stocks caught up with the rest of the stock market. Even in October, according to AC Nielsen's retail sales data, fast moving consumer goods grew 5.8 per cent year-on-year, the highest in the past seven months.

No wonder, the stock markets are rewarding this performance with the BSE FMCG Index rising 48.09 per cent over the past year. The index would have been higher were it not for heavyweight HLL, which gained 23 per cent.

But are valuations running too far ahead? While in some stocks such as ITC and Godrej Consumer, the rise in P/E is justified by the numbers, in many of the stocks, the P/E seems to have expanded rather rapidly. 

GOING AHEAD
Company	P/E
	5-Dec-04	5-Dec-05
ITC	12.45	14.29
Hindustan Lever	22.86	33.78
Nirma	11.19	10.60
Dabur	21.07	30.24
Britannia Ind	11.30	24.13
Procter & Gamble	17.84	22.54
Colgate-Palmolive	20.43	29.76
Godrej Consumer	19.20	26.81
Godfrey Phillips	9.40	21.90
Gillette India	37.75	37.05
Tata Tea	23.24	31.22

Hindustan Lever was trading at a trailing 12-month P/E of 22.86, which has gone up to 33.78. Colgate's P/E has gone up from 20.43 to 29.76. Beyond the upward shift in P/E multiples across the market, there is definitely a lot more expectation built into the FMCG sector.

Yes, volumes have expanded for most companies, but pricing power still seems elusive. Even the 4-5 per cent price hike effected last week will offset the cost increase only partially.

The urban consumer is moving up the value chain, and FMCG companies need to tap this segment before it shifts to the easily-available imported products. There also seem to be expectations of higher consumption in the rural market, after a good monsoon and a 2 per cent rise in agriculture in the GDP.

Valuations look stretched at the moment and may not sustain unless FMCG companies post better-than-expected numbers in December 2005.

Small Steel Companies

Small and medium-sized steel companies are witnessing a slight improvement in their operating environment and that's thanks to a weakening in international spot iron ore prices.

Spot iron ore prices are currently hovering at about $50-55 a tonne (approximately Rs 2,250 a tonne) compared with $74-77 per tonne (about Rs 3,300 tonne) in the first week of September.

Iron ore typically accounts for about 20 per cent of the total cost of hot rolled coil (HRC) production for a small steel company, point out analysts. The stock market, however, has not taken much notice of this development with stocks of several mid-sized players lagging the broader market over the past two months.

For instance, Uttam Galva has fallen about 21.7 per cent compared with a 10.2 per cent fall in the BSE's Metal index. Bhushan Steel & Strips, too, has also fallen about 20 per cent in this period.

Meanwhile, integrated steel mills such as SAIL and Tata Steel's production costs are not affected by fluctuations in iron ore prices given their captive resources. What factors have led to this easing in spot iron ore prices?

With prices of steel products such as HRC currently down about 25 per cent on a y-o-y basis, it has forced non-integrated players to ease the margin pressure via lower input costs.

Also, Chinese iron ore imports are expected to grow at a slower pace in CY2006 "" an incremental growth of 35 million tonne is projected for the next year compared with earlier forecasts of 56 million tonne.

Large Indian ore exporters such as Sesa Goa are not affected by weakening spot prices and that's owing to an overwhelming majority of its exports being long-term contracts.

A cushion on margins for smaller steel companies is also expected from met coke prices easing about 20-22 per cent in the last six months.