Moving slow

FMCG Index, which has been underperforming the market, hit 4-month low at 1906.53 yesterday

The BSE FMCG index closed at a four-month low of 1906.53 after breaching the 1900 mark during intra-day trading.

The index has underperformed the Sensex for four months now. While the benchmark index has gained 21 per cent, the FMCG index has moved up by just 1.8 per cent during the period.

For FMCG, key players such as Hindustan Lever and ITC have turned out to be laggards and, hence, the culprits. While HLL has lost as much as 24 per cent from its high in April, ITC has shed 18.5 per cent since its high in May.

But it's not that the sector has been doing so bad "" volumes for the September quarter are estimated to have grown at around 15 per cent, y-o-y, for the sector, compared with 12 per cent for the June quarter. While ITC managed a revenue growth of 32 per cent y-o-y, HLL came up with just under 14 per cent y-o-y for its existing businesses.

Toothpaste major Colgate turned in a top line growth of 15 per cent y-o-y. With rural demand kicking in and modern trade channels growing, sustaining the top line growth should not be an issue for HLL.

Pressure on operating margins, however, continues with costs of raw materials still on the rise "" palmolein prices, for instance, have jumped 25 per cent in the past six months.

Not everyone managed to tide over the cost inflation in the September quarter. Thanks to the changing product mix, away from cigarettes, ITC's operating profit margin fell 400 basis points, y-o-y, in Q2 of this financial year.

Besides, in a highly competitive environment, Britannia was not able to pass on the higher input costs to its customers and its operating profit margin crashed to just over 5 per cent from 14 per cent in Q2 FY06. Nestle, too, saw margins dip 80 basis points, y-o-y, to 19.7 per cent.

HLL's operating margins expanded slightly "" about 50 basis points "" since it has been able to take price rises for several of its products including soaps and detergents.

However, the Street is not convinced that margins of these companies can improve given the continuing pressure from higher raw material costs. And unless that happens, it is difficult to justify current valuations, which are undoubtedly expensive.

For instance, HLL trades at nearly 26 times CY07 estimated earnings and ITC, which faces some uncertainty over VAT for cigarettes, trades at just under 20 times.

Patel Engineering: Strong growth

Patel Engineering, like other players involved in the construction business, enjoyed buoyant growth in the September quarter.

The company's consolidated operating profit surged 47.8 per cent, y-o-y, to Rs 36.8 crore in Q2 FY07, compared with 32.1 per cent growth in net sales to Rs 243.7 crore. Its operating profit margin also increased 170 basis points, y-o-y, to 15.2 per cent in the last quarter.

The company's improved performance has not gone unnoticed by the Street. The Patel Engineering scrip has gained 27.5 per cent over the past three months vis-a-vis 10.8 per cent growth in the Sensex.

The company management said Patel Engineering was currently implementing 20 projects in diverse areas such as dams, tunnels, bridges and hydropower, and inflows from these projects helped drive growth.

Among others, Gammon India saw its operating profit margin dip 470 basis points, y-o-y, to 10.8 per cent in the last quarter, owing to rising operational costs. Incidentally, Patel Engineering bagged some large orders in the September quarter, including a Rs 447 crore order from NHAI in Karnataka.

Strong growth in the company's top line helped it offset rising operational costs, for instance, the cost of construction, which jumped 29.8 per cent, y-o-y, to Rs 183.5 crore in Q2.

The company's recent acquisition of 51 per cent stake in Michigan Engineering is expected to provide synergies in tunnelling and hydropower projects. The Patel Engineering stock "" trading at 25 times estimated FY07 earnings "" is expensive at this moment.

With contributions from Shobhana Subramanian and Amriteshwar Mathur