BoA ML downgrades FMCG stocks to 'underweight' from 'overweight'

Bank of America Merrill Lynch (BoA ML) has downgraded stocks in the fast moving consumer goods (FMCG) space from 'overweight' to 'underweight'. The foreign brokerage says valuations of Indian staples have soared, diverging from their global peers.

"Multiples for Indian staples have defied gravity recently. They have increased even as multiples for staples in the emerging markets (EM) are flat to falling. This is not typical," Sanjay Mookim and Nafeesa Gupta, analysts at BoA ML, wrote in a note.

The BSE FMCG index, a gauge for the performance of consumer stocks, on Thursday fell for a seventh straight trading session. Some of the key components of the index include Hindustan Unilever, ITC and Britannia.

“Indian staples come with elevated multiples and growth expectations. We remain positive on rural India, and stocks that have exposure to it. However, given the divergence of staples' multiples, we remove our overweight on the sector, preferring instead to have rural exposure through auto (two wheeler) and cement,” went the note.

The Morgan Stanley Capital International (MSCI) India staples index commands one-year forward price to earnings (PE) multiple of 40 times, up from 35 times in September 2017 and from lows of 18 times in early 2017. In comparison, the forward PE for MSCI World Staples has fallen from highs of 19.7 times in December to 17.3 times, while that for EM staples are down from 23 times to about 22.3 times, said the brokerage.

The country's largest consumer goods company Hindustan Unilever has seen its forward PE rise from 46 times in March end to under 54 times.

“Some Indian staples have seen earnings upgrades recently, but the aggregate earnings growth rate forecast for the sector remains in line with the long term average,” said the analyst duo at BoA ML.

The brokerage is of the view that recent changes to macro economic fundamentals augurs well for rural growth. 

“A weaker currency, increasing commodity (oil) prices and an upward bias to inflation will likely shift consumption from urban (lower disposable income) to rural India. Government welfare spending is likely to remain strong and even exceed budgets in 2018-19 as the country heads towards elections,” said BoA ML.


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