Here are the reasons why FMCG valuations will remain high in coming days

A strong performance is always rewarded whether it’s a field of sport, movie or even the equity market. And, it is exactly what most fast moving consumer goods (FMCG) companies are likely to experience. After some choppiness in the past few quarters due to note ban and then goods and services tax (GST) rollout, many companies have posted good volume growth. The road ahead is expected to be even steadier. It won’t be surprising then if investors’ love for this pack persists in near-to-medium term, keeping their valuations or price-to-earnings ratio (P/E) elevated going ahead. P/E is the ratio between companies’ share price and earnings per share.

Many big players in this pack such as Britannia, Asian Paints, Hindustan Unilever, Godrej Consumer Products and Nestle among others, are currently trading at 41-56 times their FY20 estimated earnings. Only ITC’s valuation (among top players) is on the lower side as regulatory challenges faced by its flagship business – cigarette – kept investors away from the stock, though the stock has gained about six per cent after reporting better-than-expected volume growth in the June-2018 quarter.

“Good growth is coming back to the FMCG sector. It is considered as a safe bet despite high valuation by investors including domestic institutional investors as compared to other sectors. So, FMCG valuation would continue to remain high,” says Sunil Jain, head of research at Nirmal Bang Securities.

Firstly, the overall consumer demand is improving and more importantly from rural hinterland, which was depressed in the past. It was also palpable in the June 2018 quarter results, declared so far, many FMCG companies reported double-digit volume growth, though also pushed up by the favourable base in the year-ago quarter. Rural growth was also observed outpacing that of urban and it is expected to continue going ahead. The Marico management said the recent hike in minimum support price for kharif crops, farm loan waivers and the likelihood of normal monsoons have strengthened the case for a sustained momentum in rural growth. It is likely to provide an upward thrust to the topline.

Also, upcoming state and central elections would add further to the rural demand. “For the sector, rural growth is likely to continue to outperform urban growth on the back of multiple tailwinds, further fueled by likely pre-election stimulus,” says Nitin Gupta, analyst at SBICAP Securities.

FMCG companies would get additional impetus from the recent cut in GST rates for some segments like for paint companies (GST reduced by 10 per cent), taking away the share of unorganised players.

There is a caveat, however of high inflation. While some companies have seen margins improve, prices of key raw materials like crude oil, titanium dioxide, copra to add more, are elevated (on a year-on-year basis), weighing on the profitability of others as observed in the June-2018 quarter, which cannot be ignored. However, industry experts believe some input prices would soften going ahead and companies have pricing power (besides cost-cutting efforts) to safeguard their margin. “FMCG companies are expected to undertake price hikes in the near term amid high input costs to protect their margins,” Gupta added.

But, whether stiff competition restricts their pricing power or FMCG companies compromise on profitability in a bid to retain their market share would be an interesting watch.

In this backdrop, experts still believe that any correction in select stock would be a bottom-fishing opportunity for long-term investors. 

Company Market Cap* P/E ratio      
  Rs billion (x)      
Hindustan Unilever 3,809 52      
ITC 3,712 26      
Asian Paints 1,354 46      
Nestle India 994 49      
Godrej Consumer Products 905 44      
Dabur 771 41      
Britannia Industries 768 51      
Marico 455 40      
Procter & Gamble Hygiene 338 55      
Colgate-Palmolive India 305 38      
Berger Paints 305 46      
GlaxoSmithKline Consumer 286 31      
Kansai Nerolac Paints 257 36      
Emami 257 35      
Gillette India 218 53      
*As on August 3, 2018      
P/E: price to earnings (based on FY20 estimated earnings)
Source: BSE, analysts' reports      

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