Slowing consumer demand, high stock valuations to weigh on FMCG companies

FCL has also been tapping into parent Future Group’s vast database to create and promote new product categories through what it terms ‘desire creation’
The good times seen by fast moving consumer goods (FMCG) companies and their investors may hit a rough patch in the coming months, thanks to the current downturn in consumer demand and high stock valuations.

This in contrast to the situation seen until the quarter ending December 2018, when the FMCG space saw strong investor support with a robust volume-led growth. As a result, the average price-to-earnings (P/E) valuation of the FMCG sector (barring ITC) hit a high of 51-52 times, based on one-year forward estimates. This is a 32 per cent premium to the 10-year median of 38 times and a hefty 144 per cent premium to the S&P BSE Sensex P/E of around 21 times, as per SBICAP Securities. Until very recently, the Street was expecting the pricey valuation of FMCG to continue in light of stable demand, elevated margins, etc. However, the latest signs of slowing consumption demand has poured water on these expectations.

“We have come across some kind of consumer demand slowdown. This would impact the volume growth of many FMCG major players such as Dabur, Hindustan Unilever, among others,” says Vineeta Sharma, head of research at Narnolia Financial Advisors. There could be some correction in valuation of FMCG stocks in the near term with 12-15 per cent decline in stock prices, she adds.

P/E is the company’s share price divided by earnings per share, and indicates how many times the profit an investor is paying for the stock.

Management of some consumer companies such as Dabur have also recently indicated their concern over slowdown in overall consumer demand. Not only urban, but rural growth has also tapered despite a strong stimulus by the government. Rural growth is now 1.15 times faster than urban versus 1.3 times earlier. A likely delay in implementation of government’s rural boosting schemes such as Pradhan Mantri Kisan Samman Nidhi Yojana, a direct income transfer scheme for farmers, and subdued crop prices are likely to have pulled down growth from the hinterland.

For instance, as per Edelweiss Securities, not even 25 per cent of the expected 120 million beneficial families have received first tranche of the payout under this scheme as others are under the validation process.

Besides, a change in climatic conditions i.e. prolonged winter troubling sale of summer-centric products and impact of liquidity crisis of September last year are among other factors disturbing consumption demand. Also, Credit Suisse says the tailwinds from the GST rate cuts of November 2017, which benefited companies like Hindustan Unilever in term of offering extra volumes, are now in the base.

This high base could be another drag on volume growth. Many consumer companies have continuously reported high single to double digit volume growth in past quarters. So, the demand moderation is likely to be double whammy. Firstly, with such demand scenario the companies may not afford to take price hikes to protect their overall topline. Also, many companies would focus on market share gains going ahead, as indicated by some major FMCG players such as Marico and Dabur. This would warrant additional advertising and promotional spends and would weigh on operating profit margin.

As per Credit Suisse, there is a clear increase in thrust on consumer promotions from many companies. Expanding margins will be tough in the current environment as there are no tailwinds on input costs and the low revenue growth does not give much operating leverage.

However, analysts do not see the dismal demand situation to be structural. Post the central election in India, demand would fire up again, once direct transfer schemes are fully implemented and given the expected better monsoon and improving distribution reach among others, say analysts at Edelweiss Securities. Focus on e-commerce would also support growth in the longer run.

Overall, long-term investors are recommended to be selective while bottom fishing till the shadow of slowing growth clears. While Marico and Britannia are top picks of some analysts from consumer staples, Asian Paints, Titan and Pidilite top the list from the discretionary pack. 

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