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A safe haven

FMCG stocks have not succumbed to the subprime storm and many still make attractive investments.

Kapil Bajaj        Print Edition: May 4, 2008

Amid the general gloom in the equity markets, it’s a consumption carnival that’s hard to miss. The new-found momentum in the FMCG space not only allays fears of a slowdown but also promises handsome returns to investors.

Hindustan Unilever (HUL), for instance, has beaten the downturn in the stock market and recorded positive returns since January 11, when the markets began to react to the subprime crisis. The robust FMCG performance is despite rising inflation and increasing raw material prices.

 
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“Since January 2008, when the market crashed, we have seen investors diversify into the FMCG, capital goods and banking sectors— they are largely insulated from negative global factors. When the Index of Industrial Production (IIP) showed that the capital goods sector had slowed to 2.1 per in January from 16 per cent in December 2007, funds that had invested in capital goods started to move into FMCG,” says Bhavesh Shah, Vice President (Research), Asit C. Mehta Investment Intermediates. Besides, the FMCG space is linked to domestic growth and consumption expenditure, making it a “defensive play” in the uncertain markets, notes Anand Mour, Senior Research Analyst, Prabhudas Lilladher. “India’s strong economic growth, increasing urbanisation, the growth of modern retail, and the fact that most FMCG categories remain under-penetrated are major triggers,” he adds.

FMCG rising

Having languished for almost three years since 2002 due to various reasons (including price wars between HUL and P&G), FMCG stocks picked up momentum in 2005. “Since 2005-06, the sales and profits after tax (PAT) of FMCG companies have grown at least 15-16 per cent,” says Mour. Anand Shah, Analyst (Retail and FMCG), Angel Broking, says FMCG companies have been aggressively launching new products and even expanding their international footprint. HUL, for example, recently launched PureIT, entering into the water purification market, Nestle launched Nescafe Mild Coffee and Cerevita breakfast cereals.

Godrej Consumer Products is also getting into the act. Having made international acquisitions like Keyline (with brands like Cuticura and Erasmic) and Rapidol, it plans to launch these brands in India. The FMCG space, however, has also been characterised by stiff competition, which can undercut companies’ pricing power and margins.

“We expect new product launches to intensify the competition across segments and product categories. This will put pressure on incumbents to launch new variants and increase spends on advertising and brand building,” says the India Strategy Report of Motilal Oswal, released in early April 2008.

Price sensitive

Inflation, which jumped to a threeyear high of 7 per cent for the week ended March 22, remains a risk to FMCG demand, as does the possibility of a bad monsoon this year. “Rising food prices have been a worry for FMCG companies. Regular price hikes, following an increase in raw material prices, will surely put some pressure on volumes growth. But the companies in general have been able to make judicious price hikes,” says Mour of Prabhudas Lilladher. Last year, FMCG companies increased prices by 5-10 per cent on an average in all segments. FMCG stocks also seem to be holding on to their levels amid rising inflation because of the power of the brands.

 
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“Nestle, for example, has been posting fabulous numbers despite a 20-30 per cent rise in food prices over the last one year,” notes Shah of Angel Broking. When consumers down-trade from expensive to cheaper brands, large companies like HUL, which are present across price points, are well placed to capture the spend.

Bhavesh Shah, of Asit C. Mehta, notes that a positive for the FMCG space is that it represents demand for items of essential consumption. If inflation persists too long, however, it can create a cloud of uncertainty over the sector. Anti-inflation measures, on the other hand, can improve the sector’s prospects.

“In edible oils, the FMCG companies are going to benefit from import duty cuts announced in Budget 2008-09,” he says. HUL recently cut prices of three soap brands to pass the benefit of 2-14 per cent excise duty cuts on to the consumers. There are other factors that bode well for FMCG, particularly the Centre’s farm loan waiver scheme and the recasting of income tax slabs, which will put higher disposable incomes in the hands of the consumer, says Mour of Prabhudas Lilladher.

Compelling valuations

“Colgate has been trading at 20-21 times its estimated 2008-09 earnings. Its net sales are growing consistently at about 14-15 per cent. From 2003-04 to 2006-07, its PAT has grown at 23 per cent CAGR,” says Mour, who’s also bullish on HUL.

Trading at 13 times the estimated 2008-09 (the company follows the calendar year as its financial year) earnings, GSK Consumer Healthcare is also a great bet as its main brands, Horlicks and Boost, continue to do well, adds Shah of Angel Broking, noting that sales have been growing 15 per cent and margins are also expanding handsomely.

He also recommends Marico (trading at 21 times the estimated 2008-09 earnings; most of its brands are posting good sales), Nestle (though pricey at 28 times the estimated 2008-09 calendar year earnings, it has been posting 20-30 per cent growth in sales and 20 per cent growth in EBIT), and Dabur (with an aggressive product pipeline, it operates in categories with relatively moderate competition).

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