The fast moving consumer goods (FMCG) sector is never in the limelight when the bulls are in command of the market. In the last one year (May 25, 2009 to May 25, 2010), the BSE FMCG index gave returns of 30.07 per cent compared to 75 per cent from BSE Information technology, the best-performing index over the same period. But considering the sector's resilient nature, perhaps it is time to look at it again, especially against the backdrop of the European crisis.
Krishnan Thampi K of Hedge Equities expects the FMCG sector to do well over the next 12 months, chiefly on account of demand from the growing middle class and from rural India. He adds: “One also has to consider the growth of the infrastructure sector, the construction sector, and the realty sector that have led to better and sustained job opportunities for labourers, resulting in higher wages. Now they are able to direct a greater proportion of their wages towards FMCG products.”
According to Ashwin Shetty, analyst with Execution Noble, “Due to NREGS (National Rural Employment Guarantee Scheme), rural spending continues to be robust. And the good news is that the meteorological department has given a positive outlook for the monsoon.” He further adds: “Food inflation is easing as is evident from the drop in prices of key food products such as onion, sugar, etc. Though the overall wholesale price index (WPI) of food articles is still high at 16.49 per cent, this is driven by milk and eggs, as against the across-the-board inflation of January 2010.” In his view, these three factors together bode well for volume growth in the FMCG sector.
However, a few negative factors are also at play. Says NV Sivakumar, Leader Retail Practice, Pricewaterhouse-Coopers: “Some challenges in the sector include commodity price fluctuations, food inflation and increase in packaging costs.” Both Thampi and Shetty expect increasing competition to put pressure on FMCG companies' margins.
Impact of monsoon
In India, a good monsoon provides relief not only from high temperatures but bodes well for the FMCG sector as well. When the monsoon fails, as it did last year, agri-commodity prices rise. This is a triple-edged sword for the FMCG sector: not only do the costs of their raw materials increase, urban consumers hit by high food inflation have less money to spend on FMCG goods, and rural demand shrivels. Says Thampi: “A good monsoon will result in a strong harvest, which will help bring down food inflation. It will also enable farmers and rural India to spend more on FMCG products.”
Defensive role of FMCG
FMCG stocks were among the best performers in the aftermath of the 2008 crisis, when the market at large nosedived.
According to Sivakumar, “We believe that FMCG players are bullish this season, judging from the increased expenditure on advertising, marketing and promotions across categories that include home care, personal care, skincare, hair care, etc. Despite the world economic situation, consumers need essential FMCG products, such as detergents, deodorants and toothpaste.” Adds Thampi: “When uncertainties loom large in the markets, investors tend to shift to defensive sectors such as FMCG and Pharma. So long as the European crisis lingers, the FMCG sector will remain a good bet.”
Selecting the right stock
According to Shetty, the important factors investors should keep in mind while choosing FMCG stocks are a diverse product basket, strong distribution reach, brand strength and rural exposure (the higher the better).
Adds Thampi: “Look at each stock closely. Valuations are quite stretched and intense competition continues to erode margins. Factors to include in your analysis are the company's product range, reach and margins.”
According to Sivakumar, “Check out whether the company has scope for expanding into new markets internationally, new product launches, rural penetration, and existence of a war chest for acquisitions.”
Thampi recommends Marico. His reasons are as follows:
One, though valuations within this sector are stretched, Marico is better placed. Its current trailing at a 12-month PE of 26.77, lower than its average historical PE (between 2007 and 2010) of 30.67. Two, what's impressive about the company, says Thampi, is that it regularly launches new variants in order to cope with competition. And three, he says, Marico is less dependent on the monsoon than its peers such as HUL, Dabur and Colgate.
Thampi expects Marico's earnings to grow 20-23 per cent annually over the next couple of years, and earnings from its international business to grow at 25-30 per cent annually. At the current market price of Rs 106 the stock is trading at a forward PE multiple of 20 times its FY12E earnings.