Shares of companies making personal and home care products have behaved as classic defensives in the past year and a half.
While the BSE 100 index on the Bombay Stock Exchange has fallen by 36% since 1 January 2008, the BSE FMCG index has risen by 1%. In the past one month, too, while the broad market has corrected by about 11%, these shares have risen by 6%. It’s interesting that investors chase these stocks when markets correct, especially keeping in mind that their valuations aren’t cheap. BSE’s FMCG index trades at a past price to earnings multiple of 27 times, compared with 20 times for the BSE 100 index.
Subsidiaries of multinational companies such as Unilever and Nestle have traditionally enjoyed a premium over market valuations owing to their relatively stable earnings growth, high capital efficiency and liberal dividend payouts. In recent years, even valuations of domestic consumer goods firms have risen sharply primarily because of consistent earnings growth.
But these stocks may well be at the threshold of a difficult period, if the India Meteorological Department’s (IMD) prediction of a below-normal monsoon comes true. This year’s south-west monsoon is expected to be 93% of the average. Uttar Pradesh, Punjab, Rajasthan, Haryana, Chandigarh, Delhi, Uttarakhand, Jammu and Kashmir and Himachal Pradesh are likely to receive just 81% of the average, IMD has predicted.
Since 1 January 2008, the BSE FMCG index has risen by 1%. Graphics by Sandeep Bhatnagar / Mint
According to Citigroup Research, consumer goods stocks tend to underperform the market over a 12-month period after a weak or deficient monsoon. Also, the last three times monsoons have been deficient, private consumption has dipped sharply. Between fiscal 2001-02 and 2004-05, when the monsoon was deficient for two years, revenues of these companies grew at a compounded annual growth rate of 3% and their earnings growth was flat.
Of course, the contribution of agriculture to the overall economy has reduced considerably since then and the impact of a below-normal monsoon will be lower this time around. Besides, the recent Budget’s rural thrust, which includes the extension of the farm loan waiver till December this year and a liberal rural employment scheme, should help companies weather the storm to some extent in rural markets.
Still, unless the monsoon in July and August makes up for the shortfall, rural consumption will be hit. For companies such as Hindustan Unilever Ltd, rural India contributes to around 50% of revenues. Note that urban consumers had also cut back owing to the economic slowdown and spending hasn’t recovered fully.
With valuations of the major companies at around 30 times earnings, there is room for a sharp correction if the monsoon actually ends up being deficient.
Write to us at firstname.lastname@example.org