The fast moving consumer goods (FMCG) sector, which has so far been a bulwark against the forces ravaging the stock market, is finally showing signs of cracking.
The Bombay Stock Exchange’s FMCG index, which ended May at a level just 5.5% off the highs reached this January, is now 19% off that high. Stocks like ITC Ltd and Hindustan Unilever Ltd are now down 23% and 19% from their 52-week highs respectively. United Spirits Ltd is down 43%.
This is the background in which Citigroup Inc has brought out a research report that says revenue growth in the FMCG sector has peaked and the outlook is going to get more difficult, as high inflation cuts down disposable income.
The report says that in this environment it is a company’s ability to manage costs and ability to boost margins that will drive incremental growth. In future, says the note, the outperformance of FMCG stocks is likely to moderate. Consumer non-durables showed a year-on-year growth rate of 9.8% last April. Income tax relief, farm debt waiver and the sixth pay commission hike had all been expected to line the pockets of consumers and these factors, apart from the allure of FMCG as a defensive play, buoyed the segment.
During the downturns of the late 1990s and early 2000s, consumer non-durable demand was affected quite severely, but that was because agriculture did very badly in some years. With agriculture supposed to do well this year, demand for consumer staples is unlikely to flag. However, FMCG stocks are a different matter altogether. At the end of March 2003, FMCG stocks were lower by 49% from the highs reached in February 2000.
Even if we assume that this time things will not be so bad for the sector, there seems to be a long way for the index to fall.
As the Citigroup researchers point out, the average dividend yield for the consumer sector is still low compared to what government bonds are currently yielding (8.5%-9%). Citi believes there is further (but limited) downside for the consumer sector (if one looks for parity between risk-less assets and dividend yields).
Unitech reports a drop in margins
It doesn’t always make sense to judge real estate companies on their quarterly results. Much depends on the number of projects launched in a certain quarter, the mix of projects sold and whether the company was able to offload projects to other investors.
Unitech Ltd, the country’s second-largest developer by market value, for instance, saw revenue dropping by 27% last quarter over the year-ago March quarter, but that’s no reason for great alarm. Analysts point out that last year’s results represented a high base, with unusually high sales during that period.
Still, the fact that operating margin also fell sharply is a cause for concern. Based on Unitech’s consolidated results, operating margin dropped to 41.5% in the March quarter, down from 64.3% in the December quarter. In the preceding three quarters, operating margin averaged 56.7%.
What adds to the concern is that a similar trend has been witnessed in the results of Parsvnath Developers Ltd and Omaxe Ltd, where margins fell compared to the December quarter.
Most analysts tracking the sector are saying that rising interest rates and the downturn in the economy will lead to lower sales and have hence lowered their valuation estimates of real estate stocks.
The Bombay Stock Exchange’s Realty index has fallen 65% from its 52-week high, and Unitech shares have fared no better, dropping by 66.6% from its highs in January. They now trade at nearly a 50% discount to Citigroup Inc’s net asset value estimate for the company of Rs358 per share (based on a report released on 29 April).
But there still aren’t any takers for Unitech’s or any other real estate company’s shares. In the case of Unitech, the outlook’s cloudier, with over 75% of its projects being in the residential space. This segment was propped up till early this year by the ‘investor’ community, who have since gone missing because of the expected downturn in property rates.
Property developers such as Unitech say that end-user demand has picked up, but according to most analysts that won’t be enough to make up for the drop in investor demand.
Already, property rates have dropped in different parts of the country – this is expected to turn into a nation-wide phenomenon. With interest rates inching up in the recent past, the outlook for end user demand has become bleaker.
Another factor that’s affecting Unitech is the high debt on its books. It’s imperative now that the company raises equity funds, which has become increasingly difficult given the state the markets are in.
One may argue that all this is factored in the company’s current share price. But considering that newsflow continues to be largely negative, it’s unlikely that sentiment for the stock will change anytime soon.
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