Home >market >mark-to-market >FMCG: an expensive bellwether

If you are looking for cheap valuations, the fast-moving consumer goods (FMCG) sector can be excluded. Even when times are bad, investors use this sector as a defensive option. In good times, companies have delivered good growth rates, making them a staple addition to a broad-based portfolio.

The long-term opportunity remains one of serving India’s growing consumer population. These companies also have low debt levels, relatively clean balance sheets, high asset utilisation ratios, good cash flows and a proven track record.

The consumer goods sector trades at a price-to-earnings (P-E) ratio of 27.5 times its 1-year forward earnings. This is lower than that at the start of the calender year 2016. Look back a decade, and it traded at this level only once in 2013 and had neared these levels in 2006. Valuations are expensive as investors are valuing the relative strength of this sector when the rest of the economy is finding the going tough.

Although a relative outperformer, the consumer sector has its share of troubles. Take ITC Ltd for instance. A series of excise duty hikes have hobbled growth in the past few years, but the last Budget saw a relatively small increase. That made investors think it may do better. But the issue of bigger health warnings on cigarette packs has become a concern. ITC’s ability to navigate these regulatory issues has become critical for its cigarettes business.

The FMCG business, too, has been affected by the economic slowdown of the past few years. Consumption demand growth is slower in both urban and rural areas. Lower commodity prices have helped lower input costs but have also meant slower growth in realisations, or even price cuts.

Both sales and profit growth have been affected, as a result. Investors are looking forward to a better monsoon and a boost to consumption from a forthcoming pay hike for government employees. Improved demand and a little support from higher inflation can turn around the sector’s sales and earnings growth. This is likely when economic growth recovers. But this phase may see other sectors gaining more on the market.

Most FMCG shares are already trading at either near to or higher than their historical valuations. Hindustan Unilever Ltd, for instance, is trading at a 1-year forward P-E ratio of 39 times, the same as a year ago and compared to 29.4 times two years ago. Bloomberg’s data shows that a larger number of brokers have a sell or a hold rating, compared to a buy rating on HUL and Nestle India Ltd. Buy recommendations exceed hold or sell by a wide margin for Britannia Industries Ltd and ITC and by a lesser margin for Godrej Consumer Products Ltd. Dabur India Ltd and Marico Ltd are evenly placed.

The sector is a good one to have in an investor’s portfolio, with the caveat that it has the potential to provide steady returns in the longer run but is unlikely to set your returns on fire in the near to medium term.

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