Mumbai: Rural stocks, barring fast-moving consumer goods (FMCG), have underperformed so far this year, despite widespread optimism about growing demand from the rural sector.

According to Bloomberg data, BSE FMCG index gained 5.91%, while BSE Auto, BSE Consumer Durables and BSE Consumer Discretionary Goods slipped 6-8.78% between January and May. In contrast, the BSE Sensex gained nearly 5% during the period.

According to Pankaj Pandey, research head, ICICI Securities, several of these stocks had already surged on expectations of better rural recovery, after the disruptions caused by demonetisation. “For these stocks, one will see sustained performance and then some price corrections, followed by a rally again," he said. “There is profit taking in these stocks, which is why they have slipped. It is not because there is any U-turn in the outlook. FMCG is one segment where there has been no price correction so far."

BSE FMCG index gained 31.54%, while BSE Auto (up 32.06%), BSE Consumer Durables (up 101.92%) and BSE Consumer Discretionary Goods (up 54.37%) had a stellar run in 2017.

Analysts said the factors contributing to the revival in overall rural demand include expectations of normal monsoons, the fading effect of demonetisation, the government’s renewed focus on the rural economy in FY19 budget allocation and the overall cyclical recovery in rural demand.

In a note on 24 May, Motilal Oswal Securities Ltd said that while urban volume growth has remained fairly resilient at mid-, single-digit levels, rural growth, at 1.5-2 times urban growth in the years leading to FY14, had declined to flat and even negative levels in the years that followed. “This continued to be the case until Q1FY18, which was also affected by channel disturbances ahead of goods and services tax (GST) implementation from July. For the third consecutive quarter (Q4 FY18), all consumer companies that have rural reach of over 30% have stated that rural growth has outpaced urban growth."

Rural demand had slowed down in FY15 and FY16 because of drought. In FY17, the centre’s demonetisation move had negated the potential positive benefits of a normal monsoon.

However, rural wage growth, which had started improving in 2017 (after four years of deceleration), has reversed course in the past six months, and is now at a decadal low of 3%, which is surprising and concerning, said Edelweiss Securities Ltd.

The brokerage firm thinks one possibility is that a renewed weakness in rural wages is due to temporary factors that are hard to identify and will reverse in the coming months. Post-GST, the sustained weakness in labour-intensive segments (textiles, leather, gems and jewellery) could have slowed the pace of labour migration from rural areas and that maybe weighing on rural wage growth.

“For now, we maintain that the rural economy is on a slow mend and weakness in labour-intensive segments will not last long. However, if the sluggishness persists, it could jeopardize the nascent rural recovery."

Analysts are, however, worried given that valuation-wise, the rural-themed stocks are expensive. Nomura said in a note on 7 March that while both staples and discretionary stocks have done well in the past year, staples, as a whole, are currently more expensive. “This is despite the fact that discretionary growth is already picking up, and fundamentals justify a continuation or even acceleration of the trend, based on under-penetration, rising shift to the organised sector and premiumization."

Nomura, however, believes that the consumer sector is well-placed given its earnings stability, compared to the overall market. “We do not see scope for a re-rating either in the short-to-medium term, given the growth challenges we foresee for several companies within the sector as they adjust to the new norm."