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Graphic: Naveen Kumar Saini/Mint (Naveen Kumar Saini/Mint)
Graphic: Naveen Kumar Saini/Mint
(Naveen Kumar Saini/Mint)

Mark to Market | FMCG valuations: heads I win, tails you lose

A pertinent question is if consumer companies run the risk of not being able to sustain growth

The government’s recent reforms have helped improve the sentiment for Indian stocks. Understandably, shares of packaged consumer goods companies, traditionally seen as defensive bets, haven’t reacted as positively.

When investors anticipate a boost in economic growth, then cyclical sectors are preferred by them. The FMCG index of BSE has fallen 3.8% in the past week, though it is still up 33% year-on-year. In comparison, the benchmark Sensex gained by 1.6% over a week ago, and is up by 7.1% from a year ago.

The main concern for investors is valuations, as the FMCG index trades at a price-earnings multiple of 35 times, compared with 17 times for the broad market.

While valuations may be high, a pertinent question is if consumer companies run the risk of not being able to sustain growth. This year, the rains have not been favourable for farmers, but the good news is that it was not as bad as expected.

A pickup in monsoon rainfall in the latter half of the season has done some good. Crop sowing data shows that area under cultivation as of 7 September is down by 5.2% over last year’s figure. A month ago, the deficit was 8.8%.

If this ensures rural markets do not see a severe demand slowdown, or that food inflation does not skyrocket, it will be a key positive factor favouring consumer companies.

In recent quarters, earnings of consumer companies have seen the impact of rising prices, coupled with a slight moderation in volume growth. Some companies have taken price increases to recover the increase in costs, but that has had some impact on demand, especially in the packaged foods segment. Inflation in non-food inputs has moderated, which offers some comfort, especially to manufacturers of home and personal care products.

A big risk for the sector is the health of the economy. A slowing trajectory is not good, as it can affect disposable income and, eventually, consumer demand. Large companies are better placed, as they have products at various price points, and have also been eating away at the share of regional and smaller firms. But that cannot continue forever.

The risks to demand growth is a definite concern. But what may comfort investors in these stocks is the fact that if slower economic growth continues, more investors will jump into the arms of defensive stocks. There may be some logic to their sky-high valuations, after all.

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