Home >market >mark-to-market >Monetary tightening gives consumer sector valuations new wings

Wholesale price inflation data released on Monday showed that food inflation remains high, as prices of primary food articles rose by 9.8% in June. That is not good news for consumer companies as rising food prices eat into spending budgets, potentially affecting demand for less essential goods. Food inflation had declined in early 2013 but has again begun an upward move since April.

The demand-side picture in the June quarter is a bit mixed so far. April saw a spurt in demand but May saw a reversal, and collectively the consumer non-durable sector’s output has risen by 6.7% in April-May over the year-ago period. Data for June will reveal if the deceleration seen in May was an aberration.

But quarterly earnings to be declared by consumer companies in the forthcoming weeks will give a better clue on how they have fared. All eyes will be on volume growth to see if companies have succeeded in combating slow demand growth through a mixture of promotions and advertising. Though this strategy can potentially hit margins, companies have been using the savings in input costs to fund it. What needs to be seen is if that was sufficient to enable margins to grow, despite higher expenditure.

Analyst estimates for the quarter peg sales growth at 13-15% during the June quarter compared with the year-ago period, and an improvement of 30 to 60 basis points in Ebitda (earnings before interest, tax, depreciation and amortization) margins. Net profit for the sector is expected to grow in the 12-15% range. That is not a spectacular performance, but is better than many other sectors. One basis point is one-hundredth of a percentage point.

With expectations not running sky-high, what should investors watch for in the forthcoming results? Certain one-off events could distort numbers, such as the strike in Maharashtra by traders who were protesting against the local body tax imposed by municipalities. Another is the possibility of demand from the military’s canteen stores department, which had slumped last year, coming back on track and giving a push to sales growth. The international businesses of companies such as Dabur India Ltd and Godrej Consumer Products Ltd, too, could hold some surprises due to foreign exchange volatility.

But these are factors that need to be adjusted for while analysing results. The factors that merit attention are volume growth and the direction it is headed in, and the outlook on the sector’s profitability. If these show some strength and resilience, then investors will continue to favour the consumer sector, until the broad economy shows signs of recovering.

The Reserve Bank of India’s (RBI’s) move to indirectly hike interest rates could well delay economic recovery, which makes this sector’s defensive nature even more attractive to investors. That’s why the S&P BSE FMCG index was the top performer on Tuesday, up 1.8%, while the broader market was down 0.9% as RBI’s latest move led to a decline in equities.

If expectations for financial results in the June quarter appear moderate, the same can’t be said for investor expectations. The BSE FMCG index quotes at a price-to-earnings multiple of 42.7 times based on trailing four-quarter earnings per share. That is expensive, but reflects its relative strength at a time when prospects for other sectors are not encouraging.

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