The chart above shows how the stalwarts of the fast-moving consumer goods (FMCG) sector pulled the index in different directions since the goods and services tax (GST) was rolled out. Early on, ITC Ltd pulled ahead as its cigarettes business was expected to gain handsomely under GST. But the hike in cess upset calculations. Hindustan Unilever Ltd (HUL) continued its gradual uptrend but it seems dramatic in contrast to ITC’s fall, whose decline also pulled down the index. It has a free float market capitalization of Rs1.99 trillion against HUL’s Rs91,420 crore.

ITC has raised cigarette prices to recover the higher cess, and analysts expect volumes to get affected. Eventually, it will get back on its feet, especially if tax rates don’t change from here on. Also, its consumer business too should benefit from GST, in the same way that other large companies are expected to gain.

That brings us to the sector itself. A recent investor presentation by HUL updated on the trade situation. GST had led to destocking in June. The presentation stated that the trade situation is improving. It also said that the wholesale channel is stabilizing, which is a good sign as this had suffered the most after demonetization and GST. It plays a critical role in servicing rural markets.

A recovering trade situation signals a pickup in primary sales growth in the September quarter. Part of this will be refilling the thinned pipeline. Consumer offtake, also called secondary sales, will actually determine how quickly stocks are replenished later, indicating the strength of underlying demand.

A recent Economic Times report had said that rural growth was recovering on the back of a better monsoon. If the September quarter indeed sees a rural pickup, that will be a pleasant surprise as it has been lagging urban growth.

The worry, if any, should lie on the macro front. The economy is growing slower than expected, partly due to the shocks from demonetization and disruption caused by the GST roll-out. If the economy does not bounce back soon enough, it poses a risk to demand. That is the key medium-term risk for the sector.

So far, the outlook for listed FMCG companies seems good. An early assessment made by Kotak Securities Ltd suggests companies will pass on the lower tax outgo on products due to GST to customers but are likely to retain part of the benefits earned from tax savings for the business as a whole. For instance, if a corporate overhead earns an input tax credit, the company could retain some of it.

In fact, the Kotak note dated 13 September takes it a step further to suggest that this ability to retain savings from GST indicates that competitive intensity is low, and if this continues, then the rich valuations that the sector trades at can continue for longer. The S&P BSE Fast Moving Consumer Goods Index is trading at a price to earnings valuation of 41 times its trailing four-quarter earnings per share, compared to 24.2 times for the benchmark Sensex, according to data from BSE.