Consumer demand, GST to help FMCG firms; valuations to remain high: Experts

A strong performance is rewarded, whether it’s a field of sport, movie or the equity market. And it is exactly what most fast-moving consumer goods (FMCG) firms are set to benefit from.

After some choppiness in the past few quarters due to note ban and the goods and services tax (GST) roll-out, many companies have posted a good volume growth in the June 2018 quarter. And the road ahead is expected to be even steadier. It won’t be surprising if investors’ love for this pack persists, keeping stock valuations or price-to-earnings ratio (P/E) elevated.

P/E is the companies’ share price divided by earnings per share, and indicates how many times the profit an investor is paying for the stock.

Many big players such as Britannia, Asian Paints, Hindustan Unilever, Godrej Consumer Products and Nestlé are trading at 41-56 times their FY20 estimated earnings. Only ITC’s valuation (among top players) is relatively on the lower side as regulatory challenges faced by its flagship business — cigarette — keep investors away from the stock though it has gained about seven per cent after reporting better-than-expected volume growth in the June 2018 quarter.

“Good growth is coming back to the FMCG sector. It is considered as a safe bet despite high valuation by investors. So, FMCG valuation would continue to remain high,” says Sunil Jain, head of research at Nirmal Bang Securities.

Firstly, the overall consumer demand is improving, more importantly from the hinterland. It was also palpable in the June 2018 quarter results, when many FMCG companies reported a double-digit volume growth, though also pushed up by a favourable base in the year-ago quarter. Rural growth was also observed outpacing that of urban and it might continue. The Marico management said a recent hike in minimum support price for kharif crops, farm loan waivers and the likelihood of normal monsoons have strengthened the case for a sustained momentum in the rural growth. It is likely to provide an upward thrust to the top line.

Also, upcoming elections would add to the rural demand. “For the sector, rural growth is likely to continue to outperform urban growth on the back of multiple tailwinds, further fuelled by likely pre-election stimulus,” says Nitin Gupta, an analyst at SBICAP Securities.

FMCG companies would get additional impetus from the recent cut in GST rates for some segments such as paint (GST reduced by 10 per cent), taking away the share of unorganised players.

There is a caveat, however, of high inflation. While some companies have seen margins improve, prices of key raw materials such as crude oil, titanium dioxide and copra are elevated (on a year-over-year basis) weighing on profitability of others, according to the June 2018 quarter.

However, industry experts believe some input prices would soften and companies have pricing power (besides cost-cutting efforts) to safeguard their margin. “FMCG companies are expected to undertake price hikes in the near term amid high input costs to protect their margins,” Gupta added.

But, whether a stiff competition restricts their pricing power or FMCG companies compromise on profitability in a bid to retain their market share would be interesting to watch.

In this backdrop, experts still believe any correction would be a bottom-fishing opportunity for long-term investors.