FMCG stocks trip on high valuations; analysts see further correction

Usually, when markets fall, fast moving consumer goods (FMCG) stocks are seen as safe havens. However, this time around, FMCG stocks were among top losers as markets fell, mainly due to their pricey valuations. Being amongst the few attractive sectors, FMCG stocks had remained in the sweet spot. In just eight months ending August, the index had rallied over 19 per cent. Stocks such as Hindustan Unilever, Nestle, Britannia, among others, were trading above 50 times their respective FY20 estimated earnings before the recent correction, which now is down to 45-46 times, though still on the higher side. 

A key worry for consumer companies is rising input costs which is impacting profitability and overall earnings outlook. Prices of many key raw materials such as crude oil derivatives, palm oil, mentha are trending northward. This is further aggravated by a weak rupee. However, companies have been able to cut their other operating expenses besides selectively raising prices, to protect their margin profile, so far. Hindustan Unilever (HUL), for instance, witnessed a sharp 162 basis point year-on-year expansion in operating profit margin in September 2018 quarter, despite 61 basis point dip in gross margin. Rising competition, however could restrict pricing power for companies, say analysts. 

Having said that, improving demand could spur volumes. Importantly, companies having more exposure to rural markets and strong rural distribution franchise such as Asian Paints, Hindustan Unilever would stand out. The recent hike in minimum support price for kharif crops, near normal monsoon and upcoming elections should provide upward thrust to rural consumer demand going ahead. Many companies had reported faster volume growth from rural markets  in June quarter. Even in September 2018 quarter, HUL indicated its rural business is growing 1.2-1.3 times its urban business. Supportive development at macro level such as sharp cut in goods and services tax (GST) for some segments like paints and footwear provide comfort on volumes front.

The ability to protect profit margin along with strong distribution are important for FMCG companies at this juncture. Given the improving demand scenario any further correction in major players such as HUL, Asian Paints is a good buying opportunity.